When I read all of the complaints by people and organizations that have lost everything investing in Bernard Madoff’s Hedge Fund, I think about a recent Country song titled “…What Was I Thinking…” People who invest should know four basic principles:
1. Never place all of you investment in something where you have no idea how it will be used. Madoff never described how his Hedge Fund worked. This should have been a clue that something was fishy in on Wall Street.
2. Never put more than you can afford to lose in any one investment. Usually this means no more that 5% of you total investment. Endowment Funds, Pension Funds, and Financial Institutions should know this. In addition, individuals who are investing their pensions should follow the same philosophy.
3. If something is too good to be true it probably is. Madoff was consistently paying steady returns no matter what happened to the market. Markets are volatile by their nature. As a result, it is almost impossible to have steady returns over time.
4. Higher returns are the result of higher risk. 25 Years ago the President of my firm asked me to invest with a firm that was offering 75 to 125 basis points above market for Repurchase Agreements. I refused, saying that there must be a risk that hadn’t been identified. I only kept my job as Treasurer because the CFO backed me. Several months later local school districts and municipalities lost millions when the seller went under.
These four items may not make you rich however; they can help you from ending up poor. Individuals have to be especially careful in regard to these principles because people have a harder time recovering than organizations.
I firmly believe that the Trustees of the Charities that lost all of their endowments were lax in following their fiduciary responsibilities. While I feel for the beneficiaries of the charities; I don’t have sympathy with the managements or trustees. What were they thinking?
Tuesday, December 16, 2008
Sunday, December 14, 2008
IS DON QUIXOTE BERNANKE FIGHTING WINDMILLS WITH HIS LOYAL SANCHO PAULSON BY HIS SIDE
Once Again I read the newspaper and I am astounded by the cluelessness of our economic leadership. Today there is talk that the Fed will again lower the interest rate at which banks lend to each other (The Federal Funds Rate). You would think that by now Mr. Bernanke would realize that the country is in a liquidity trap where the traditional tools of Monetary Policy are ineffective. This is evidenced by the fact that both Mr. Bernanke and Mr. Paulson have been pouring liquidity intro the systems and the banks have responded by buying other banks, paying dividends, and funding bonus pools instead of making loans with the new found liquidity. Attacking an economic crisis with monetary tools when the country is in a liquidity trap is akin to tilting at windmills in the hope of killing a dragon.
The time has come to start using Keynesian aggregate demand based economics instead of the pump priming of liquidity enhancement. The pump is primed; the liquidity is there. What we need now is someone to start demanding the water. This can only be accomplished by a government spending stimulus package that is large enough to turn the economy around. This means that we need to spend as if we were fighting a war. All of the criticisms of the New Deal boil down to the fact that even FDR was too timid in his spending proposals. Alan Greenspan set the precedent of a Fed chief commenting on Fiscal Policy. It is now Mr. Bernanke’s turn to push Paulson toward a fiscal stimulus. At a minimum this should be a set of loans to GM and Chrysler that would stave off a shrinkage in demand. These two firms will eventually have to file for bankruptcy, but the inevitable can be delayed until the economy is better able to manage it and congress has time to arrange a post filing financing package which will mitigate the worst effects of a filing.
The time has come to start using Keynesian aggregate demand based economics instead of the pump priming of liquidity enhancement. The pump is primed; the liquidity is there. What we need now is someone to start demanding the water. This can only be accomplished by a government spending stimulus package that is large enough to turn the economy around. This means that we need to spend as if we were fighting a war. All of the criticisms of the New Deal boil down to the fact that even FDR was too timid in his spending proposals. Alan Greenspan set the precedent of a Fed chief commenting on Fiscal Policy. It is now Mr. Bernanke’s turn to push Paulson toward a fiscal stimulus. At a minimum this should be a set of loans to GM and Chrysler that would stave off a shrinkage in demand. These two firms will eventually have to file for bankruptcy, but the inevitable can be delayed until the economy is better able to manage it and congress has time to arrange a post filing financing package which will mitigate the worst effects of a filing.
Wednesday, December 10, 2008
What Fools the Conservatives Be
The title of this piece is very misleading because, for one of the rare instances in my life, I find that I am actually in agreement with the conservatives regarding the Detroit Bailout. The conservatives are calling for a “Structured Bankruptcy” in- stead of the bailout that is being proposed by democrats. In a November 26 letter to the editor of the “Allentown Morning Call” I outlined the advantages of a structured bankruptcy without using the term.
So, why am I calling the congressional conservatives fools? The problem lies in the fact that politics was once called the art of the possible. (I wish I could remember where the quote came from) The Republican leadership seems to have forgotten this. They are so intent on getting their own way that they appear to be willing to let the country slide further into the abyss of depression rather than agree to a program, which although flawed, has a possibility of passing. Eventually, GM and Chrysler will have to go for a structured bankruptcy. However, just letting them go into Chapter 11 now, without a government financed structure, would throw innumerable Americans out of work and exacerbate the economic downturn. Getting a bankruptcy plan passed under current conditions is impossible.
There is a time for principle and a time for action. Sometimes they do not coincide. This is one of those times. Conservative obstructionism may insure that Republican congressional representation remains out of power for another 40 years as happened in the mid 20th century.
So, why am I calling the congressional conservatives fools? The problem lies in the fact that politics was once called the art of the possible. (I wish I could remember where the quote came from) The Republican leadership seems to have forgotten this. They are so intent on getting their own way that they appear to be willing to let the country slide further into the abyss of depression rather than agree to a program, which although flawed, has a possibility of passing. Eventually, GM and Chrysler will have to go for a structured bankruptcy. However, just letting them go into Chapter 11 now, without a government financed structure, would throw innumerable Americans out of work and exacerbate the economic downturn. Getting a bankruptcy plan passed under current conditions is impossible.
There is a time for principle and a time for action. Sometimes they do not coincide. This is one of those times. Conservative obstructionism may insure that Republican congressional representation remains out of power for another 40 years as happened in the mid 20th century.
Monday, December 01, 2008
LIVING IN LA-LA LAND
This afternoon I listened to Paulson and Bernanke answer questions regarding the bailout and alternative solutions to our financial problems. Paulson was asked why he is not giving greater support to Sheila Bair’s proposals from the FDIC. Mr. Paulson’s response boiled down to the fact that he was more interested in saving Capital Markets.
What he forgets is that the failure of the Capital Markets comes from the inability to price Securitized Debt Derivatives because of the failure of the underlying debt which was securitized. This inability to price the derivatives means that their book-value is limited. (Simply, you can’t sell the derivatives because nobody knows if the original debt is good.) Limited book-value means that some of the financial institutions’ capital has vanished.
However, if the underlying debt is somehow guaranteed then the securities would become marketable. If the securities are marketable the markets will establish a price and capital would be restored. This is the approach that Ms. Blair has proposed and Mr. Paulson has pooh-poohed because he believes that it might apply to mortgages but, according to him, it doesn’t apply to what we are facing in the near future.
The future problems facing us have to do with more securitized debt. This time it is in car loans and credit card debt that has been bundled and sold as derivatives. Again, if we find a way to insure the debt, we can stabilize the price of the derivatives and avert a meltdown.
This is where Mr. Paulson is living in La-La Land. He is so close to the capital markets community that he forgets that the USA is a consumer driven economy. He wants to insure the capital markets without addressing the needs of the consumer. However, the capital markets don’t trust the consumer and are raising interest rates and reducing credit limits on credit cards in spite of the capital infusions Mr. Paulson has provided them. Convincing the consumers that they will not face foreclosure and that their debt will be put on a feasible workout schedule is the only way to restore consumer confidence and hopefully increase spending by those with the capacity to do so. Ms Blair’s approach seems to accomplish this goal as well as the goal of stabilizing the prices of the derivatives and should be expanded to other types of underlying debt.
What he forgets is that the failure of the Capital Markets comes from the inability to price Securitized Debt Derivatives because of the failure of the underlying debt which was securitized. This inability to price the derivatives means that their book-value is limited. (Simply, you can’t sell the derivatives because nobody knows if the original debt is good.) Limited book-value means that some of the financial institutions’ capital has vanished.
However, if the underlying debt is somehow guaranteed then the securities would become marketable. If the securities are marketable the markets will establish a price and capital would be restored. This is the approach that Ms. Blair has proposed and Mr. Paulson has pooh-poohed because he believes that it might apply to mortgages but, according to him, it doesn’t apply to what we are facing in the near future.
The future problems facing us have to do with more securitized debt. This time it is in car loans and credit card debt that has been bundled and sold as derivatives. Again, if we find a way to insure the debt, we can stabilize the price of the derivatives and avert a meltdown.
This is where Mr. Paulson is living in La-La Land. He is so close to the capital markets community that he forgets that the USA is a consumer driven economy. He wants to insure the capital markets without addressing the needs of the consumer. However, the capital markets don’t trust the consumer and are raising interest rates and reducing credit limits on credit cards in spite of the capital infusions Mr. Paulson has provided them. Convincing the consumers that they will not face foreclosure and that their debt will be put on a feasible workout schedule is the only way to restore consumer confidence and hopefully increase spending by those with the capacity to do so. Ms Blair’s approach seems to accomplish this goal as well as the goal of stabilizing the prices of the derivatives and should be expanded to other types of underlying debt.
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