Posts tagged ‘financial crisis’

Solving Europe and Your Deadbeat Cousin

The fall holidays are quickly approaching, and almost every family has at least one black-sheep member among the bunch. You know, the unemployed second cousin who shows up for Thanksgiving dinner intoxicated – who then proceeds to pull you aside after a full meal to ask you for some money because of an unlucky trip to Las Vegas. For simplicity purposes, let’s name our deadbeat cousin Joe.

Right now the European union (EU) is dealing with a similar situation, but rather than being forced to deal with money-begging cousin named Joe, the EU is being forced to confront the irresponsible debt-binging practices of its own relatives – the PIIGS (Portugal, Ireland, Italy, Greece, and Spain). The European troika (International Monetary Fund/IMF; European Union/EU; and European Central Bank/ECB), spearheaded by German and French persuasion, is contemplating everything from prescribing direct bank recapitalization, bailouts via the leveraging of the EFSF (European Financial Stability Facility), ECB bond purchases, debt guarantees, unlimited central bank loans, and more.

New stress tests are being reevaluated as we speak. Previous tests failed in gaining the necessary credibility because inadequate haircuts were applied to the values of PIIGS debt held by European banks. European Leaders are beginning to gain some religion as to the urgency and intensity of the financial crisis. Just today, Germany’s chancellor (Angela Merkel) and France’s President (Nicolas Sarkozy) announced that they will introduce a comprehensive package of measures to stabilize the eurozone by the end of this month, right before the summit of the G20 leading global economies in Cannes, France.

Pick Your Poison

Whatever the path used to mop up debt excesses, the options for solving the financial mess can be lumped together in the following categories:

1. Austerity: Plain, unadulterated spending cuts is one prescription being administerd in hopes of curing bloated European sovereign debt issues. Negatives: Slowing economic growth, slowing tax receipts, potentially widening deficits (reference Greece), and political reelection self interests call into question the feasibility of the austerity option. Positives: Austerity is a morally correct fiscal response, which has the potential of placing a country’s financial situation back on a sustainable path.

2. Bailouts: The troika is also talking about infusing the troubled banks with new capital. Negatives: This action could result in more debt placed on country balance sheets, a potentially lower credit rating, higher costs of borrowing, higher tax burden for blameless taxpayers, and often an impossible political path of success. Positives: Financial markets may respond constructively in the short-run, but providing an alcoholic more alcohol doesn’t solve long-term fiscal responsibility, and also introduces the problem of moral hazard.

3. Haircuts: Voluntary or involuntary haircuts to principal debt obligations may occur in conjunction with previously described bailout efforts, depending on the severity of debt levels. Negatives: There are many different sets of constituents and investors, which can make voluntary haircut/debt restructuring terms difficult to agree upon. If the haircuts are too severe, banking reserves across the EU will become decimated, which will only lead to more austerity, bailouts, and potential credit downgrades. Such actions could hamper or eliminated future access to capital, and the cost of access to future capital could be cost prohibitive for the borrowing countries that defaulted/restructured. Positives: Haircuts eliminate or lessen the need for other more painful austerity or restructuring measures, and force borrowers to become more fiscally responsible, not to mention, investors are forced to conduct more thorough due diligence.

4. Printing Press: Buying back debt with freshly printed euros hot off the press is another strategy. Negatives: Inflation is an invisible tax on everyone, including those constituents who are behaving in a fiscally responsible manner. Positives: Not only is this strategy more politically palatable because the inflation tax is spread across the whole union, but this path to debt reduction also does not require as painful and unpopular cuts in spending as experienced in other options.

The Costs

What is the cost for this massive European debt-binging rehabilitation? Estimates vary widely, but a JP Morgan analyst sized it up this way as explained in the The Financial Times:

“In a worst-case, severe recession scenario, €230bn in new capital is needed to meet Basel III requirements, assuming a 60 per cent debt writedown on Greece, 40 per cent on Ireland and Portugal and 20 per cent on Italy and Spain, and that banks withhold dividends.”

 

More bearish estimates with larger bond loss haircuts, stricter regulatory guidelines, and harsher austerity measures have generated recapitalization numbers north of €1 trillion euros. Regardless of the estimates, European governments, regulators, and central banks are likely to select a combination of the poisons listed above. There is no silver bullet solution, and any of the chosen paths come with their own unique set of consequences.

As time passes and the European crisis matures, I am confident that you will be hearing more about ECB involvement and the firing-up of the printing presses. Perhaps the ECB will fund and work jointly with the EFSF to soak up debt and/or capitalize weak banks. Alternatively, and more simply, the ECB is likely to follow the path of the U.S. and implement significant amounts of quantitative easing (i.e., provide liquidity to the financial system via sovereign debt purchases and guarantees).

Dealing with irresponsible and intoxicated deadbeat second cousins (or European countries) fishing for money is never a pleasurable experience. There are many ways to address the problem, but ignoring the issue will only make the situation worse. Fortunately, our European friends on the other side of the pond appear to be taking notice. As in the U.S., if government officials delay or ignore the immediate problems, the financial market cops (a.k.a., “bond vigilantes”) will force them into action. In the recent past, European officials have used a strategy of sober talking “tough love,” but signs that the ECB printing presses are now beginning to warm up are evident. Once the euros come flying off the presses to detoxify the debt binging banks, perhaps the ECB can print a few extra euros for my cousin Joe.

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in JPM, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

October 9, 2011 at 4:36 pm 2 comments

Shoot First and Ask Later?

The financial markets have been hit by a tsunami on the heels of idiotic debt negotiations, a head-scratching credit downgrade, and slowing economic data after a wallet-emptying spending binge by the government. These chain of events have forced many investors and speculators alike to shoot first, and ask questions later. Is this the right strategy? Well, if you think the world is going to end and we are in a global secular bear market stifled by a choking pile of sovereign debt, then the answer is a resounding “yes.” If however, you believe the blood curdling screams from an angered electorate will eventually influence existing or soon-to-be elected politicians in dealing with the obvious, then the answer is probably “no.”

Plug Your Ears

Anybody that says they confidently know what is really going to happen over the next six months is a moron. You can ask those same so-called talking head experts seen over the airwaves if they predicted the raging +35% upward surge last summer, right after the market tanked -17% on “double-dip” concerns and Fed Chairman Ben Bernanke gave his noted quantitative easing speech in Jackson Hole, Wyoming. I’m still flicking through the channels looking for the professionals who perfectly envisaged the panicked buying of the same downgraded Treasuries Standard and Poor’s pooped on. Oh sure, it makes perfect sense that trillions of dollars would flock to the warmth and coziness of sub-2% yielding debt in a country exploding with unsustainable obligations and deficits, fueled by a Congress that can barely blows its nose to a successful negotiation.

The moral of the story is that nobody knows the future with certainty – no matter how much CNBC producers would like you to believe the opposite is true. Some of the arguably smartest people in the world have single handedly triggered financial market implosions. Consider Robert Merton and Myron Scholes, both renowned Nobel Prize winners, who brought global financial markets to its knees in 1998 when Merton and Scholes’s firm (Long Term Capital Management) lost $500 million in one day and required a $3.6 billion bailout from a consortium of banks. Or ask yourself how well Fed Chairmen Alan Greenspan and Ben Bernanke did in predicting the credit crisis and housing bubble.

If the strategist or trader du jour squawking on the boob-tube was really honest, he or she would steal the sage words of wisdom from the television series secret agent Angus MacGyver who articulated, “Only a fool is sure of anything, a wise man keeps on guessing.”

Listen to the “E”-Word

If you can’t trust all the squawkers, then whom can you trust (besides me of course…cough, cough)? The answer is no different than the person you would look for in other life-important decisions. If you needed a serious heart by-pass surgery, would you get advice from a nurse or medical professor, or would you listen more closely to the top cardiologist at the Mayo Clinic who performed over 2,000 successful surgeries? If you were looking for a pilot to fly your plane, would you prefer a 25-year-old flight attendant, or a 55-year old steely veteran who has 10 million miles of flight experience? OK, I think you get the point…legitimate experience with a track record is key.

Unfortunately, most of the slick, articulate people we see on television may look experienced and have some gray hair, but the only thing they are experienced at is giving opinions. As my great, great grandmother once told me, “Opinions are a dime a dozen, but experience is much more valuable” (embellished for dramatic effect). You are better off listening to experienced professionals like Warren Buffett (listen to his recent Charlie Rose interview), who have lived through dozens of crises and profited from them – Buffett becoming the richest person on the planet doesn’t just come from dumb luck.

If you are having trouble sleeping, you either are taking too much risk, or do not understand the nature of the risk you are taking (see Sleeping like a Baby). Things can always get worse, and the risk of a self-fulfilling further decline is a possibility (read about Soros and Reflexivity). If you are determined to make changes to your portfolio, use a scalpel, and not an axe. The recent extreme volatility makes times like these ideal for reviewing your financial position, goals, and risk tolerance. But before you shoot your portfolio first, and ask questions later, prevent a prison sentence of panic, or your financial situation may end up behind bars.
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Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in MHP, CMCSA, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

August 20, 2011 at 2:53 pm 1 comment

Reality More Fascinating than Fiction

Make-believe is fun, but reality is often more fascinating than fiction. The same can be said for the books I read. Actually, all the books reviewed at Investing Caffeine have been non-fiction. My movie-viewing preferences happen to be quite similar – comedies and dramas are terrific, but I’m also a documentary fanatic. As a matter of fact, I have rented or watched more than 125 documentaries (and mockumentary, This is Spinal Tap) over the last six years.

There have been a slew of non-fiction books written about the recent global financial crisis, including the ones I reviewed: Too Big to Fail, The Greatest Trade Ever, and The Big Short. When it comes to videos, I have seen several TV-based documentaries covering various aspects of the global meltdown, but the Inside Job did an exceptionally good job of providing a global perspective of the financial collapse. The film was produced, written, and directed by Charles Ferguson (you can call him “doctor” thanks to the Ph.D he earned at MIT) and also narrated by Academy Award winner Matt Damon. The Inside Job provided a comprehensive worldly view by filming on location in the United States, Iceland, England, France, Singapore, and China. Not only did Ferguson break down the complex facets of the crisis into easily digestible pieces for the audience, but he also features prominent journalists, politicians, and academics who describe the complicated global events from a birds-eye view. Hedge fund manager George Soros,  former Federal Reserve Chairman Paul Volcker, former New York Governor Eliot Spitzer, and economist Nouriel Roubini, are a small subset of the heavy-hitters interviewed in the movie.

A wide range of causes and effects were explored – everything from derivatives, lack of regulation, excessive banker compensation, and the pervasive conflicts of interest throughout the financial system. Bankers and politicians shoulder much of the blame for the global crisis, and Ferguson does not go out of his way to present their side of the story.  Ferguson does a fairly decent job of keeping his direct personal political views out of the film, but based on his undergraduate Berkeley degree and his non-stop Goldman Sachs (GS) bashing, I think someone could profitably prevail in wagering on which side of the political fence Ferguson resides.

Although I give Inside Job a “thumbs-up,” I wasn’t the only person who liked the movie. The Inside Job in fact won numerous awards, including the 2010 Academy Award for Best Documentary, Best Documentary from the New York Film Critics Circle, and the Best Documentary Screenplay from the Writers Guild.

Slome’s Oscar Nominees

As I mentioned previously, I am somewhat fanatical when it comes to documentaries, although I have yet to see Justin Bieber’s Never Say Never. Besides the Inside Job, here is a varied list of must-see documentaries. There may be a conflict of personal tastes on a few of these, but I will provide you a hand-written apology for anybody that falls asleep to more than one of my top 15:

1)      Murderball

2)      A Crude Awakening  

3)      Touching the Void

4)      It Might Get Loud

5)      Hoop Dreams

6)      Lewis and Clark: The Journey (Ken Burns)

7)       The Staircase

8)      Enron: The Smartest Guys in the Room

9)      Cracking the Code of Life  

10)   Paradise Lost

11)   The Endurance

12)   Devil’s Playground  

13)   Everest: Beyond the Limit

14)   The Devil Came on Horseback

15)   Emmanuel’s Gift

I’m obviously biased about the quality of my recommended documentaries, but you can even the score by sharing some of your favorite documentaries in the comment section below or by emailing me directly. I will be greatly indebted for any suggestions offered. Regardless, whether watching a truth-revealing thought-piece like the Inside Job or A Crude awakening, or an inspirational story like Murderball or Touching the Void, I’m convinced that these reality based stories are much more fascinating than the vast majority of recycled fiction continually shoveled out by Hollywood. For those adventurous movie-watchers, check out a documentary or two – who knows…there may be an inner-documentary fanatic in you too?

Wade W. Slome, CFA, CFP® 

Plan. Invest. Prosper. 

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in GS, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

April 4, 2011 at 11:10 pm 3 comments

Banking Crisis Broken Record (1907 vs. 2007)

Like a spinning and skipping broken record, our history has been filled with an endless number of banking crises. And unfortunately, the financial crisis of 2008-2009 will not be our last (read more about rhyming history). Robert F. Bruner, professor and Dean at the Darden Graduate School of Business Administration, has studied the repetitive nature of banking crises and identified core foundational aspects present in these vicious financial events.

In a period spanning 105 years (1900 – 2005) Bruner references 31 separate crises occurring across the world in various countries. Just in the last handful of decades, Americans have experienced the seizure of the Continental Illinois National Bank and Trust Company (1984), the S&L crisis (Savings & Loan – late 1980s), the disintegration of Long-Term Capital Management (1998), followed by the recent falling of dominoes in the first decade of the 21st Century (Bear Stearns, Lehman Brothers, Wamu, AIG, etc.).  What do many of these crises have in common?

In comparing the recent global financial crisis, Bruner compares the recent events to the “Panic of 1907” – the last financial crisis before the creation of the Federal Reserve System in 1913. The last few years have been rough, but a century ago San Franciscans endured the mother of all crises. This is how Bruner described the time period:

“The San Francisco earthquake of 18 April 1906 triggered a massive call on global gold reserves and a liquidity crunch in the United States. A recession commenced in June 1907. Security prices declined. In September, New York City narrowly averted a failure to refinance outstanding bonds. Then, on 16 October, a “bear squeeze” speculation failed and rendered two brokerage firms insolvent. The next day, depositors began a run on Knickerbocker Trust Company…Runs spread to other trust companies and banks in New York City. And the panic rippled across the United States.”

Bruner highlights four key factors inherent in these, and other, financial crises. Here is a summary of the four elements:

Existence of Systemic Structure:  In order for a crisis to occur, an economy needs a collection of linked financial intermediaries to form a system. Throughout history, transactions and deposits have connected to multiple systems around the globe.

Systemic Instability: Hyman Minsk, a renowned 20th Century economist, was known for his thoughts on his “Financial Instability Hypothesis.” At the core of Minsky’s crisis beliefs was the idea that economic slumps were caused by the credit cycle. At the late stages of an economic cycle there is a larger appetite to assume additional risk and debt. A spiraling vortex can occur as “Easy credit amplifies the boom, and tight credit amplifies the contraction,” Minsky states.

Systemic Shock: Beyond an unstable system, a crisis needs a spark. For Bruner that spark must have four characteristics:

  • Real, Not Apparent: The shock must be “real, not apparent.” The disturbance must be disruptive enough to shake the trust of the financial system and be large enough to have a real economic impact (e.g., new technologies, massive labor strike, deregulation, or even an earthquake). 
  • Large:  The trigger of a financial crisis must be large enough to shift the outlook of investors.
  • Unambiguous and Difficult to Repeat: The shock must unambiguously stand out from the standard marketplace news.
  • Surprising: The event must be unanticipated and cause a shift in thinking.

Response and Intervention: Effectively, the response to a shock converts an overconfident boom into fear and pessimism. The reply can often be an overreaction to the existing fundamentals, which flies in the face of efficient markets and rational decision making.

According to Bruner, crises including the one triggered by the earthquake of 1906 carry the four previously mentioned elements.

Solution = Leadership

At the vortex of any financial crisis lies fear and panic, which require leadership to mitigate the damage. John Pierpont “J.P.” Morgan, semi-retired banking executive, orchestrated leadership in 1907 by organizing a rescue of “trust companies, banks, the New York Stock Exchange, New York City, and the brokerage firm of Moore and Schley.”

Time will tell and history will judge whether Federal Reserve Chairman Ben Bernanke and Treasury Secretaries Hank Paulson and Timothy Geithner provided the necessary leadership to sustainably lead us out of the financial crisis. Of course, decisions made by the key U.S. leadership figures are not made in a vacuum, so choices made by our international brethren can impact the success of our monetary and fiscal policies too.

There have been 18 substantial global bank crises since World War II and the recent credit-induced collapse will not be the last as long as Bruner’s four elements of a crisis exist (structure, instability, shock, and intervention). The ultimate outcome of a crisis will be dependent on the nature of leadership, coordinated government intervention, and regulation. The global economic record will continue spinning, but with Robert Bruner’s lessons learned from the Panic of 1907, hopefully the music will last for a very long time before skipping on a crisis again.

Read the whole Bruner article

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper. 

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds and a derivative security of an AIG insurance subsidiary, but at time of publishing had no direct positions in JPM. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

February 11, 2010 at 11:00 pm 2 comments

Lessons Learned from Financial Crisis Management 101

For many investors the financial crisis over the last 24 months was an expensive education. Rather than have to enroll and take the courses all over again, I am hopeful we can put that past education to good use. Here are some valuable lessons I learned from my two year degree in Financial Crisis Management 101.

Investors Don’t Get Paid For Emotions: In investing, emotional decisions generally lead to suboptimal decisions. Over the financial crisis, despite the market rebound last year, many investors fell prey to fear. This queasiness (see Queasy Investors article) resulted in money being stuffed under the mattress – earning subpar yields – and asset allocations dramatically shifting towards bonds. Not surprisingly, the Barclays Aggregate Bond Index fell -1% in 2009 as the herd piled in. On the flip side, those willing to brave the equity markets were rewarded with a +23% gain in the S&P500 index. Certainly this bond-equity picture looked different in 2008, but unfortunately many mainstream portfolios lacked adequate bond exposure then. As famed Fidelity Magellan fund manager Peter Lynch points out, fretting about your portfolio can work against you:  “Your ultimate success or failure will depend on your ability to ignore the worries of the world long enough to allow your investments to succeed.”

Martin Luther King Jr. put anxious emotions into perspective by expressing, “Normal fear protects us; abnormal fear paralyses us.” Prudent conservatism makes sense, but panicked alarm can lead you astray. Behavioral economists Daniel Kahneman and Amos Tversky punctuated this idea by showing the impact that “loss” has on peoples’ psyches. Through their research, Kahneman and Tversky demonstrated the pain of loss is more than twice as painful as the pleasure from gain. Euphoria, whether for homes or for other forms of credit-induced spending, is not a desirable emotion when investing either – just ask any house-flipping Florida or California resident looking for work. The moral of the story: plan for a rainy day and don’t succumb to the elation of the herd. Create a disciplined systematic approach that relies less on your gut. Emotional decisions, as we’ve seen over the last few years, generally do not fare well.

Quality Doesn’t Die in a Crisis: Good companies with solid growth prospects don’t disappear in a bear market. On the contrary, they typically are in much better position to invest, step on the throats of their competitors, and steal market share. Many of the quality companies left for dead last year have risen from the ashes. Leveraged financials and debt laden companies were hit the hardest, and bounced nicely last year, but the market leaders are the companies that endure through bull and bear markets.

Buy and Hold is Not Dead:  Catching fish can be difficult if one constantly dips their line in and out of the water. Academic research falls pretty bluntly on the shoulders of “day traders,” and I’m still searching for a Warren Buffett equivalent to show up on Oprah or Charlie Rose espousing the virtues of speculation – oh wait, maybe Jim Cramer qualifies?

Long-term investors are a rare but dying breed – just look at the average fund manager’s holding period, which has dropped from about five years in the 1960s to less than one year today. The 1980s and 1990s weren’t too bad for buy and holders (about a +1,400% increase), but the strategy has subsequently gone in hibernation for a decade. Warren Buffett may be pushing a bit too far when he says, “Our favorite holding period is forever,” but directionally this posture may actually work well over the next ten years. Patience can pay off – even if you arrive late to the game. For example, if you bought Wal-Mart shares (WMT) after it rose 10-fold during its first 10 years, you still could have achieved a 60x return over the next 30 years. I, myself, believe there is a happy medium between high frequency trading (see HFT article) and “forever” investing. Regardless of your time horizon, I agree with late Sir John Templeton who said, The only way to avoid mistakes is not to invest – which is the biggest mistake of all.”

Cyclical is Not Secular: Party crashers may be optimistic about the prospects of a gathering, but if they arrive too late to the event, there may be no more food or wine left. The same principle applies to investment themes, as well-known value manager Bill Miller states, “Latecomers are usually persuaded that the cyclical has become the secular.” Over the last few years, the secular arguments of “real estate prices will never go down nationally,” and the belief that emerging markets like China would “decouple” from the U.S. market in 2008, simple were proved wrong. Time will tell if the gold-bugs will be right regarding their call for continued secular increases, or if the spike is a crescendo on a return to more normalized levels. On the whole, I much rather prefer to arrive at a big party prematurely, rather than showing up late sifting through the crumbs and scraping the bottom of the punch bowl.

Turn Off the TV: Fanning the flames of our daily emotions are media outlets. Thanks to globalization, the internet, and the 24/7 news cycle, we are bombarded with some type of daily fear factor to worry about. Typically, an eloquent strategist or economist pontificates on the direction of the market. In many instances these talking heads don’t even manage client money or are not held accountable for their predictions (see Peter Schiff article). I like Barron’s Michael Santoli’s description of these story-telling market mavens, “A strategist’s first job is to have a plausible, defensible case to shop around client conference rooms globally. Being right is gravy.”  Although intellectually stimulating, I advise you to limit your consumption and delivery of strategist commentary to cocktail parties and don’t let their advice sway your portfolio decisions. You’ll be much better served by listening to veteran investors who have successfully navigated choppy market cycles. Famed growth investor William O’Neil shrewdly chimes in on the subject too, “Since the market tends to go in the opposite direction of what the majority of people think, I would say 95% of all these people you hear on TV shows are giving you their personal opinion. And personal opinions are almost always worthless … facts and markets are far more reliable.”

Bad Loans are Made in Good Times: Markus Brunnermeier, a Princeton economist known for studying financial bubbles, declared this observation regarding loans. Hindsight is 20-20, but it’s no wonder that boat loads of no-doc, no down-payment, teaser rate subprime loans and overleveraged risky private equity loans were being made when unemployment was at 5% — not today’s 10% rate. Now with the loan spigots shut, the tables have been turned. Relatively few loans are now being made, but with a massively steep yield curve, surviving financial institutions are in a golden age for bringing on new wildly lucrative assets onto their balance sheets. Sure, the industry is still saddled with toxic legacy assets, but the negative impact should begin fading in coming quarters if the economy can continue building a firmer foundation.

Diversification Matters: Contrary to current thinking, which believes diversification didn’t help investors through the crisis, owning certain asset classes like treasuries, certain commodities, and cash did help in 2008. Certainly, the correlations between many asset classes converged in the heat of the panic, but I’m convinced the benefits of diversification provide beneficial shock absorbers for most investment portfolios. Princeton professor and economist Burton Gordon Malkiel sums it up succinctly, “Diversity reduces adversity.”

The Herd is Often Led to the Slaughterhouse: The technology and housing bubble implosions serve as gentle reminders of the slaughterhouse fate for those who follow the herd. Avoiding consensus thinking is virtually a requirement of long-term outperformance.  As Sir John Templeton stated, “It’s impossible to produce superior performance unless you do something different from the majority.” John Paulson can also attest to this fact. If aggressively shorting the housing market and loading up on CDS insurance was the consensus, his firm would not have made $20 billion over 2007 and 2008.

These are obviously not all the lessons to be learned from the financial crisis, and by following a philosophy of continual learning, future mistakes should provide additional insights to help guard against losses and capitalize on potential opportunities. Having freshly graduated from Financial Crisis Management 101, I hope to immediately implement this education to land on the financial market’s Dean’s List.

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper. 

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds (including fixed income ETFs and FXI). Also at time of publishing SCM and some of its clients had a direct long position in WMT, but no position in BEN or BRKA/B. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

January 11, 2010 at 12:40 am 2 comments

Too Big to Fail (Review)

Some call Andrew Ross Sorkin’s new behind-the-scenes book about the financial crisis of 2008-2009 “Too Big to Read” due to its meaty page count at 624 pages (a tad more than my book). But actually, once you crack the first chapter of Too Big to Fail you become immediately sucked in. In creating the “fly on the wall” perspective covering the elite power brokers of Wall Street and Washington, Sorkin utilizes 500 hours of interviews with more than 200 individuals.

Through the detailed and vivid conversations, you get the keen sense of overwhelming desperation and self-preservation that overtakes the executives of the sinking financial system. Some of the chief participants failed, some were triumphant, and some were pathetically bailed out. History will ultimately be the arbiter of whether government and Wall Street averted, mitigated, postponed, or contributed to the financial collapse. Regardless, Sorkin brilliantly encapsulates this emotionally panicked period in our history that will never be erased from our memories.

Here are a few passages that capture the feeling and mood of the book:

Merger Musical Chairs

The terror-induced insanity of merger musical chairs is best depicted through the notepad of Timothy Geithner, then the president of the New York Federal Reserve Bank:

“On a pad that morning, Geithner started writing out various merger permutations: Morgan Stanley and Citigroup. Morgan Stanley and JP Morgan Chase. Morgan Stanley and Mitsubishi. Morgan Stanley and CIC. Morgan Stanley and Outside Investor. Goldman Sachs and Citigroup. Goldman Sachs and Wachovia. Goldman Sachs and Outside Investor. Fortress Goldman. Fortress Morgan Stanley. It was the ultimate Wall Street chessboard.”

 

AIG Bombshell

The book is also laced with financial nuggets to put the scope of the crisis in perspective. Here Sorkin examines the distressed call of assistance from AIG CEO, Bob Willumstad, to Timothy Geithner:

“A bombshell that Willumstad was confident would draw Geithner’s attention-was a report on AIG’s counterparty exposure around the world, which included ‘$2.7 trillion of notional derivative exposures, with 12,000 individual contracts.” About halfway down the page, in bold, was the detail that Willumstad hoped would strike Geithner as startling: “$1 trillion of exposures concentrated with 12 major financial institutions.’”

 

Bernanke’s Bumbled Spelling Bee

In setting the stage for the drama that unfolds, Sorkin also provides a background on the key players in the book. For example in describing Ben Bernanke you learn he was

“born in 1953 and grew up in Dillon South Carolina, a small town permeated by the stench of tobacco warehouses. As an eleven-year-old, he traveled to Washington to compete in the national spelling championship in 1965, falling in the second round, when he misspelled ‘Edelweiss.’”

 

TARP Tidbits

On how the precise $700 billion TARP (Troubled Asset Relief Program) figure was created, Sorkin describes the scattered thought process of the program designer Neel Kashkari:

“They knew they could count on Kashkari to perform some sort of mathematical voodoo to justify it: ‘There’s around $11 trillion of residential mortgages, there’s around $3 trillion of commercial mortgages, that leads to $14 trillion, roughly five percent of that is $700 billion.’ As he plucked numbers from thin air even Kashkari laughed at the absurdity of it all.”

 

Mercedes Moment

Mixed in with the facts and downbeat conversations are a series of humorous anecdotes and one-liners. Here is one exchange between Goldman Sachs CEO, Lloyd Blankfein, and his Chief of Staff Russell Horwitz:

“’I don’t think I can take another day of this,’ Horowitz said wearily. Blankfein laughed. ‘You’re getting out of a Mercedes to go to the New York Federal Reserve – you’re not getting out of a Higgins boat* on Omaha Beach! Keep things in perspective.’”

 

*Blankfein’s quote: A reference to the bloody D-Day battle. 

Too Big to Fail is an incredible time capsule for the history books. Let’s hope we do not have to relive a period like this in our lifetimes. I wouldn’t mind reading another Andrew Ross Sorkin book…just not another one about a future financial crisis.

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper. 

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but did not have any direct positions in any stock mentioned in this article at time of publication (including GS, AIG, WFC, MS, and C). No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

December 28, 2009 at 2:00 am 3 comments

Back to the Future: Mag Covers (Part III)

Diploma

Congratulations to those who have graduated through my first two articles (Part I and Part II) regarding the use of media magazine covers as contrarian investment indicator tools. We’ve reviewed magazine’s horrendous ability of predicting market shifts during the 1970s and Tech Bubble of 2000, and now we will take a peek at the “Great Recession” of 2008 and 2009. If you have the stamina to complete this final article, your diploma and selfless glory will be waiting for you at the end.

This magazine cover series was not designed to be utilized as an exploitable investment strategy, but rather to increase awareness and raise skepticism surrounding investment content. Just because something is written or said by journalist or blogger does not mean it is a fact (although I fancy facts). In the field of investing, along with other behavioral disciplines, there are significant gray areas left open to interpretation. A more educated, critical eye exercised by the general public will perhaps release us from the repetitive boom-bust cycles we’ve become accustomed to. Perhaps my goal is naïve and idealistic, nonetheless I dare to dream.

The wounds from a year ago are still fresh, and we have not fully escaped from the problems that originally got us into this mess, but it is amazing what a 60%+ market move since March can do to the number of “Great Depression” references. Let’s walk down calamity memory lane over the last year:

Great Depression Redux?

Great Depression 2008

Months ago we were in the midst of a severe recession, and the media was not shy about jumping on the “pessimism porn” bandwagon for the sake of ratings. Like a Friday the 13th sequel (nice tie in!), CNBC just weeks ago was plugging the crisis anniversary of the Lehman Brothers failure. Time magazine’s portrayal of the financial crisis as the next Great Depression, including the soup kitchen lines, mass unemployment, and collapse of thousands of banks, was used like chum to feed the frenzy of shocked investing onlookers. Unemployment rates are still creeping up, albeit at a slower rate, but we are nowhere near the 25% levels seen in the Great Depression.

American Disintegration

U.S. Evaporation

One of my favorite articles (read here) of the global crisis was written by The Wall Street Journal late last year about a Russian Professor, Igor Panarin (also a former KGB analyst). I find it absurdly amusing that the WSJ would even give credence to this story, but perhaps now I can look forward to an Op-Ed in their newspaper from Iranian President Mahmoud Ahmadinejad or North Korean Leader Kim Jong Ill. Not only did Professor Panarin pronounce the complete evaporation of the United States, but he also provided a specific timeframe. In late June or early July 2010, he expects the U.S. to fall into civil war and subsequently get carved up into six pieces by particular foreign regions, including China, Mexico, E.U., Japan, Canada, and Russia (which will control Alaska of course). I guess Sarah Palin will not be a happy camper?

Other Crisis Souvenirs

Soros Headline

Hey Georgy, let me know when you turn bullish…so I can sell!

Market Mayhem

New Yorker Cover 10-08
Who’s that on the cover? Nancy Pelosi?!

 

Lessons Learned

Contrarianism for the sake of contrarianism is not necessarily a good thing. Trend can be your friend too. Bubbles take much longer to inflate than they burst, so it may be in your best interest to ride the wave of ecstasy for longer than the early alarm ringers. Take for example Alan Greenspan’s infamous irrational exuberance speech in 1996, when the NASDAQ index was trading around 1300. As we all know, the NASDAQ went on to pierce the 5000 mark, four years later. Sorry Al…right idea, but a tad early. Although he may have been correct directionally, his timing and degree were way off.  Pundits like Nouriel Roubini and Peter Schiff are other examples of prognosticators who identified the financial crisis many years before the catastrophe actually hit. As I noted previously, trading based on magazine covers was not conceived as a legitimate investable strategy, but as I’ve shown they can be indicators of sentiment. And these sentiment indicators can be used as a valuable apparatus in your toolbox to prevent harmful decisions at the worst possible times.

 Thanks for coming Back to the Future on this historical tour of cover stories. Now that you have graduated with honors, next time you are in line at the grocery store, feel free to flash your diploma to receive a discount on a magazine purchase.

Class dismissed.

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.  

DISCLOSURE: No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

November 13, 2009 at 2:39 am 3 comments

“Bill, Say It Ain’t So…”

Bond guru and Newport Beach neighbor, Bill Gross, is out with his entertaining monthly PIMCO piece (Click Here). Try to keep a box of tissues close by in case you cry during the read. His views support my stance on short duration bonds and TIPs (Treasury Inflation Protected Securities), but big Bill would NEVER stand to root for equities – especially after his call for Dow 5000 a while back.

In this CNBC piece, he points out the obvious troubles we face from all the debt we’re choking on. As a country, we need the “Heimlich Maneuver!”

"Save to Your Grave"

"Save to Your Grave"

 Click Here for Video

June 4, 2009 at 7:00 am 2 comments

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