Airtime: Mon. Aug. 2 2010 | 6:30 AM ET
Insight on futures, with Kathy Lien, GFT Forex; Carl Larry, Oil Outlooks & Opinions; and Peter Yastrow, Yastrow Origer.
Tags: double dipInsight on the market action, with Matt Smith, Summit Energy; Andrew Wilkinson, Interactive Brokers; and Peter Yastrow, Yastrow Origer.
Tags: Bears warnedExecutives, traders, CEO’s are all paid to make decisions. They are expected to look at all of the facts, and determine the best course of action. Weigh the options, consider the probabilities, calculate the expected values and make a decision that will have an impact on the lives of all of the people involved. If a company chooses one vendor over another, not only are all of the people affected at both vendors and our company, but the lives of all of the children and spouses as well. Decision makers are burdened with tremendous responsibility, and must cope with stress and doubt around the clock.
When the future seems more uncertain, decisions become even more difficult. When conditions are in a state of flux, EVEN IF THEY ARE IMPROVING, a decision maker often chooses to wait. Waiting and being patient are valued skills, and when the facts are changing, they are most needed. Starting a course of action, when you know that in a matter of days it might be necessary to stop, and even reverse course would seem reckless and frantic. Therefore decision makers will sit on their hands and do nothing when conditions are changing.
Knowing this:
1.What will happen before a big vote on tax increase ?
2. What will happen before a big vote on tax decreases?
3. What will happen during stimulus package implementation?
4. What will happen when rates are getting slashed?
5. What will happen when rates are getting raised?
6. What will happen before almost anything big gets finalized?
If you answered: We should see economic activity slow – YOU RE RIGHT !
This crippling fact is often why the Government and the Federal Reserve seem to get results that are contra to classic economic dogma. They seem to forget that at the end of the day, the markets, and the economy consists of millions of individuals, all acting rationally, all fearing their own humanity, not wanting to commit an error. They will each choose to wait and see how things unfold.
If our Government wants to help our economy, they should understand that enacting policies has a large cost. Unless the benefits are going to be very large, it is probably best to do nothing. Doing nothing reassures decision makers. Doing nothing lets decision makers plan for the future. Our medical community lives by the Hippocratic Oath; First Do no Harm. I can think of no better motto for our Government to live by.
J.O.Y. to the world
peter
Tags: government intrusionThe concept behind any stimulus plan, or easing campaign is quite simple. By assisting or jump-starting a sector or segment of an economy, we can then expect that other sectors of the economy will also benefit. In economics, the concept of a multiplier effect, with regard to bank lending, is considered an absolute. There is no doubt among FED officials and economists world wide, that we can expect a domino effect with regard to lending. For example, lending money to a bread maker will mean that the farmer sells more wheat, eggs, and butter. The farmer’s increased business causes him to buy more chicken feed, and milking machines. The cycle continues on, as the people who provide for the farmer see their sales rise. This ripple effect through the economy causes the positive benefits of the original bank loan to be multiplied.
When we created mortgages, we also had multiplier effects. When a mortgage banker secured a loan for a homebuyer; there was an enormous ripple effect.
The homebuyer needed movers, and curtains, and paint, and cable, and dishes, and towels, etc. All stores, from Bed Bath and Beyond to Home Depot, were positively impacted.
By making lending standards more stringent, and realistic, we should anticipate a huge negative multiplier effect. The reduction in loans being made will lead to less stimulation across many, many sectors of our economy. This contraction across all industries can only be offset by a new driver, or stimulating industry. Without a big development, then we will be hard pressed in this country to offset the drop in real estate activity.
HOWEVER- I am not advocating a reduction in lending standards- or any program that continues to allow misguided U.S. consumers to borrow money recklessly.
The last 10-15 years we saw our economy grow like never before. Lifestyles advanced. The standard of living increased. Unfortunately, this growth was a result of negligent lending that created a multiplier effect. Americans saw their business boom, and their property values increase. They were lulled into believing that this was the new normal. Now that this reckless lending has been curtailed, the multiplier effect has been lost as well.
Economies require constant technological breakouts and innovation in order to grow. We benefitted from computers in the 80s; the Internet pushed us along in the 90s. Then something changed. In the years that followed, our economy was fed a diet of artificial activity. We borrowed and borrowed rather than created and innovated. We built houses with borrowed money. The lenders thrilled to be making loans. The borrowers thrilled to be buying a house. (Maybe the biggest problem we face/ buying outright vs. credit)
It felt the same. The multiplier effects seemed real, and many of us developed a huge misconception of how strong the economy, our own finances, and our own businesses really were.
J.O.Y. TO THE WORLD peter
Tags: lending, multiplier effectThere is a healthy discussion with regard to the “Saving the Dollar” taking place right here at PeterYastrow.com. I am psyched reading all of the comments. However, I think we need to set a few things straight.
Lower rates make an economy go faster.- No debate.
BUT, there is a cost to lowering rates- No debate.
Otherwise everyone would keep rates at zero- but like all things economic, there is a golden mean, an ideal level.
So, let’s not get all crazy. There are costs associated with cutting rates to zero. We can debate whether or not it is fair; who will feel the most pain, and how the costs will manifest (will it be inflation, depression, stagflation…?).
We can also agree that rates are low. Historically, in nominal terms, they are low. In real terms, they are low. But, if there is massive deflation coming… they ain’t low enough.
I like to think of supply and demand. There is a huge supply of money. Demand is weak. The pain is being felt by savers.
The analogy I like is a cancer patient. We have performed financial chemotherapy on our very sick economy. The weakness in our currency is akin to the patient feeling weak, sluggish and rundown. However, we all understand that there are terrible side effects from the most powerful cures.
J.o.y. to the world - Peter
Tags: demand, discussion, interest rates, money, recession, supplyAustralia’s increase in rates caused an immediate rally in the Australian Dollar. It also caused a stir in the U.S. I was interviewed yesterday by a reporter eager to complete a story about the possibility that the U.S. would have to raise rates to protect the dollar. I almost puked.
Later as the evening wore on, I hear this ridiculous notion being bandied about, “That We Should Raise Rates, to Protect the Dollar.” The only lesson that we learned from the Great Depression was that we should not choke off credit in difficult economic times. During the Great Depression, the effort to protect the dollar, along with protectionist legislation, combined to crush the U.S. economy. This lesson is well known among economists. Our very own Ben Bernanke, Chairman of the Federal Reserve, did his Master’s thesis on the Great Depression.
There is no chance that our Fed is going to make the same mistakes that were made in the 1930s. They are not going to raise interest rates to improve our exchange rates. They are not going to try to strengthen the dollar and risk sending the global economy into a massive depression.
As for our government, that is a different story. There is a growing cry to protect our jobs and our industries. Our politicians could cave in to pressure and begin enacting tariffs and trade barriers. This would be the biggest mistake our nation could make at this juncture. Our country cannot raise the standard of living by taxing and impeding the flow of goods and services. Stopping or slowing foreign products from flowing into our country will do more harm than good. But politicians are not always so good with economics.
J.o.y. to the world - Peter
Tags: Australia, Ben Bernanke, credit, dollar, economics, Fed, Great Depression, recession
Groucho Marx had a famous line: “I never would want to belong to a club that would have someone like me for a member.”
I take it one step further: I would never lend money to anyone who would need to borrow from me.
Lending and borrowing are essential to a healthy and successful economy.
Lending requires trust and insight. People must be thoughtful in their lending decisions. Lending cannot be made without proper due diligence. Even if we are absolutely confident in the borrower’s integrity and desire to pay back the money, we must question his ability. Maybe the borrower is an ignoramus, who has a flawed business model. The lending decision must consider the macro-economic environment and how it will impact business owners and entrepreneurs. These owners are often so highly focused on their respective companies that they could miss the forest for the trees. Lenders cannot afford to take people at their word.
Borrowers must remain credit-worthy. For argument’s sake, let’s say a certain loan is questionable at 10%. For instance, you wish to borrow one million dollars, with the promise of repaying the million AND $100,000 of interest at the end of one year. The people decide they wish to pass. How can you sweeten the deal?
The borrower can’t offer to pay 20%!
If it looked unlikely that the borrower could get the $100,000, how does the promise of $200,000 make the deal any more feasible? The lender makes a GO or NO GO decision based on the creditworthiness of the deal (we hope), and the interest rate charged is arrived at after that decision is made. The borrower’s burden would only be greater if charged a higher interest rate. If they can’t make 10% – they certainly can’t make 20%.
This inability to borrow becomes a vicious cycle, as credit-worthiness deteriorates and borrowing costs increase. The higher costs eat into margins and weaken the financial standing of the entity. Driving borrowing costs even higher…
Once firms or industries or even individuals are caught in this quagmire, it usually ends in bankruptcy. Lenders often continue to lend to creditors with the misplaced hope that they will turn it around, or because they gave so much of themselves, they no longer can remain in business themselves.
Credit formation, credit markets, borrowing and lending- is advanced citizenship. In order for it to work, everyone must be credit-worthy. The cheaters and abusers of the system hurt everybody. The entire credit crisis facing the world today could have been avoided if the lenders had done a better job of scrutinizing, and the entire thing could have been avoided if the borrowers paid back their obligations.
Now our government is lending good money after bad. They changed the FASB rules and removed “Mark to Market” accounting rules so they can justify making bad loans. They are not being diligent, or scrutinizing, they are printing money and throwing it at the problems. The lending function has been corrupted.
We have jumped in the raging sea.
Joy to the world- peter
Tags: accounting, borrowing, credit, Groucho Marx, interest rates, lendingConvexity or Gamma in the financial world makes people think of high school geometry class, and their eyes glaze over. Yet convexity is a major source of our global credit market pain. All around the world, investors have been burned by toxic mortgage products. The toxicity of these mortgages is a result of the “short gamma” or negative convexity embedded in these products.
Convexity, or gamma, means that your instrument of choice, whether it be a bond, or an option does not move in a consistent manner, but rather its performance accelerates, or decelerates as compared to its benchmark or underlying assets.
This changing correlation means that to hedge the instrument, the trader must continually rebalance the amount of securities in his portfolio.
The curvature in mortgages comes from prepayment. The borrower has an option to pack back early. The choice to immediately terminate the loan, or not, gives borrowers great power. Consequently it gives the lender a tremendous burden. Hedging can be quite difficult.
In a simple example:
Peter borrows $1 million from Mortgage Mavens to buy a house. Mortgage Mavens charges Peter 5% on a 15 year loan. MM is at risk.
If interest rates rise, then they get burned on the cost of their money. That is easy to hedge, they just borrow the money and lock in the lower rate.
Problem- what if rates drop, and MM already locked up the rates? No problem because they lent at 5%, and have locked up the rate… except now Peter pays back the loan, because he was offered a 4% mortgage by FU and Co. There is no safety for the mortgage lender.
The problem never goes away, until the mortgage is paid off. However, the less volatile the interest rate market, the easier it will be to hedge the products. It will also be less expensive in a calm market, as fewer trades will be required.
Unfortunately, our Federal Reserve is in the middle of the biggest financial experiment in the history of the world, at the same time that our government has created the biggest deficit in the history of the world. This makes divining future interest rate changes almost impossible. We are in unchartered waters. Interest rates are extremely volatile, and will remain volatile for a long time.
The housing market was fueled by cheap finance- without cheap finance, the prices of homes, and the frequency by which they were bought and sold will be significantly lower. The US economy was powered by ridiculous lending standards, and will not recover any time soon.
Tags: convexity, credit, economics, hedging, housing market, interest rates, investing, lending, mortgages, recession, risk