Central Bank Schizophrenia

Reuters Staff
Jun 30, 2008 16:29 UTC

The Fed’s critics have complained very loudly since Ben Bernanke began lowering interest rates last Fall. They argue that low interest rates encourage more borrowing and consequently more spending. And that low interest rates depress the the foreign exchange value of the dollar. They say all of the above are driving inflation higher and point to exploding food and oil prices worldwide as evidence.

For his part, Bernanke has said that risks to economic growth “outweigh” the risks of higher inflation. That is why he had continued to lower interest rates despite the threat of inflation. (until last week anyway)

Just today, the Bank for International Settlements published a schizophrenic report in which they argue that the end of the credit boom poses more serious threats to the world economy than the “consensus view seems to expect. At the same time, inflationary forces…could prove unexpectedly strong and persistent.” Translation: growth is slowing more quickly than people expect while inflation is accelerating more quickly than people expect.

What is Ben Bernanke to do? Since his job is simultaneously to avoid recession while protecting against inflation, and right now there’s evidence he faces both problems, he’s in a difficult spot. This is because the policy prescription to fix anemic economic growth will tend to increase inflation. But the prescription to fight inflation will suppress economic growth. You might say Bernanke is between a rock and a hard place. Or up shit creek.


$200 oil?

Reuters Staff
Jun 25, 2008 14:29 UTC

If Israel bombs Iran, $200 oil is a distinct possibility. Both look more likely given recent developments. Consider:

  • Israel is making oddly accommodating overtures to erstwhile enemies Syria and Hamas. Hamas has been firing rockets non-stop from Gaza into Southern Israel since they drove out Fatah a year ago. Syria had begun constructing a nuclear reactor before the Israelis bombed it last September. Yet in the last two weeks, Israel set a truce with Hamas, revealed secret negotiations with Syria, and even urged the Lebanese to open peace talks. Are the Israelis reaching out to their secondary enemies so that they can concentrate on Iran, their primary strategic foe?
  • Israel has dialed up its rhetoric too. On June 6th, Israeli cabinet minister and former army chief of staff Shaul Mofaz called an attack on Iranian nuclear sites “unavoidable.” [That was the day oil jumped $10 a barrel, incidentally.]
  • And most notably, the Israeli Air Force recently rehearsed a potential attack on Iran. The intent was for the World, and the Iranians, to notice.

And that may be all Israel is doing here: reminding the Iranians, and the World, that they are prepared to act if sanctions fail to arrest Iran’s nuclear program. Others believe Israeli action is a foregone conclusion.

Forthwith some predictions in the event Israel attacks…….(plus a nifty chart for those of you who read on)


Reconsidering the “Home-ownership Rate”

Reuters Staff
Jun 22, 2008 06:40 UTC
  • “Rise in Renters Erasing Gains in Ownership,” New York Times, June 21st 2008

The story above is based on home-ownership data released by the Census Bureau back in April. The article bemoans the fall in the home-ownership rate from 69.1% in the first quarter of 2005 to 67.8% as of the first quarter this year. Yet I wonder: did the home-ownership rate ever really reach 69.1%?U.S. Homeownership Rate

What I doubt isn’t the Census Bureau’s figure, I doubt their definition of home-ownership.

With approximately 110 million households nationwide, the decline to 67.8% represents 1.7 million households that shifted from owning to renting. But who were these 1.7 million households? How did they come to own their house and how much of their house did they actually own?



To be an owner you need to have clear title and exclusive use. If you have a morgage and you are not sure who the owner is , stop making the payment and you will find out who the owner is. If someone could find the numbers for people with clear title I think we would find that home ownership in the U.S. has gone down.


BankUnited imploding

Reuters Staff
Jun 19, 2008 03:19 UTC

After an analyst downgrade sent their stock diving 30% to $2.35 today, BankUnited Financial of Florida tonight issued a press release announcing a secondary stock offering. The bank is looking to raise $400 million of capital, which at the current stock price would translate into an additional 170m shares.

As of March 31st, the company had only 35 million shares outstanding. I’m no expert on secondary stock offerings, but seems to me that issuing another 170 million will effectively wipe out existing shareholders. With the stock down to $2 from a high above $30 back in 2006, I guess they’ve already been wiped out. But talk about adding insult to injury.

The management team vociferously argues that BKUNA shouldn’t be lumped together with the worst subprime lenders. In their investor talking points (slide 11) they emphasize….

  • No subprime lending
  • No piggyback loans
  • Strong underwriting standards

And yet they conveniently forget to mention that 60% of their loans outstanding are option ARMs. [For this tidbit, you have to go to the fine-print on pages 14-15 of their most recent 10-Q filing.] And 91%(!) of those loans were accumulating negative amortization as of March 31st. Don’t let that ugly term scare you away, let me explain….


Not Backing the Buck

Reuters Staff
Jun 17, 2008 04:50 UTC

Yesterday’s Page One article in the Journal suggested the Fed is in no rush to boost interest rates to protect the value of the dollar:

The Federal Reserve is almost certain to leave interest rates unchanged when it meets next week, and it currently doesn’t appear to see a compelling case for raising rates before the fall, unless the inflation outlook deteriorates considerably. [See this tutorial to help understand how higher interest rates may impact the dollar's value.]

Hmmm. Ben Bernanke said last week that exploding energy prices were causing the inflation outlook to deteriorate:

“The latest round of increases in energy prices has added to the upside risks to inflation and inflation expectations,” he said in a speech on June 9. He said that the Fed “will strongly resist” allowing inflation expectations to get out of hand. When people believe prices are bound to rise, workers tend to seek wage increases and businesses to mark up their prices, boosting inflation.

But Bernanke’s hands may be tied by the Fed’s “dual mandate:” its twin, and often conflicting, directives to achieve low inflation AND low unemployment. Raising rates to fight inflation and protect the dollar will likely deepen the economy’s funk by driving house prices down even more.


NYT: We need a bailout now!

Reuters Staff
Jun 15, 2008 15:11 UTC

The New York Times editorial board devotes today’s top editorial to criticizing the Bush administration, and John McCain, for doing “so little” in response to “the foreclosure crisis.” [Not the first time they've called for a bailout.] Doing “nothing” to prevent foreclosures will have an unacceptably large negative impact on the broader economy, they argue.

Naturally they favor Democrats’ favorite response to the crisis: “allowing bankrupt homeowners to have the terms of their mortgages modified under court protection.” They claim Barack Obama is on board with this proposal.

Have they considered the utterly ruinous effects of runaway litigation on other parts of the economy?

In the trial happy state of Mississippi, for example, potential employers wouldn’t open for business and doctors facing outrageous malpractice insurance rates simply left. But the governor was able to pass tort reform four years ago and employers and doctors came back (or at least stopped leaving).

Personally, I miss diving boards. They’ve all but disappeared due to sky-high insurance rates. Pool operators just can’t afford the premiums that insurance companies have to charge in a world where any injury can lead to a $5 million jury award.


P/E Ratio Defined

Reuters Staff
Jun 14, 2008 18:16 UTC

This is the second part of a three-part tutorial on measuring a company’s valuation. You can find Part 1 here. Part 3 is coming soon.

What is P/E?

Short for “Price to Earnings ratio,” P/E measures the “value” of a stock by comparing the cost of that stock with the earnings allocated to it. Remember back to Part 1, we explained that a share of stock represents a fractional share of ownership in a company. Companies are in business to make a profit, after all. If the purpose of a company is to earn a profit, the purpose of owning a piece of the company is to own a piece of its profits.


Abu Dhabi negotiating to buy Chrysler building

Reuters Staff
Jun 11, 2008 15:25 UTC

The latest high profile investment by a sovereign wealth fund (SWF) may be Abu Dhabi’s purchase of the Chrysler building here in New York.

This is making headlines because of the nature of the transaction. A landmark American building, being purchased by an Arab investment fund with $875 billion to spend. That cash accumulated via exports of oil.

But really, this deal isn’t a big one. $800 million for the 75% stake in the Chrysler building may grab headlines, but SWFs are announcing far larger investments regularly. For instance, Abu Dhabi also announced today that it plans $5 billion of additional investments this year, including a joint venture with a large U.S. utility. And yesterday, China’s State Administration of Foreign Exchange (SAFE for short) announced they are investing $2.5 billion with American private equity firm TPG.

So you see: SWFs are very busy, making a dozen headlines every day. With $3.3 trillion of assets under management at the end of 2007, they certainly have the financing to make those headlines. Check out this report for more details on SWF assets.

It’s worth noting that the $3.3 trillion figure DOESN’T include China’s SAFE, which technically isn’t considered a sovereign wealth fund. One expert thinks it should be now that it is investing more of its accumulated reserves.

Thinking about SAFE for a minute, it’s fascinating to ponder just how fast their assets are growing. I blogged about their stunning growth two days ago. They are accumulating $80 billion of fresh reserves every month. Their $2.5 billion investment in TPG represents only one day’s growth in assets.

All of the above is to be expected. As the United States continues to run a large trade deficit, and as low interest rates and a slowing economy make U.S. assets less attractive, U.S. dollars will flee to foreign locales.

Why is this significant?

At the end of the day, a dollar is a claim on U.S. goods or assets. While U.S. mutual funds and pension funds still control more assets than foreign central banks and SWFs, the latter are growing fast. Remember: he who owns the most dollars, owns America.

Getting Over Our Debt Addiction

Reuters Staff
Jun 10, 2008 22:36 UTC

OptionARMageddon is all about raising awareness of our debt-fueled lives and economy. Debt is a dangerous crutch to lean on. It’s a drug, really, offering users the temporary and totally artificial high of having more stuff: the bigger house, the faster car, the size D breasts.

In today’s NYT, David Brooks has a great Op-Ed on our troubling national debt habit:

The people who created this country built a moral structure around money. The Puritan legacy inhibited luxury and self-indulgence. Benjamin Franklin spread a practical gospel that emphasized hard work, temperance and frugality. Millions of parents, preachers, newspaper editors and teachers expounded the message. The result was quite remarkable.

The United States has been an affluent nation since its founding. But the country was, by and large, not corrupted by wealth. For centuries, it remained industrious, ambitious and frugal.

Over the past 30 years, much of that has been shredded. The social norms and institutions that encouraged frugality and spending what you earn have been undermined. The institutions that encourage debt and living for the moment have been strengthened. The country’s moral guardians are forever looking for decadence out of Hollywood and reality TV. But the most rampant decadence today is financial decadence, the trampling of decent norms about how to use and harness money…..

Deeper into his article, Brooks mentions a great piece with additional detail on the topic. You can find that article here.

Finance: The next industry to be outsourced?

Reuters Staff
Jun 10, 2008 00:22 UTC

What could be a better bargain than hiring a kid out of college at $100,000 per year to work 90 hours per week? How ’bout hiring a Chinese kid to do the same thing for less than half that.

The wave of outsourcing that has decimated employment in manufacturing and even IT in recent years may be coming to the financial world some time very soon. That is, if CFA test-taking numbers are any guide.


The New Dollar Carry Trade?

Reuters Staff
Jun 8, 2008 21:01 UTC

There’s been much chatter recently from bloggers covering China’s economy. It seems China is raking in foreign reserves at an astonishing rate so far this year. Perhaps as much as $365 billion through April. Drilling down into the sources of that cash suggests the emergence of a new and very sizable “carry trade,” in which investors sell a currency with a relatively low interest rate and buy a different currency yielding a higher interest rate.

[For a primer on the relationship between interest rates and currency values, see this tutorial.]

A very common carry trade the last few years has been to borrow & sell Japanese Yen and use the proceeds to invest in the U.S. and elsewhere. But after the Fed’s significant rate cuts the past few months, the dollar itself may be the new currency to finance speculative bets. China’s exploding reserves provide stark evidence.

China has been a net importer of currency for some time, given their large trade surplus and the interest payments their accumulated reserves generate. And yet these two sources of income explain less than half of the recent increase in reserves. So where is the rest of the money coming from? As discussed below, it appears the rest is being generated by so-called “hot money.” So much is pouring into the country, China’s central bankers may have lost control over monetary policy.


Oil up $10 a barrel so far today

Reuters Staff
Jun 6, 2008 18:03 UTC

Update 2:28PM: oil now up over $11–

Oil is near $139 a barrel as I write this, a record high even after accounting for inflation.

Lots going on here. The biggest issue may be comments from the European Central Bank Chair suggesting a possible rate increase later this year. Interest rate hikes for the Euro, or simply the prospect of them in the future, strengthens that currency versus the dollar as investors searching for higher yields will sell dollar-denominated fixed-income investments in favor of Euro-denominated ones.

Oil, a commodity priced in dollars, has become a play on the weaker dollar. The falling value of the dollar means it can buy less oil, hence the dollar cost of oil goes up.

Also, the jobs report was very weak today. With nonfarm payrolls falling 49,000 in May the unemployment rate jumped to 5.5% from 5.0% last month. Deteriorating employment weakens the economy and gives the Fed less room to raise rates later in the year. Tough talk two days ago from Ben Bernanke was intended to suggest the Fed might do exactly that: raise rates later in the year to fight inflation.

Historical Crude oil prices from the Energy Information Administration

Oil responded to those comments the day Bernanke made them, falling $2 a barrel to $122.30.

And yet after today’s employment report and the threat of higher rates in Europe, investors appear to be calling Bernanke’s bluff.

Will he actually raise interest rates to combat inflation in the face of continuing economic weakness? Markets appear skeptical.

Also driving oil’s price today, comments from Shaul Mofaz that Israel may be forced to bomb Iran’s nuclear facilities if Iran refuses to stop enriching uranium for a nuclear weapon. Mofaz is Israel’s Transporation Secretary, and a potential successor to embattled Prime Minister Ehud Olmert.

Iran, of course, is a major oil supplier, and has threatened to bomb other oil facilities in the Mid-East if attacked.

Depending on your point of view, higher oil prices may be good news.

Evander and Ed

Reuters Staff
Jun 5, 2008 22:23 UTC

What do Ed McMahon and Evander Holyfield have in common? Foreclosure.

But seriously folks, the Mortgage Bankers Association reported today (via HousingWire) that deliquencies are accelerating among prime borrowers faster than among subprime borrowers:

While foreclosure activity hit an all-time record in the first quarter, according to statistics released Thursday morning by the Mortgage Bankers Association, an alarming shift of the mortgage mess towards prime borrowers appears to be taking place as well — signaling that the credit crunch that began among those with less-than-perfect credit is now marching onward towards borrowers usually deemed better credit risks.

Of course a far higher percentage of subprime borrowers remain delinquent on their mortgages; but the trend is still worrisome. All the while, inventories are at record highs and climbing, while mortgage applications are plummeting.

All of the above puts a dent in argument(s) that the housing crisis is behind us.

Supply and demand at work folks. Rising supply and falling demand is a recipe lower prices.


Update: McMahon speaks

The Great Risk Dispersion that Wasn’t

Reuters Staff
Jun 5, 2008 02:15 UTC

The Daily Telegraph in London has an interesting article comparing bank strategies today with similar strategies used in 1929:

Perhaps the most intriguing parallel…is the crude attempt at self-preservation made by the investment trusts in 1929 and the banks now.

In the great crash, investment trusts with vast cross-holdings in each other tried to stem their collapse by buying up their own stock in what the economist JK Galbraith…described as an act of “fiscal self-immolation”. At the time, “support of the stock of one’s own company seemed a bold, imaginative and effective course,” Galbraith wrote, but ultimately the trusts were just “swindling themselves”….

To free their books of the estimated $1,000bn (£505bn) of sub-prime assets and $340bn of leveraged loans banks have been left carrying since the credit markets shut down last year, [many] are offering to sell these damaged assets cut-price and – crucially – are willing to lend investors the money to buy them. In other words, the banks are providing new debt for the old debt they no longer want.

Experts refer to such financial chicanery as adding “liquidity” to the financial system. All that’s really happening is a game of high finance hot potato: handing off bad debts between banks and big investors. None of this repairs the credit markets’ fundamental problem of solvency. It doesn’t change the fact that in the end, someone is going to get burned holding the defaulted loan of a bankrupt borrower. [For a great discussion of the difference between liquidity and solvency, see Paul Krugman].

The article notes that today’s banks think themselves “more sophisticated” than those that faced the Great Depression. “Sophisticated” moves like the ones above will not just solve liquidity problems, say the banks, they could mitigate solvency issues as well. I wouldn’t hold my breath.

I’m very skeptical of the “sophistication” of modern bankers. And let me explain why….


What is a share of stock?

Reuters Staff
Jun 4, 2008 20:37 UTC

[One of O.A.'s goals is to help readers with the vocabulary of investing and economics. This is the first in a regular series of posts I'll call "tutorials." We'll collect these and post them under a tab at the top of the page....With that, I present Part 1 of our first tutorial]

I got a little riled up when I read this in in the Journal a couple weeks back:

Is Yahoo’s standalone potential so great that it should command a 48 times price-to-earnings ratio for next year’s earnings…?

The point was that Yahoo should “strike while the iron is hot.” YHOO’s shareholders should count themselves lucky with MSFT’s offer valuing their shares at a whopping 48 times earnings.

Mish made a similar comment earlier this year:

Yahoo!Finance…shows the P/E of Yahoo to be 55. That is hugely overpaying even in a good environment, and is preposterous heading into a recession that figures to be both long and nasty.

The reason I’m bothered by such comments is that the P/E ratio is an incomplete and, in this case, totally misleading way to measure a company’s value.

Forthwith, a brief tutorial on P/E: what it means, why investors use it, why it’s incomplete and a better, more accurate alternative.

And as we go through these questions I also promise to give you a better understanding of what a share of stock actually is and why people buy stock to begin with. In fact, that’s where we’ll start…