There has been tremendous blame levied on the finance industry for buying up collateralized debt obligations. And this makes intuitive sense since we ought to expect them to exercise better personal judgment. The little known fact is that their personal judgment has been largely crowded out by the SEC and replaced by its own list of approved judges.
In 1975 the SEC began requiring the use of credit rating agencies that only the SEC could approve. At the time, the requirements for using these agencies were limited in scope, but in the past 30 years this has grown in scope to the point where only a handful of companies are the de facto judge and jury for financial worthiness. In effect the SEC has crowded out independent judgement by sanctioning these rating agencies.
You can learn more about this regulation at from the SEC itself, the rating agency article on Wikipedia and a recent Wall Street journal op-ed.
It is amazing the SEC has faced so little public criticism for its role in this debacle as well as the Bernie Madoff scandal where it completely failed to protect investors. It is about time we stop pretending the SEC protects us and start reinstituting private credit rating agencies with full latitude to find and prevent such meltdowns.
Computer World is reporting that students are considering changing from finance to IT and software development. There is also specultation that many of the unemployed from Lehman, Meryll and WaMu will be sending their resumes to IBM, Microsoft, Google and Oracle. This is a small sign that the economy is starting to right itself. The sooner labor is put where it can best generate profit, the sooner we can get back to growing GDP.
This development underscores, why we need to reach a faster valuation of these so-called “toxic assets”. The faster money flows out of unproductive investments and into productive ones, the better off our day-to-day lives will get. Money invested in great companies yields cheaper and better products for consumers. For investors it means higher profits, dividends and stock valuations. The longer money is tied up in this bad investments, the longer we delay these fruits by holding back money from people in the economy ready to create new ventures.
Two things will help us get to faster valuations. First and foremost, the government can stop injecting itself into the equation and showering money on worthless assets. Secondly, we can eliminate the up-tick rule on shorting stocks. When stocks are shorted someone makes a profit on the drop, once they make that profit, they can invest that money in something more productive. Instead, regulators like Barney Frank and Christopher Cox would prefer money is left in withering investments.
There is a great post that helps concretize the lost value over the past year at TechCrunch: The Mess on Wall Street Four Trillion Dollars Down the Drain.
Where did this money go though? It didn’t all just vanish. Yes, some is the result of people simply buying for less, but they didn’t buy it for $0. Some of it flowed into other capital markets where investors thought it was better spent.
This capital retraction will also affect IT spending as pointed out by Valleywag. Ironically, this is the very time that the finance sector should be bullish on IT investment, but I am willing to believe they in fact will not be.
Just came across this http://www.jacksonfish.com/blog/2008/02/04/and-this-is-why-going-public-is-a-non-goal/ and was reminded of a class I took this summer on corporations. I had a good realization in that class that really public markets afford a specialization or division of labor that focuses on capital allocation and leaves management to someone else. If you don’t need that specialization of capital allocation from someone else, and you don’t want to be beholden to that, you really shouldn’t be going public. There’s lots of excitement around IPOs and public companies, so a lot of people assume that’s the only route to go.
It’s also not clear trading publicly in the market is so great anymore. There is so much regulation, that now we’re seeing lots of private acquisitions.
Note to self for future… this is a good site for compiling stats: http://www.bea.gov/national/nipaweb/TableView.asp?SelectedTable=299&FirstYear=2002&LastYear=2004&Freq=Qtr
I need to get smarter about what GDP really means. It’s interesting that it discounts housing, which is a huge part of the economy (it’s my biggest monthly expense). I don’t get why this is discounted.
I read up a bit from Salsman who rightly points out a lot of GDP is bunk: http://forums.4aynrandfans.com/index.php?showtopic=679
As mentioned in my last post, I think the most interesting news going on in business is getting burried in the press. Burried on page 73 of Business Week in an article titled $1.6 Trillion. Now We’re Talking Stimulus, to be precise.
Here are some select quotes:
- “But before you get stoked over just $150 billion in tax aid, forget not the huddled, cuff-linked masses, those with millions of fiduciary mouths to feed but who are too scared to spend. American CEOs, with hundreds of billions at their disposal, could make more of a stimulative difference than all of our shopping sprees combined.”
- “According to Moody’s Investors Service, a record $1.6 trillion in cash sits on the books of nonfinancial U.S. companies, $600 billion more than was there five years ago.”
- “”Management is admitting that they just see no opportunities,” says Ivan Feinseth, chief investment officer of AlphaWorks, a Manhattan hedge fund that screens investments for how efficiently they use capital.”
- “Prediction: This passivity will not stand. In a hyperglobalized, weak-dollar economy, U.S. balance sheets have never been so prone to international scrutiny. Cash is fungible and speaks all languages. It appeals to every constituency, from employees and shareholders to lawmakers and creditors, from Wall Street analysts to labor unions. Leave too much of it out there, and you will be told what to do with it.”
What does this mean in the short term? I consider it a huge insurance policy against a crash in the market. Companies who see their stocks dips are very likely to buy back their own stock at discounted prices.
What does it mean in a historical sense though? This is the real question that interests me. It’s alarming to hear this surplus has grown 60% in 5 years. I wish I could dive deaper into the Moody’s report, but their website doesn’t list much stuff that you can get for free. That aside, the numbers in the BW article tell me that companies don’t have great ideas on where to put their new found profits.
I will go out on a limb and guess they also don’t have the staff to charter new endeavors. And if that’s right it means we have billions of dollars of opportunity cost queued up behind finding a class of workers that can seize working capital and launch into new businesses, even create whole new industries. It’s ironic that at this very time Republicans are hell bent on selecting a presidential candidate that will close down our borders and want to spend billions upwards of $80 billion on fencing and law enforcement. What if we spent just $100 million in ads around the world attracting college graduates to come to the U.S. to work?
I think this is also an indicment on MBA programs. While Gross National Income is certainly one measure of their success, this $1.6 trillion is a measure of opportunities management and leadership could not harness.
It’s a great time to be a manager and leader, because there are more than a billion people from Brazil, Russia, India and China coming into the world marketplace. This has been well reported by Thomas Friedman. And now we find their is hundreds of billions of dollars waiting to be spent sitting in the pockets of corporate America.
I just got through reading this weeks Business Week and wanted to make sure to capture some things I thought were interesting so I can chew on them.
The splashy cover story “Credit on the Edge” details what BW thinks is a coming crisis in consumer credit. The most interesting stat to me is the mean household credit card balance–$7,000. That would be a lot for me to carry even on my salary. I can’t imagine that on the median income in the U.S. of $44,389 where more than half of those homes support 1 kid (based on a median household size is 2.57)–see Wikipedia for details.
I was curious what the total dollar figure of consumer debt is. The BW article didn’t include this so far as I could tell. The Motley Fool takes a crack at this. Their numbers don’t add up though if you assume there are 114 million households in the U.S. The Motley Fool number would get you a mean debt of $14,912–a full 86% more than both the BW number and Motley’s own $8,562 number. So I think folks are either counting what constitutes “consumer credit debt” differently or are using spurious numbers for the number of households.
In any event, if you take the low number of $8,562 that’s really high. In the short term I would invest in companies like Pay Day Loans and Money Tree, because they will make a fortune trying to provide liquidity for families. Interestingly, the BW article points out these same companies are now building stores in more affluent neighborhoods they wouldn’t have touched 5 years ago. In the medium term, I am sadly resigned that congress will step in trying to solve the problem and of course end up making it a bigger mess. I would not want to be in the banking industry, because there’s so much uncertainty what regulation will do. And certainty is exactly what the industry needs, since it’s the only way investors will get back in the game. And that’s why I am sad about what our politicians will likely do.
So does this mean the U.S. is horribly unhealthy and in deep danger? Part of me instinctively says no, because I know what’s really happening here: companies like Citi, Capital One and Chase in exchange for providing liquidity to consumers reap large profits. They don’t stuff that money in their mattress, but instead either invest in new business by handing out loans or return that money to shareholders in dividends and stock buy backs. So far America is doing just fine. The one problem I see though is that we’re tying up a lot of human energy (and probably capital assets) spining our money around in ways that could be easily avoided if we all just spent our money more wisely and saved enough so that we didn’t cary credit card balances month to month. How much energy is spent on this? It’s hard to say, but I’ll take a very crude stab. Capital One employes 31,000 people. They certainly do more than credit cards, but this is easily the bulk of their business providing about 75% of their net income. That’s 31,000 people that could have been employed building other cool products or delivering fantastic service. Those 31,000 people are put in probably dozens if not hundreds of office buildings; space tied up that could be used for something better.
On the balance, I think the macro economy is just fine. I am very happy to have those 31,000 people at Capital One, because it means I don’t have to make extra trips to the cash machine. I just plunk down my Visa and get a cup of coffee at Starbucks. And I pay one single bill for the whole thing at the end of the money. It’s a huge time saver for me and no doubt thousands of other people.
The real news in BW was burried on page 73. I think it’s so important I am going to give that news its own blog entry.
Part of my goal with this blog is to keep better track of ideas I have on businesses I could start down the road.
One of the huge opportunities is personal finance. Here are some observations:
- The national savings rate is getting a lot more attention, and I think people are paying more attention to consumer credit debt
- I meet a lot of people who don’t understand how to make their money work for them and truly appreciate what it’s doing
- One friend owns a condo and is reluctant to take out a home equity loan to pay for improvements in their kitchen
- One friend thinks they should pay down their home loan faster
- Another follows the news in the stock market and feels powerless amidst all the bad news in the press
- Internationally lots of new people are coming onto the playing field of capitalism with little training from their parents who grew up in a totally different political situation
- Lots of boomers are going to start cashing out their 401k and pensions
- It’s hard to see the forest from the trees, a lot of the tools out there today are for paying bills and managing the tactics of finance–not helping me see the big picture
- Apps like Money and Quicken make it seem like the goal is to get things balanaced and accurately account for everything–that’s basically a giant waste of time!
- I have to log into Fidelity, Bank of America, Amex, and Chase all separately to make transactions. Money or Quicken will aggregate data in a one-way approach, but that doesn’t really help me take action
- Whenever I listen to the radio, there is a deluge of ads for refis. This has got to be artificial. There really cannot be that much human value in this. We’ve started to see a correction in this, and we’ll see more I think.
Some companies I want to explore more: Geezeo, Yodlee, Mint, Voyant, BoulevardR, Quicken, Wesabe.
Another way to think of it: what would it mean to “zillow”-ify the finance space.
Finally, and perhaps most interestingly, the advertising industry is going to grow hugely. No one seems to be really cashing in on the notion of pay-per-spend advertising. It’s all about pay-per-click. There are clearly privacy issues, but utlimately their is a HUGE goldmine of information in people’s spending habits.