A Conversation with Doctor Death

No, not Jack Kervorkian....Nouriel Roubini.

Beware, after listening to this guy I wanted to take several long cleansing breaths in an airtight garage (while my car was idling).

Charlie Rose's 50 minute interview with the economist currently experiencing his 5 minutes of fame is here.

The Foremost Expert on Monetary Policy

Is a 92 year old woman named Anna Schwartz. Here's another WSJ article worth reading, click thru here. Below are a few excerpts:

Most people now living have never seen a credit crunch like the one we are currently enduring. Ms. Schwartz, 92 years old, is one of the exceptions. She's not only old enough to remember the period from 1929 to 1933, she may know more about monetary history and banking than anyone alive. She co-authored, with Milton Friedman, "A Monetary History of the United States" (1963). It's the definitive account of how misguided monetary policy turned the stock-market crash of 1929 into the Great Depression.

Ms. Schwartz thinks that our central bankers and our Treasury Department are getting it wrong again....

To understand why, one first has to understand the nature of the current "credit market disturbance," as Ms. Schwartz delicately calls it. We now hear almost every day that banks will not lend to each other, or will do so only at punitive interest rates. Credit spreads -- the difference between what it costs the government to borrow and what private-sector borrowers must pay -- are at historic highs.

This is not due to a lack of money available to lend, Ms. Schwartz says, but to a lack of faith in the ability of borrowers to repay their debts. "The Fed," she argues, "has gone about as if the problem is a shortage of liquidity. That is not the basic problem. The basic problem for the markets is that [uncertainty] that the balance sheets of financial firms are credible."

So even though the Fed has flooded the credit markets with cash, spreads haven't budged because banks don't know who is still solvent and who is not. This uncertainty, says Ms. Schwartz, is "the basic problem in the credit market. Lending freezes up when lenders are uncertain that would-be borrowers have the resources to repay them. So to assume that the whole problem is inadequate liquidity bypasses the real issue."

How did we get into this mess in the first place? As in the 1920s, the current "disturbance" started with a "mania." But manias always have a cause. "If you investigate individually the manias that the market has so dubbed over the years, in every case, it was expansive monetary policy that generated the boom in an asset.

"The particular asset varied from one boom to another. But the basic underlying propagator was too-easy monetary policy and too-low interest rates that induced ordinary people to say, well, it's so cheap to acquire whatever is the object of desire in an asset boom, and go ahead and acquire that object. And then of course if monetary policy tightens, the boom collapses."

Performance Reviews Get Trashed

This Wall Street Journal Editorial crushes the modern concept of an annual performance review. It calls them one-sided and intimidating, and says they spend too much time dredging up past employee inadequacies. The alternative is a "performance preview" where the manager and employee have a conversation and discuss future expectations. The writer is a management professor at UCLA.

I have been in some performance reviews that left me flat (an anti-climax to a year of very hard work), and I have been in some performance reviews that left me angry or disappointed. I am pretty certain that I am not alone in these opinions, so I thought there might be other folks out there that would find it interesting.

Let me know if you do....

Warren Buffett Op-Ed in NY Times

Read it here.

Letter from a hedge fund manager

http://www.google.com/gwt/n?u=http%3A%2F%2Fwww.ft.com%2Fcms%2Fs%2F0%2F128d399a-9c75-11dd-a42e-000077b07658%2Cs01%3D1.html
Sent from my Verizon Wireless BlackBerry

Friday Fun

21 years ago, Wall Street was released. Does Michael Douglas's quote at the end of this clip blow your mind? Like, maybe we took Oliver Stone's advice and 20 years later found out he was wrong?

A Car in Every Chinese Garage

Time Magazine Online has a piece of perspective here (emphasis mine):

The last time global oil prices collapsed on such a scale — in the early 1980s — they stayed down for almost a decade and a half. That's unlikely to happen this time. Oil demand in countries like China and India may be slowing down right now, but it's not going away, and economic growth in those countries will, over time, again drive sharp price increases. Gasoline consumption in China is certain to soar over the next 10 years. This year alone up to 25,000 new cars have hit the streets in China every day. And a global financial crisis and economic slump won't change the fact that nothing denotes middle-class status in China as much as ownership of an automobile, which, for the foreseeable future, will be gas-powered.

Hedging Cuts Both Ways - Southwest Airlines

Jet Fuel Hedges Keep SWA In The Money from USA Today on 7/24, (when heating oil was over $4.00)

Southwest Posts Loss on Hedge Charge from NY Times 10/16, (after the biggest price retreat ever)

Southwest Airlines has been heralded for its hedging choices. It is important to remember that hedges can make you look both smart and dumb before they are done. However, they are put in place for a reason - to manage volatility or to lock in profitability.

"Throughout this decade, Southwest has been the airline industry’s most aggressive player in purchasing contracts to guarantee the price of fuel. It has contracts covering part of its fuel purchases through 2012, and has begun buying contracts for 2013.

The practice seemed particularly prescient earlier this year, when fuel prices nearly doubled compared with 2007.

In past quarters, Southwest has booked millions of dollars in gains because it paid far below market price for fuel.

At the end of the second quarter, those contracts, which stretch through 2010, were worth $6 billion. But at the end of the third quarter, the value of the contracts had dropped to about $2.5 billion."

Southwest just posted the first quarterly loss in their history.

The Goldman Roll

When I first got started trading, I was taught about the Goldman roll. Goldman Sachs had one of the first long-only index funds for commodities. It was invested in a basket of commodities - but always in the front month. The fund would have to roll positions from one month to the next as the front month contract was about to expire. So folks would position themselves to take advantage of the roll - where Goldman had to sell the front month and buy the next month out. If they did this in size it could affect the spread dramatically.

Now, years later, Goldman is just one of many index fund market participants. But over the past several years, they have become more and more famous for their oil forecasting. They are no better at it than any other firm. The new "Goldman Roll" was present today, as they "rolled over" and accelerated their shift from being bullish on energy to being bearish on energy. Let me demonstrate:

In this article from May, they revised their estimates upward to $141 from $107.

In this article from today, they lowered their price forecast from $115 to $70.

A few years ago, I worked for an economist. He was fantastic. And well respected. And after watching him, I ascertained the three great characteristics that every good economic forecaster must have:

1) They write, speak, and present well. (Much like the weatherman...if they are right but incompetent they do not get credit for their predictions, but if they are wrong and smooth they are able to divert the blame.)

2) Many choose to follow trends. (If they make predictions against the trend which do not come to pass, they get called out much more easily.)

3) They make bold predictions. (A conservative prediction is forgettable, a bold prediction is gutsy, and much more easy to explain away if proven wrong..."Chinese demand did not grow the way we expected" or "No one could have anticipated the global economic meltdown.")

The crazy thing about economic forecasts is that they can move commodity markets...and it is not illegal for those who issue forecasts to hold positions in the markets they cover. This fact was not lost on any of the well respected houses that issued price forecasts in the last two years.

Now, Goldman has "rolled" over on their price forecasts of the oil markets. And T. Boone has lost billions for his customers. But they were bold, they caught a trend, and they were consummately professional and believable in their forecast presentations.

They learned the three rules early, and used them for incredible gains over the last 24 months.

Simple Overview of the Crisis

This is a post from Barry Ritholtz's blog, The Big Picture. It was short and high quality, so instead of linking to it, I just copied it in to this site.

From a speech back in 2004 comes this telling quote:
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"One other thing I've done, is I've called on private sector mortgage banks and banks to be more aggressive about lending money to first-time home buyers. And the response has been really good. There's a lot of people in this -- our communities around the country that deeply care about the issue of homeownership, and they've been responsive."

- George W. Bush, U.S. President, March 26, 2004.

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Its important to understand how this situation occurred in the first place, if we want to be able to fix it. Blaming the CRA and Fannie/Freddie is a total misunderstanding of how the problem occurred, and what we need to do to fix it now, and avoid doing it again in the future.

To repeat my prior arguments, the proximate cause of the Housing crisis were 1) Ultra-low rates; and 2) Abdication of traditional lending standards, thanks to 3) originators ability to resell mortgages for securitization purposes, and hence, 4) not have to worry about loan defaults.

The credit crisis was caused by 1) the above securitized mortgage paper, that was 2) rated triple AAA by Moody's and Standard & Poors, which then 3) Which was then "insured" by credit default swaps (CDS) -- the unreserved for, shadow insurance products 4) whose exemption was made possible by the Commodities Futures Modernization Act. That legislation exempted these derivatives from any supervision or regulation. The lack of reserve requirements is why there is now $62 trillion in CDS, many of which will never pay their counter parties the promised insurance.

If you are going to blame Fannie/Freddie/CRA, or George Bush or Barney Frank, you are missing the big picture.

Two Multimedia Recommendations

Here are two worthwhile pieces:

One is a graphic from the Wall Street Journal about home prices, here.

The other is Charlie Rose's show from last night, including Princeton Economist Alan Blinder, here.

Friday Fun

Since no one has the stock market beat these days...how about Judge Smails' zen comments for inner peace?



Have a great weekend!

The 4 + 1 Market List

This is my second installment of the 4+1 Market List. It discusses the four things affecting the market, and one thing that doesn't matter at all. Things that matter:

1) The credit markets.
Until banks trust each other again, economic progress in this country will be halted. No development by business, no consumption by the retail sector. And until trust and confidence are restored throughout the world, oil will fall. This is bearish for energy prices.

2) Bank de-leveraging and hedge fund redemption.
Investment banks were leveraged 30 to 1 in some cases. Even commercial banks have deployed borrowed money into commodities in massive amounts. Now, as banks try to hold cash (cash is king), financial positions throughout the universe of available investments are being unwound. Until 6 weeks ago, money was pouring INTO hedge funds. Now, folks can't get their money out fast enough. Will the last one on wall Street please turn out the lights? This is bearish for energy prices.

3) Growth in China and India.
It was assumed even up to 6 weeks ago that China and India would continue on their torrid growth rate in oil demand. Now, it is common thinking that continuing that rate of growth is impossible. This is bearish for energy prices.

4) The value of the dollar
The fed keeps minting money. They will stop the market's hemorrhaging at some point, and everyone will take a deep breath when this crazy time is over. But the injection of that much money into the economy sets us up for significant inflation, and might devalue our currency with respect to other sovereign currencies worldwide. This is bullish for energy prices.

+1) The thing that doesn't matter?
Inventories. The domestic inventories are adequate, and the market is concerned about other stuff right now. There is a low likelihood that the market will make much fuss over the inventory report.

The Fed's Balance Sheet

Here is a good post from Econbrowser, detailing the Fed's balance sheet. Ben Bernake has promised billions and billions of dollars to the market, by securitizing assets and making derivatives markets more liquid. It seems that every day, the Fed makes a statement that it will help in a new area of the market. The post graphically demonstrates the magnitude of the commitments.

This is a pretty academic post, but I chose to put it here since the Fed seems to have run to the aid of the market on a daily basis lately.

Warren Buffett on Charlie Rose

This was a highlighted article on the sidebar last week, but I think it deserves a more prominent place than the sidebar.

Charlie Rose Interviews Warren Buffett

It is a candid interview with the Oracle, and I just got finished listening to it.

What I took from it:
1) "You should be fearful when others are greedy and greedy when others are fearful"
2) The treasury plan is really an attempt to create liquidity in a broken market, and if done correctly it may very well make the government a good deal of money.
3) Trust and Confidence are what is missing in the market right now - and those attributes are like "oxygen." You can live for 50 years without thinking about the oxygen you breathe to sustain your body. But the minute there is no oxygen....it is the only thing you think about. We must restore trust and confidence.
4) Once we do this, and spend some time patching the holes we made in the system over the last 12 months, everything will be fine in the economy.
5) But (big "but" here) the treasury plan is inflationary. Price inflation was the lesser of two evils...either we allow the credit markets to seize like a engine without oil....or we have a functioning credit market with some potentially nasty inflation.

I hope you enjoy it, it is 54 minutes, but it is worth a listen - especially in this volatile time.