Thursday, October 9, 2008

Diane Francis on Financial Turmoil

These columns by Diane Francis are a good commentary and also enlightening regarding the current credit collapse. The first item was on her blog and is a response to her column that is the second item. I have read her stuff since she cut her teeth in Vancouver many years ago.

It is very encouraging to see how Bank of America is handling their mortgage portfolio inherited from Countrywide. They are not foreclosing, but are rewriting the mortgages so that the customers can do a workout. This is similar to what I have been posting. It is wonderful to see that at least one bank has remembered what business that they are in.

Expect to see every other bank to follow this lead as the only way forward. This means that it is now very timely to acquire distressed properties because fresh inventory will cease coming to the market. It will still take a fair bit of time for this to fully be understood, but the first major step by the nation’s most important bank has been taken.

This means a reinvigorated housing market and a chastened banking industry that is no longer chasing the mirage of high returns from fine financial manipulation. I am possibly months early in proclaiming an end to this disaster but we are surely at the bottom of the equity slump and the banking industry is having to having to confess its sins and governments are doing their duty in applying the necessary bandages and extracting a very punishing pound of flesh so that the owners never forget the drubbing.

I think it is very appropriate that the five largest independent brokers are no longer investment bankers at all. What were they thinking? They were paid to know better and instead they destroyed their firms and even the wealth of everyone they ever worked with. Yet all of the next tier of independent brokers are obviously doing fine and are quite happily picking up the slack. That alone tells you that what they did was likely fraud. Their real peers all knew better.

To help understand what can go wrong, let me try to explain it. Banking works because you can borrow short term and lend long term and you are licensed and regulated to do so. The challenge is to match maturities as best that you can in order to allow you to do more business.

The risk is collusion in the creation of credit worthy product that is long term in nature that allows a pig to be slid past the watchdogs. We are now hearing for the first time about credit swaps. Quite simply, I guarantee the value of my two five thousand dollar pigs when I sell them to you and you guarantee the value of the ten thousand cow you sell me in exchange. We then trade these guarantees of to an impecunious pauper so that it becomes third partied. This also allows you to avoid the sharp eyes of your own auditors or al least provides appropriate cover for their collusion.

You then make a business of it and it becomes known as a Ponzi scheme in all but name. Obviously all five convinced themselves that the short term money would always be there and that their gold plated reputations would maintain the bluff. Yet the Achilles heel was always that such schemes must continue to grow because no one can actually repay the loans. And then the music stops.

How anyone thought that individuals could support a mortgage without first establishing a sufficient income is utterly beyond me.

Better solutions needed now

Posted: October 07, 2008, 8:00 PM by Diane Francis

Filed under:
Greed,U.S. Politics

You're asking me? President Bush in action today at a press conference on the crisis
Great idea to fix this mess

This is a wonderful solution for the credit crisis which was sent to me by the smart and sometimes irreverent Fred Lazar, Professor at York University in Toronto. It would provide a global fix and also makes a whole lot more sense than does the $700-billion idea of buying the junk out from under the investment banks and others:“
Dear Diane

I am writing in response to your article in today's Financial Post. Here are my suggestions for addressing the mess in the financial markets.

First, Bernanke, (who is brilliant and doing everything possible, unfortunately with little help form anyone else) and Paulson should invite their counterparts from Europe and Asia to Washington. Once there, they should lock them in a room, with a number of thugs from the Teamsters hired to act as security. No food or drink should be provided. Then, while I would like the Teamsters to pound some sense into the Europeans and Asians, I will settle for Bernanke and Paulson reading them the riot act. In particular, that if they do not get their full cooperation, the US will go into protectionist mode once the worse of the crisis is over.

Stopping the hedge fund/stock market catastrophe

After this meeting, Bernanke, Paulson and their brethren from Europe and Asia should invite the CEOs of every major financial institution in the world, including hedge funds, pension funds and mutual funds. Again, the Teamsters would be a nice touch.The hedge funds should be offered access to short-term financing and a 12-month freeze on redemptions. In return, the hedge funds will give up their 2% fee, and reduce their 20% share of profits to 5%.

If they do not agree, they should be cut off from funding, and the international government bailout company should move in to buy all assets which the incalcitrant hedge funds will be forced to liquidate at pennies on the dollar. The objective is to stop hedge funds from dumping assets.

Similarly, the mutual funds should be offered a 12-month freeze on redemptions, but only if they reduce their MERs to below 75 bps.

Commercial banks

The banks should be told that they better start lending short term and lower the rates on these loans. They should be given a few hours to do so. In return, the bailout company will acquire their most illiquid and toxic assets for about 60 cents on the dollar. In addition, the CEOs will only be paid $250,000 per year for each of the next five years, with no bonuses, stock options, share grants or other forms of compensation.If a bank refuses to go along with this, it should be excluded from the buy-out of toxic assets, and the governments should bad mouth the bank so as to drive down the share price. Create uncertainty and panic in the minds of investors in banks who do not go along with the plan, and then the bailout company can buy control at a deep discount.Governments must take over

Governments will have to put a lot of pressure on all financial institutions to get off their asses, takes some more hits, make some sacrifices and start taking some active responsibility for helping to get out of this mess.


Another systemic fix, coordinated globally, is also needed -- interest rate cuts; relief from mark to market adjustments and this is very well articulated by one of my favorite economic journalists, Martin Wolf at the
FT today.

Posted: October 06, 2008, 4:50 PM by Diane Francis

Filed under:
Greed,U.S. Politics

Warren Buffett warned two years ago that the derivatives madness generated by Wall Street was the ultimate “weapon of mass destruction”.

In essence, US$42 trillion worth of bets, called credit default swaps and peddled by the Big Five, were offside. So US$42 trillion – roughly one year’s global GDP – is owing by a bunch of people and companies who cannot afford to pony up to a bunch of people.

These were a form of lucrative “insurance” policies but without any capital or assets to back up the bet.
So what’s happened is that everybody who thought they were “insured” against risk were not, as though some gigantic global insurance company sold hurricane insurance and had no money to repair the devastation after the hurricane hit.

It was a massive loophole through which the MBAs and others on the street leaped, raking in upfront premium income but without anything to back up their guarantee. I think it’s fraud and I hope that every executive with every Wall Street firm is pursued by police, shareholders, regulators and tax officials.

Buffet was right and I’ll bet he wishes he wasn’t.

Now we are starting a long “nuclear winter”, or two, as credit seizes up with countries like Russia and state governments like California hitting the wall. More will follow and the multi-billion dollar bailouts will swell to trillions.

It will take a global effort: Interest rates must be cut worldwide. Mark to market rules eased. Without these measures, the global economy is a corpse without blood to sustain life.

Here are some stories from the trenches south of the border:

A relative of mine who works for a medium-sized engineeringn consulting firm said there have not been any projects for weeks and none on the horizon.

Discretionary infrastructure projects are financed by local/state governments and they raise money by selling bonds, many of which are in default or cannot be rolled over.

This emergency is going to require a global fix involving alln the sovereign governments. Some of the financial institutions, or large corporations, that will go under are too big to be bailed out by the nation-state they reside in. Like Fortis, which has had to be bailed out by three countries.

The stocks of fertilizer companies were clobbered last weekn because U.S. farmers cannot get loans to plant their next crops or to buy equipment or feed. The equivalent of ten states of agricultural output are exported from the United States around the world so this has frightening implications unless Washington bails out its farmers.

Most of the Wall Streeters, including those who had alreadyn left their firms within the last two years, have mostly been
wiped out. The rules on the street were that you were paid in stock options which were usually not vested for two years after departure. One woman I interviewed in New York this weekend was two months away from being able to cash in her nest egg of Lehman Brothers stock. She is wiped out completely and is declaring personal bankruptcy to get out from under tax, bank, mortgage and other obligations.

Retailers are in trouble and September sales were down byn double-digits among most chains. Wal-Mart, the market leader, announced it will cut in half its toy prices for Christmas.

` The Center for Economic and Entrepreneurial Literacy inn Washington revealed that eight out of 10 congressman have no background in economics or business. Little wonder that economic management or policy was not a priority.

The only good news in this global reverse beauty contest (least ugly wins) is that Canada is going to have problems, but is actually the least-ugly of the bunch.

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