Tuesday, March 18, 2008

House of Cards

I know many felt it was just a matter of time before our consumer driven economy faltered. But lately it feels much more like a complete collapse than a falter.

Try as I might, I am having a hard time grasping what value these financial firms bring to our economy. I understand the concept of buying and selling stocks, since you are actually buying and selling ownership of something. I also understand margins, having money to back up your purchases. But the sophisticated financial “products” these firms sell, tend to be associated with a “position,” an “instrument”, or a “strategy.”

To be completely cynical about this....and I think the $2 share price of Bear Sterns might back me up, these companies don't produce anything of actual value. They seem to be middlemen that assist with transactions, or structure a deal, and take an enormous cut (hmmm...that sounds really familiar =) Even the WSJ theorized yesterday that the only real asset of BS may be the building that houses the employees.

Its not that I haven’t tried to understand, but the proliferation of these “products” have become mind numbing to your average suburban mom (hedge funds, EFTs, SIVs, CDOs, and the list goes on). According to my egocentric view of the world, if its so complicated that I can’t understand what purpose it serves, why should we use taxpayer money to bail them out?

All the headlines seem to emphasize the need for liquidity to conduct all these “transactions.” But these financial “innovations” and “transactions” all seem to be predicated on a house of cards. Once the rug is pulled out from under, the entire thing collapses.

What really gets me about this whole situation is the hypocrisy of it all. Many of these financial types are not in favor of safety nets for the American people, but yet they advocate them for their troubled financial firms and markets.

(And I am not so naïve to think all these products are completely without merit. In my industry, it was widely publicized how Southwest Airlines uses fuel hedges to stay ahead of its competition.)


alba said...

Ben Bernanke wants to know what these mortgage backed securities are worth. Too few "insiders" really know what's going on. And most of this nonsense occurs without regulation, and without transparency. You know just about as much about this as any of us!

As for the house of cards, I think they're mostly worried about the domino effect, across many banks, and, therefore our entire banking system, than any one player (company).

The building is estimated to be worth more than $1B, and they paid $239M for the company. But they are also charging $6B in acquisition charges. Somebody always gets paid...and its not the rank and file.

Taking equity out of a home, say $1, and turning it into a $32 bad bet, is going to have significant effects...on all of us.

Jacob said...

The fed keeps cutting the rates, another .75 today but banks keep raising mortgage rates cause we are not in a liquidity problem, there is plenty.

But the bottom line is if you want to buy a $400k home, the bank now expects you to be able to pay back the loan (*gasp*).

And for so long people were buying homes, cars, TVs etc well beyond their means.

So banks stop lending, people stop spending, can't buy homes, can't tap the refi atm.

Conpanies lose money and start laying people off which just takes more money out of the economy.

Its a downward spiral and there is nothing anyone can do to stop it. The market will find equilibrium one way or another.

All this bs accouning and funny money loans were based on homes increasing in value. Now that that has stopped the hole game is coming to an end.

Kip said...

For a market to work properly, some businesses must fail and some succeed. We ought to view these institutions the same way we view any other business. If you bail it out, you do so much more damage to the market, and you ensure there will be similar problems for future generations.
Bad decisions, from small ones to very very large ones, carry their own inherent consequences. These consequences provide the fuel for the evolution of systems and societies. These consequences are the very basis of the spontaneous order that comes from millions of individuals participating in an economy.
Undermining this natural process by attempting to remove the effects of bad decisions will set back our progress for multiple generations.

Kip said...

to further explain the mechanism I'm referring to,
the severity of the consequences that follow good or bad decisions is directly correlated with the weight one places on the decision making process. This is an intuitive truth that applies to every aspect of life, from child-rearing to large scale business decisions. If you soften consequences that follow the wrong decision, you propagate an attitude of flippancy in those that would make similar decisions in the future.

Buying Time said...

Any type of firm, that avoids transparency, regulation and paying taxes, does not deserve the governments money.

If you aren't willing to pay the costs, you shouldn't enjoy the benifts. I don't care if you are too big to fail. It send the wrong message. They shouldn't be allowed to free ride on our system.

alba said...

Love the fury! At least they tried to make it look like BSC didn't get bailed out. They were sacrificed. The employees, including any stockholder, got crushed financially. An investor named Joe Louis lost a $1B on the transaction. The market rallies, because they see this as a clean stoppage of the carnage...little, to no, collateral damage. The Fed pumps in more liquidity, and the problem is dissappated. Either you believe they've stopped the bleeding, or just delayed it further, with future exponential damage.

Sippn said...

BT - you got it right on.

Forget teh fancy names for the stuff - its all leverage - all a house of cards.

Southwest hedging is nothing more than a bet that prices will go higher. If fuel prices drop, they've wasted their money. THey're essentially buying fuel into the future at a predetermined price. Simple. I go to Costco and hedge toilet paper all the time. . . which right now is worth more than Bear Stearns.

sacramentia said...

I wonder if some of these investment banks will use their new ability to borrow from the Fed to start buying up the foreclosures in large chunks.

The business model is pretty good. Buy them in groups at 50 cents on the dollar, finance everything direct from the fed at sub-3% interest.

Rent from one house could cover the cost of 2 with financing direct from the discount window.

I wish I was on the list to borrow directly from the fed - I'd leverage 32:1 on that deal.

Cmyst said...

I keep touting the book "American Theocracy" by Kevin Phillips.

It is only 1/3 about theocracy; the rest of the book focuses on energy policy and on financial policy.
Phillips believes, and has convincingly argued, that the decline of a global superpower can be predicted based on their clinging to an inefficient or declining energy source (wind for Amsterdam, coal for England) and the increasing dependence of their economy on the rentier class -- which does nothing but move money around and make money off of money.
It's a very illuminating book.