Posts Tagged ‘Finance’
Macro Level Resolution Strategies per the Ongoing Financial Systems Crisis of 2008
Just a few thoughts and possible resolution strategies (in outline format) to consider per the current financial system crisis from a concerned long-term investor, citizen, and voter. And from an Independent’s perspective, the political players from both parties don’t seem to be focusing on real solutions, just the problems and the resulting finger-pointing (or “blame game”) that occurs. Note: In terms of presenting a macro causal analysis for this financial crises, private sector lenders issued risky home loans to buyers who could not afford them, which they then sold to Wall Street financial institutions as bundled, mortgage-backed securities that eventually became worthless with the downturn in the housing market. As a result, the heavily leveraged financial institutions became overly susceptible to the collapsing asset class, leading to a liquidity crisis, a disturbance of bank lending, and an overall global contagion.
I. Short-Term Macro Level Strategies to Mitigate Current Crisis (note that some of these strategies are now being implemented in some fashion) –
1). Continued Implementation of timely “lender-of-last-resort” measures by central banks are needed in order to mitigate the current credit crisis before it spirals completely out of control.
1a). Immediate, large-scale damage-control measures are needed in order to restore the public’s confidence in financial markets and institutions.
1b). Organized bailout programs by central banks across the globe are needed in order to reduce the overall amount of help and costs involved (i.e., the quicker the better in terms of lowering costs).
2). Aggressive actions required on the part of central banks and governmental agencies in order to mitigate the seizing global credit crisis include the following:
2a). Continued cutting of short-term interest rates and increasing the amounts of loans made available to banks via auctions in order to maintain fluid liquidity levels.
2b). Force remaining lenders to extend low “teaser” rates on ARM based loans that have been given to sub-prime borrowers.
2c). Force remaining lenders to restore partial homeowner equity to sub-prime mortgage holders having negative equity in order to forestall the foreclosure rates.
2d). Continued swapping of Fed funds (e.g., Treasure bills, etc.) for “Level 3” securities from struggling financial institutions in order to provide them with necessary liquidity.
2e). Permanent providing of emergency loans to the remaining investment banks, with the resulting increase in regulation that should go with it (i.e., like that required for commercial banks).
2f). The establishment (ASAP) of an organization similar to the former Resolution Trust Corporation of the S&L days to use taxpayer funds to buy out the worst sub-prime loans. Note: When the current credit crisis finally does ease up, central banks will then need to expedite reverse monetary actions designed to prevent the reintroduction of market speculation using “cheap” money.
II. Long-Term Macro Level Strategies & Proactive Regulatory Measures –
1). Implementation of stricter governmental regulations for securitized mortgage loans.
1a). SEC directed revamping of underwriting standards to reduce the chances that credit risks will be underestimated, which in turn will reduce the overvaluing of securitized sub-prime loans.
1b). SEC led mitigation of regulatory capital arbitrage attempts in the securitization process by enforcing the maintenance of minimum capital requirements by financial entities.
1c). SEC led mitigation of “safety net” and risk transfer abuses in the securitization process.
2). Require that mortgage loan originators hold bigger equity positions in the securitized packages and that banks issue “covered” bonds backed by securitized mortgage loans in order to keep the risks on their balance sheets.
2a). Increase involvement of criminal investigation agencies in the securities arena to mitigate the misrepresentation of the quality of mortgage loans in securities filings by financial entities.
2b). Implementation of more stringent licensing requirements for mortgage brokers and tougher mortgage lending standards, including enhanced risk management practices by lenders.
2c). Implementation of more stringent disclosure and write-down requirements for financial institutions, as well as an increase in the monitoring of their “capital adequacy”.
2d). Consolidation of the different governmental finance agencies into a financial oversight “super” agency designed to rate sub-prime mortgages and financial securities per their safety levels.
2e). Establishment of well defined roles for the International Monetary Fund (IMF) in terms of its serving as a bailout agent for emerging market countries experiencing financial difficulties.
2f). Need to mitigate any moral hazard issues that could arise due to IMF intervention (e.g., an increase in risk-taking activities by the governments of the countries being assisted, etc).
2g). Complete banning of Alternative-A type mortgage loans, which require little or no documentation on a borrower’s wealth or income, resulting in abuses on the part of mortgage brokers.
3). Establishment of new generally accepted auditing standards (new FAS rulings) designed to force financial entities to start valuating their investment instruments (e.g., CDOs) using market based measures rather than their own pricing models, along with the reform of the credit rating agencies.
3a). Mortgage based securities should be strictly booked as “marked to market” from an accounting standpoint instead of “book” value in order to help mitigate the blatant overvaluation of the underlying collateral assets.
3b). Mortgage securities packages should be categorized and split into different “tranches” based on their differing levels of certified risk for both investing and auditing purposes.
3c). Tighter regulation of credit rating agencies (e.g., Moody’s, S&P, et al.) by the SEC and Congress.
3d). Credit rating agency reform acts are needed to mitigate the overrating of tenuous capital structures being passed as investment grade securities &d to enhance agency quality control measures.
3e). Recourse measures should include the suspending of credit rating agencies that continuously propagate inaccurate (“pumped up”) ratings due to the conflicts of interest involved with the issuers.
3f). The compensation method for credit rating agencies needs to be changed from that of being paid by the issuers of structured debt products to that of being paid by investors to eliminate conflicts of interest.
3g). Credit rating agencies should be required to decline credit rating services for exotic types of securities that have no performance records to track.
3h). Credit rating agencies should also be precluded from having exclusive access to non-public investment information.
Agency Note: SEC chief Mary Schapiro has now called for sweeping industry changes at a roundtable meeting as credit ratings agencies have been thoroughly blasted for not warning about the risks of subprime mortgage securities. Moody’s, Standard & Poor’s, and Fitch dominate the industry: one proposal calls for a governmental ratings agency that would compete with these three firms.
3i). Central banks should have quickly executable, pre-approved contingency plans “in place” for when unexpectedly large write-downs by financial institutions occur in the future. The immediate availability of liquidity measures and the continued identification of potential merger partners for failing financial institutions is key here.
3j). Tighter regulation of the corporate auditing function by the SEC & Congress. If necessary, the corporate auditing function may even need to be “nationalized” to become entirely a governmental function in order to eradicate the inherent conflicts of interest that currently exist between corporations & the private auditing/consulting firms that they employ on a high-fee basis (i.e., need to reduce the risk of over-inflated equity valuations based on creative accounting measures, etc).
Note: These macro strategies were initially conceived of as part of my section of responsibility for a group project/presentation in a graduate level finance course at the University of Houston (i.e., FINA 7340 – Financial Markets & Institutions).
Click on URL to link to a recently published NYU Stern working group paper that provides excellent insights on viable, real-time solutions for financial reform: http://govtpolicyrecs.stern.nyu.edu/docs/whitepapers_ebook_full.pdf
The Great Sirius XM (SIRI) Stock Debate!
More and more, Sirius XM stock (ticker symbol ‘SIRI’) appears to represent a good, low cost bet on making some attractive gains in the not too distant future. Nothing is ever guaranteed in life (other than the two main stays), but now seems to be very opportune time to get on the train at the beginning of what could be a very profitable ride based on the increasingly cost-effective commercial uses of satellite-based technologies (led by SIRI, for one). In a nutshell, the currently low price of SIRI stock coupled with its promising future based on the vertical integration of its product lines makes it a very inviting bet in my book. And the announcement today of the availability of Sirius XM’s new app for Android-powered smartphones (coupled with existing apps for BlackBerry and iPhone) is just the latest in a ever expanding portfolio of value adding products being offered. Finally, SIRI is starting to remind me of Apple’s stock in the late 1990′s, when it was priced around $2.00 per share and the introduction of Apple’s industry changing iPod products was just around the corner. Stay tuned!
Click on URL for the latest on SIRI stock: http://www.thestreet.com/quote/SIRI.html
Wall Street Bankers’ Bonus Abuse Issue!
The notion that Wall Street keeps its gravy train rolling by lining the pockets of our top-tier politicians with money and other influence-peddling gifts in order to condone the financiers’ actions is quite disturbing. In fact, the financiers’ claims per the paramount importance of their work as an excuse to enable them to get away with whatever they deem appropriate for themselves (e.g., awarding of excessive tax-payer financed bonuses, etc.) is very disturbing as it smacks of greed and self-centered conceit. But the biggest rub is that these absurd bonuses were largely financed via the billions of dollars in taxpayer-financed funds from the Troubled Asset Relief Program (TARP) and trillions in loans from both the Federal Reserve and the FDIC. These sources of aid money were designed to help the Wall Street financial institutions deemed too big to fail to survive their own terrible misdeeds, not to excessively reward their executives for jobs NOT well-done. This has got to be perhaps the biggest misappropriation of our hard-earned tax money that has ever transpired in the history of this country.
Finally, as long as big money talks and remains the primary influence driver in the current socio-political (or cultural) climates across the globe, then people in power will apparently continue to walk in the direction deemed appropriate by the big money purveyors (e.g., Goldman Sachs, George Soros, et al.). The condoning by governments of their large scale market manulation shenanigans for their personal gain at the expense of the taxpayers of the world speaks for itself. And their latest ploy of shorting the Euro while playing credit default swaps (CDOs) shows that there’s no shame on their part. Finally, even President Obama is softening up his tone towards the big banking entities and their actions. And speaking of being “too big to fail’, perhaps the US socio-economic system and federal government is falling under this same exact definition. This splitting up (i.e., per the splitting up of giant oil corporation Standard Oil over 100 years ago) is becoming a more realistic option over time in terms of gaining more value and growth opportunities from the resulting smaller entities that would result.
Massive Government Control of Free Markets Debate!
Quote of the Day –
“The case for free markets never was that markets are perfect … [but] that government control of markets, especially asset markets, has always been much worse.”
University of Chicago professor John Cochrane, per criticism from Paul Krugman, New York Times columnist and proponent of massive government intervention policies (click on URL below for his full rebuttal).
http://faculty.chicagobooth.edu/john.cochrane/research/Papers/krugman_response.htm
Need for Massive Government Intervention Policies?
At a sporting event, having no officiating at all would result in a very chaotic situation, whereas having too much officiating would result in a game that might as well not be played. Extending this analogy to the regulation of the American economy and securities industry, we will always need a certain amount of “officiating” in order to maintain a level (and efficient) playing field for all players and to keep things from getting chaotic. But a “massive” amount of officiating on a permanent basis (per Paul Krugman’s latest mantra) can result in the total fettering of the financial systems and the capital markets that they propagate, possibly resulting in societal chaos. The governmental approaches of the late1920s through the entire 1930’s should serve as a good case study (in general) of what works and what does not work in terms of particular actions taken and not taken (Ben Bernanke’s expertise), while keeping in mind that the playing field is now a lot bigger, faster, and more complicated (which again reinforces the need for some officiating, but not “massive” officiating). The premise here is that we want to continue to propitiate the competitive creativiity within the American financial industry, but we also need to define and enforce certain reasonable boundaries at the same time in order to keep the markets as efficient and seemless as possible. Overall, my basic premise is that “enough” regulation needs to be in place in order to keep the speculation side of the coin from overwhelming (i.e., destroying) the risk management side of the coin, but not to the point where the markets become grossly inefficient due to a paucity of speculation. So Paul Krugman’s “throwing out the baby with the bath water” mantra is not a good policy mandate in my book.
Quote: “The case for free markets never was that markets are perfect … [but] that government control of markets, especially asset markets, has always been much worse”.
University of Chicago professor John Cochrane, in response to criticisms from Paul Krugman, New York Times columnist and proponent of massive government intervention policies (click on link to peruse “How did Paul Krugman get it so Wrong?”).
http://faculty.chicagobooth.edu/john.cochrane/research/Papers/krugman_response.doc
Deregulated Market Marginalizes Gazprom’s Gas Supplier Monopoly Attempt in Europe
Per Washington Post columnist George Will’s recent editorial on the punishment of highly excessive corporate behavior by deregulated markets (i.e., his expounding upon economist David Harrington’s argument per the same), Gazprom’s natural gas supply/transportation strategy (business model) for Europe serves as an excellent example of this fairly non-intuitive concept. Harrington argues that sellers of goods who initially price their products on the extreme high end are often forced to relinquish these same goods at deep discounts later on due to the efficiencies of deregulated markets. As a result, global regulation (or re-regulation) on the part of governments becomes unnecessary over the long run. This is because the efficiencies of the deregulated markets that set in over time cause these markets to become more transparent in nature, thus resulting in better informed buyers, as well as more options being made available to these buyers. In addition, there is the time decay of the value of the goods that occurs as time passes on as well, which is somewhat similar to what happens to the value of call options as they approach their expiration dates (i.e., the “theta” concept). As a result, price gougers such as Gazprom become the victims of their own marketing (or pricing) ploys in the end as they are unable to overcome the inevitable deregulated market adjustments that occur over time.
Gazprom’s recent attempt to secure a monopoly over the supplying of natural gas to European countries has been marginalized by deregulated market forces, which have adjusted to Gazprom’s excessively high prices by reducing the demand for the product, thus resulting in lower natural gas prices (on a global level). This coupled with the current economic downturn across the world has contributed to the demise in the global demand for natural gas since less of it is being consumed now. And while attempting to establish a European based gas supplier monopoly, Gazprom became committed to long-term contracts for gas from Central Asian suppliers at a cost which is now far in excess of the current (or resulting) global natural gas prices. As a result, Gazprom is now sitting on huge contractual amounts of over-valued natural gas supplies that it must continue to purchase from Central Asian suppliers and then sell at large losses. This could conceivably result in years of major losses for Gazprom if the world’s natural gas prices continue to moderate, thus resulting in the decimation of both its current business model and its influence (i.e., Russia’s influence) as a major player in the global economy. And based on Vice President Biden’s recent “blistering criticisms” of Russia per its failing economy, loss of face, and a lack of effective leadership, the Kremlin’s declining influence within the global economy (and power) structure is becoming apparent among the world’s leaders. But all of this is still not stopping the Kremlin from attempting to forge a gas supplier monopoly in Europe in order to use it as a foreign policy “tool” with its neighbors during times of political conflicts, etc.
Note: The invoking of some type of eleventh-hour “force majeure” clause could be a last resort action taken by Gazprom in an effort to extract itself from having to contractually purchase high priced gas from Central Asian suppliers and then sell at large losses to European buyers.
Financing Models: Original Viablility Needs to be Recaptured
One of the biggest problems with today’s financing models for capitalizing small and large businesses (as well as consumers) alike is that the expectation to pay back debt seems to escape a large percentage of the eager borrowers (and some lenders). Furthermore, even the Federal government and banks seem to be treating the dollar like it’s “Monopoly Money” these days, with all of the excessive bailouts using “Fiat” money as the source. And with the securitization of subprime loans and other instruments that have been used by lenders lately to handle shaky loans, there seems to be less concern about debt repayment by the lenders and more concern about passing it on in securitized forms to unsuspecting others to glean additional profits. But at a macro level, the financing models can become viable again as long as entrepreneurs, consumers, and other borrowers keep in mind that they (as borrowers) are still expected to pay loans back and that the final lenders still expect the original borrowers to repay the loans back at some point in time; and, most pointedly, declaring bankruptcy should NOT be viewed as a viable (or desirable) instrument for handling risk by anyone.
Note: This writeup was originally written as my comments per fellow LinkedIn member Ren Carlton’s recent blog article “Financing- Is it Really Worth It?” (see http://www.businessrealityblog.blogspot.com/ ).
Reinstating Short-Selling Uptick Rule by SEC Head a Good Start
Overall, many regulatory measures still need to be revised by the SEC to catch up with the recent innovations in financing/investing methodologies in order to restore the public’s confidence in financial markets. And in light of the market turmoil that the nation has been experiencing over the past two years, it had become very obvious that the SEC needed to reinstate the short-selling Uptick Rule due to the large multitude of stock shorting transactions that get processed on a per second basis. The Uptick Rule, which forces short sellers to sell a stock above its latest traded price, got rescinded during the summer of 2007 for some strange reason, but it obviously needed to be reinstated in order to curtail the resulting phenomenon known as “piling on” by hedge-fund type investors shorting stocks (e.g., the recent Bear Stearns debacle is a good example of “piling on”). The SEC still needs to tightly regulate the practice known as naked (or uncovered) short selling as soon as possible as well. In any case, the mitigating of these major regulatory exposures by the SEC is mandatory due to the resulting havoc that has been wreaked upon our so called “efficient” markets due to the resulting lack of control on the part of certain market players (e.g., predatory hedge funds, etc).
Note: Recently the NYSE, Nasdaq & two smaller U.S. exchanges have proposed a modified uptick rule, joining the crowd calling for more restrictions on short-selling. This proposed rule would only allow shorting at a price above the best bid, going further than the old uptick rule that was rescinded in July, 2007. This proposed rule modification would apply only to stocks that dropped a certain percentage (e.g., 10%). So this may also for the first time set “circuit breakers” on single stocks, which will briefly halt short sales trading on a stock if it falls drastically.
Larry Fry, CCP, MBA
Current Blog Entries by Larry Fry, CCP, MBA 