Well, since my last post, we have seen the beginnings of what I have expounded to date. We have seen the DOW fall from roughly 11k to 8500 as of today. The DJIA is down a full 40% from it's highs exactly one year ago today of roughly 14150. A historical analysis of secular bear markets indicates that we usually see a drop from market highs of 30-50%, dependent upon various economic conditions. Given the fact that we're as close to a "perfect storm" of economic stressors as we can get without entering into a bonafide depression, I'd say we have farther to go before we see a market bottom. We're already at 40%, 50% would put us closer to DOW 7000. Only time will tell how low we will go. Secular bear markets are also characterized by lower than average PE (Price Earnings) ratios. A historical analysis of PE ratios since market inception indicates an average PE ratio of 12:1. More recent averages over a period of time post inception (the last 25-50 years) show an average PE ratio of 15:1. We're sitting close to 12:1 at this moment at DOW 8500, however, it is important to realize that we're talking a mean or an average here, and in secular bear markets, we usually see the lower side of the historical average, so it is likely we'll see DOW 7000 with PE ratios falling to 10:1 or perhaps even a bit lower.
One thing we've learned over the past two weeks is that the false assumptions made a year ago regarding the nature and extent of the problems we're experiencing are in fact far more widespread than originally expected. It was after all the very same Hank Paulson who uttered in testimony two summers ago now that the subprime mortgage problems would be contained and would not spread to other markets. Surprise! We're now suffering through the largest financial meltdown since the Great Depression itself. Some 59% of Americans, according to CNN polls, believe an economic depression may become a reality. While I am all but certain that we will suffer through a major recession, I remain somewhat optimistic given the failsafe government institutions and extraordinary measures currently being undertaken in an effort to minimize the effects of the global banking crises that we're bearing witness to. Yes folks, this is indeed a global crisis. While we're hearing about how over-leveraged the U.S. investment banks were at 30:1 on average, the European banks on average are leveraged some 50:1. Iceland has nationalized their three largest banks, and the chances of an economic depression seem likely. Overall, while it may be difficult for us to fathom, the European nations are in even worse shape financially than the U.S. banks are, and with the much higher leverage ratios, have much more pain and turmoil to look forward to. The developing nations and emerging economies, especially China and India, are heavily dependent export economies, meaning these export dependent nations primarily depend upon the U.S. and European nations to consume their exports. With the massive and inevitable financial de-leveraging process that the U.S. and European nations must undertake, which will require less lending due to tightening credit markets, export dependent economies will also be hard hit. Look for India and China to continue to experience downward economic pressures. In short, we are quite possibly looking at a global economic recession. As Thomas Friedman expounded in his book The World Is Flat, we are all connected, all of our economic systems are intimately intertwined together. A large failure in any one part of the global economic system cannot be contained, as we thought in the case of the subprime mortgage problems, and therefore by definition such a failure will have widespread effects on the global economic system.
Whatever solutions to the global economic problems we're currently experiencing will be measured in years, not days, weeks, or months. The average secular bear market lasts 17 years. The bull market ended in year 2000. We have seen below average market returns since that time, and the recent market declines take us all the way back to 2003. Chances are we will not see a return to a true bull market until the latter half of the next decade. This means we can expect single digit market returns for a number of years. For those with a 20+ year timeframe from an investment perspective, there's not much to worry about. For those with a five year timeframe, it's time to worry, even ten years out, I'd be concerned based upon historical secular bear market analysis.
Goodnight all! :-)
Thursday, October 9, 2008
Monday, September 22, 2008
Wall Street forever changed?
Yesterday evening the Federal Reserve instituted a change to the bank charters for the two remaining, surviving large investment banks. Goldmann Sachs and Morgan Stanley's banking charters are changing, literally overnight, from an invtestment banking charter to a commercial banking charter. This is yet another unprecendented change in how our financial systems are structured. As I commented just this morning on another web forum, it is hard to get my mind around the amount of change we're seeing moment by moment in the financial world right now. The entire financial landscape is literally changing form right before our very eyes. These changes will inevitably have lasting and profound effects on our collective futures. Whether these changes are for better or for worse, remain to be seen.
What does this change in banking charters for Morgan and Goldmann mean? It means that these two investment houses will be converted into bank holding companies overnight. It means that, once put into effect, just like any other commercial bank, these two entities will be able to form retail banking establishments that can take your deposit monies. This is a way to allow the struggling entities to re-capitalize over time. It also means that the era of the highly leveraged investment houses with limited oversight has come to end this week. Commercial banks have much more stringent capital requirements and are subject to much stricter and more invasive oversights than investment houses were ever subjected to. So, these two entities, which are currently leveraged well over 20:1, will need to de-leverage down to somewhere in the ballpark of 10:1. That is quite a large delta. Now, no doubt taking on additional customer deposits will help close to gap, but this is assuming there are a large number of depositors willing to take on the additional risks, even if those risks are FDIC insured, with their deposit monies. It'll be most interesting moving forward to see how these huge fundamental shifts in the banking sector will take shape over the next several months.
As this week starts out, as per my last blog post, there is much to debate surrounding the impending bailout legislation, and I've been a part of several forum conversations where opinions range from a full endorsement of a bailout to those that are deadset against any bailouts what-so-ever. For the most part, people fall somewhere in the middle. Many feel that we need to outline a lot of punitive measures as part of the initial bailout bill. I disagree, now let me explain why.
If we hold up this legislation arguing over specifics, and a financial meltdown triggers in the meantime, there will be no stopping it at some point. Timing is of the essence here. We have about a week, and if we don't see the government step in within a very short timeframe, we're in real trouble whether or not we "normal folks" can understand what's going on behind the scenes here. Very few people have a really good understanding of the critical importance of the credit markets for businesses to function day to day. The destruction of commercial credit, if "allowed" to occur, will bring on a 1930's style problem, and I don't think that is in anyone's best interest.
Yes, we need serious regulatory reform, and we need consequences doled out over the next several years to those responsible for these problems, but we don't need this verbage in the bailout bill, we need the bailout bill to be passed now, then we can dealve into the required regulatory reform and legal ramifications over the next few months. The bottom line is that the best and brightest on Wall Street are having a difficult time unravelling the complexities of the derivative securities with respect to how to move forward with any bailout. I personally don't want Congress even attempting to alter established law as they're a bunch of lawyers who don't have a good understanding of economics or finance.
Let's use an example here to drive home my point. Wall Street was just wheeled into the ER complaining of severe chest pain, akin to a heart attack in progress. That's not the time to argue over how the patient's diet over the past 20 years led them to the position they're currently in. It's also not the time for the doctor's to argue over methods of treatment, and order a bunch of tests and scans that take hours to get a result back. It's time to get the small number of key medical tests done immediately that give the doctor's enough info to administer life-saving drugs and/or surgeries in an effort to save the patient's life ASAP. Once the damage to the patient's heart has been minimized and they've made it through the initial heart attack, then the doctor's can argue over the best course of treatment and how to alter the patient's lifestyle permanently in order to give the patient the best chance to live a long, prosperous life moving forward.
Some may argue we're not in dire straits per the above example, and I would very much disagree based upon the statistics we're seeing in the commercial credit markets, housing markets, and financial markets. Introducing even more regulatory change into what is already clearly an uncertain market may have severe unintended consequences in the short term, and may in fact make any chances of a bailout succeeding much less likely. Paulson is very aware of this fact, hence his reservations. No doubt this is going to be a very interesting week on Capitol Hill. I for one will be watching quite intently day to day to see what happens.
What does this change in banking charters for Morgan and Goldmann mean? It means that these two investment houses will be converted into bank holding companies overnight. It means that, once put into effect, just like any other commercial bank, these two entities will be able to form retail banking establishments that can take your deposit monies. This is a way to allow the struggling entities to re-capitalize over time. It also means that the era of the highly leveraged investment houses with limited oversight has come to end this week. Commercial banks have much more stringent capital requirements and are subject to much stricter and more invasive oversights than investment houses were ever subjected to. So, these two entities, which are currently leveraged well over 20:1, will need to de-leverage down to somewhere in the ballpark of 10:1. That is quite a large delta. Now, no doubt taking on additional customer deposits will help close to gap, but this is assuming there are a large number of depositors willing to take on the additional risks, even if those risks are FDIC insured, with their deposit monies. It'll be most interesting moving forward to see how these huge fundamental shifts in the banking sector will take shape over the next several months.
As this week starts out, as per my last blog post, there is much to debate surrounding the impending bailout legislation, and I've been a part of several forum conversations where opinions range from a full endorsement of a bailout to those that are deadset against any bailouts what-so-ever. For the most part, people fall somewhere in the middle. Many feel that we need to outline a lot of punitive measures as part of the initial bailout bill. I disagree, now let me explain why.
If we hold up this legislation arguing over specifics, and a financial meltdown triggers in the meantime, there will be no stopping it at some point. Timing is of the essence here. We have about a week, and if we don't see the government step in within a very short timeframe, we're in real trouble whether or not we "normal folks" can understand what's going on behind the scenes here. Very few people have a really good understanding of the critical importance of the credit markets for businesses to function day to day. The destruction of commercial credit, if "allowed" to occur, will bring on a 1930's style problem, and I don't think that is in anyone's best interest.
Yes, we need serious regulatory reform, and we need consequences doled out over the next several years to those responsible for these problems, but we don't need this verbage in the bailout bill, we need the bailout bill to be passed now, then we can dealve into the required regulatory reform and legal ramifications over the next few months. The bottom line is that the best and brightest on Wall Street are having a difficult time unravelling the complexities of the derivative securities with respect to how to move forward with any bailout. I personally don't want Congress even attempting to alter established law as they're a bunch of lawyers who don't have a good understanding of economics or finance.
Let's use an example here to drive home my point. Wall Street was just wheeled into the ER complaining of severe chest pain, akin to a heart attack in progress. That's not the time to argue over how the patient's diet over the past 20 years led them to the position they're currently in. It's also not the time for the doctor's to argue over methods of treatment, and order a bunch of tests and scans that take hours to get a result back. It's time to get the small number of key medical tests done immediately that give the doctor's enough info to administer life-saving drugs and/or surgeries in an effort to save the patient's life ASAP. Once the damage to the patient's heart has been minimized and they've made it through the initial heart attack, then the doctor's can argue over the best course of treatment and how to alter the patient's lifestyle permanently in order to give the patient the best chance to live a long, prosperous life moving forward.
Some may argue we're not in dire straits per the above example, and I would very much disagree based upon the statistics we're seeing in the commercial credit markets, housing markets, and financial markets. Introducing even more regulatory change into what is already clearly an uncertain market may have severe unintended consequences in the short term, and may in fact make any chances of a bailout succeeding much less likely. Paulson is very aware of this fact, hence his reservations. No doubt this is going to be a very interesting week on Capitol Hill. I for one will be watching quite intently day to day to see what happens.
Sunday, September 21, 2008
We the taxpayers own all of the bad mortgage debt?
Well, per the title of today's blog entry, it would certainly seem so. For those who haven't seen the legalese particulars of the draft legislation to authorize the Treasury to spend some 700 billion "at any one time" to buy up the bad mortgage debts all tied up in various overly complex "investment" securities, ala RBMS, CBMS, CDO's, CLO's, etc., here it is:
The following is the legislative proposal from Treasury Department for authority to buy mortgage-related assets:
Section 1. Short Title.
This Act may be cited as ____________________.
Sec. 2. Purchases of Mortgage-Related Assets.
(a) Authority to Purchase.–The Secretary is authorized to purchase, and to make and fund commitments to purchase, on such terms and conditions as determined by the Secretary, mortgage-related assets from any financial institution having its headquarters in the United States.
(b) Necessary Actions.–The Secretary is authorized to take such actions as the Secretary deems necessary to carry out the authorities in this Act, including, without limitation:
(1) appointing such employees as may be required to carry out the authorities in this Act and defining their duties;
(2) entering into contracts, including contracts for services authorized by section 3109 of title 5, United States Code, without regard to any other provision of law regarding public contracts;
(3) designating financial institutions as financial agents of the Government, and they shall perform all such reasonable duties related to this Act as financial agents of the Government as may be required of them;
(4) establishing vehicles that are authorized, subject to supervision by the Secretary, to purchase mortgage-related assets and issue obligations; and
(5) issuing such regulations and other guidance as may be necessary or appropriate to define terms or carry out the authorities of this Act.
Sec. 3. Considerations.
In exercising the authorities granted in this Act, the Secretary shall take into consideration means for–
(1) providing stability or preventing disruption to the financial markets or banking system; and
(2) protecting the taxpayer.
Sec. 4. Reports to Congress.
Within three months of the first exercise of the authority granted in section 2(a), and semiannually thereafter, the Secretary shall report to the Committees on the Budget, Financial Services, and Ways and Means of the House of Representatives and the Committees on the Budget, Finance, and Banking, Housing, and Urban Affairs of the Senate with respect to the authorities exercised under this Act and the considerations required by section 3.
Sec. 5. Rights; Management; Sale of Mortgage-Related Assets.
(a) Exercise of Rights.–The Secretary may, at any time, exercise any rights received in connection with mortgage-related assets purchased under this Act.
(b) Management of Mortgage-Related Assets.–The Secretary shall have authority to manage mortgage-related assets purchased under this Act, including revenues and portfolio risks therefrom.
(c) Sale of Mortgage-Related Assets.–The Secretary may, at any time, upon terms and conditions and at prices determined by the Secretary, sell, or enter into securities loans, repurchase transactions or other financial transactions in regard to, any mortgage-related asset purchased under this Act.
(d) Application of Sunset to Mortgage-Related Assets.–The authority of the Secretary to hold any mortgage-related asset purchased under this Act before the termination date in section 9, or to purchase or fund the purchase of a mortgage-related asset under a commitment entered into before the termination date in section 9, is not subject to the provisions of section 9.
Sec. 6. Maximum Amount of Authorized Purchases.
The Secretary’s authority to purchase mortgage-related assets under this Act shall be limited to $700,000,000,000 outstanding at any one time
Sec. 7. Funding.
For the purpose of the authorities granted in this Act, and for the costs of administering those authorities, the Secretary may use the proceeds of the sale of any securities issued under chapter 31 of title 31, United States Code, and the purposes for which securities may be issued under chapter 31 of title 31, United States Code, are extended to include actions authorized by this Act, including the payment of administrative expenses. Any funds expended for actions authorized by this Act, including the payment of administrative expenses, shall be deemed appropriated at the time of such expenditure.
Sec. 8. Review.
Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.
Sec. 9. Termination of Authority.
The authorities under this Act, with the exception of authorities granted in sections 2(b)(5), 5 and 7, shall terminate two years from the date of enactment of this Act.
Sec. 10. Increase in Statutory Limit on the Public Debt.
Subsection (b) of section 3101 of title 31, United States Code, is amended by striking out the dollar limitation contained in such subsection and inserting in lieu thereof $11,315,000,000,000.
Sec. 11. Credit Reform.
The costs of purchases of mortgage-related assets made under section 2(a) of this Act shall be determined as provided under the Federal Credit Reform Act of 1990, as applicable.
Sec. 12. Definitions.
For purposes of this section, the following definitions shall apply:
(1) Mortgage-Related Assets.–The term “mortgage-related assets” means residential or commercial mortgages and any securities, obligations, or other instruments that are based on or related to such mortgages, that in each case was originated or issued on or before September 17, 2008.
(2) Secretary.–The term “Secretary” means the Secretary of the Treasury.
(3) United States.–The term “United States” means the States, territories, and possessions of the United States and the District of Columbia.
I especially love Section 8, complete legal immunity for everything. Beyond the usual CYA tactics, you have to wonder why that needs to be explicitly outlined.
Also, the verbage surrounding the 700 billion "outstanding at any one time" I find interesting. This could end up being manipulated to put us into a lot more than 700 billion of actual debt, dependent upon how the distressed assets are inherited, repackaged, and eventually sold off for cents on the dollar. For instance, once a distressed asset is repackaged and sold, it may technically no longer be applicable against the 700 billion limitation, because the asset was sold off the government books. Fun fun!
So, we are certainly living in interesting times. I came upon an interesting tidbit of information yesterday that I wasn't previously aware of. Apparently, in 2003 Chris Cox, who runs the SEC or Securities Exchange Commission, changed the leverage regulations for the large investment houses. Previously, the i-banks were limited to 12:1 leverage ratios. The change made under the current administration's watch effectively allowed unlimited leverage ratios for the five largest i-banks. Lehman Brothers died with a 32:1 leverage ratio. Care to guess who the five largest i-banks are? Here's the list: Bear-Stearns, Lehman Brothers, Merrill Lynch, Goldmann Sachs, and Morgan Stanley. Boy, that list sounds awfully familiar doesn't it? These are the exact same five i-banks that are now on the ropes so to speak, three of which no longer even exist in their original forms, with other two not looking so good. In hindsight, de-regulating the large i-banks without introducing additional oversite was not a good move on the part of the Bush 43 administration in my view.
More later folks! :-)
The following is the legislative proposal from Treasury Department for authority to buy mortgage-related assets:
Section 1. Short Title.
This Act may be cited as ____________________.
Sec. 2. Purchases of Mortgage-Related Assets.
(a) Authority to Purchase.–The Secretary is authorized to purchase, and to make and fund commitments to purchase, on such terms and conditions as determined by the Secretary, mortgage-related assets from any financial institution having its headquarters in the United States.
(b) Necessary Actions.–The Secretary is authorized to take such actions as the Secretary deems necessary to carry out the authorities in this Act, including, without limitation:
(1) appointing such employees as may be required to carry out the authorities in this Act and defining their duties;
(2) entering into contracts, including contracts for services authorized by section 3109 of title 5, United States Code, without regard to any other provision of law regarding public contracts;
(3) designating financial institutions as financial agents of the Government, and they shall perform all such reasonable duties related to this Act as financial agents of the Government as may be required of them;
(4) establishing vehicles that are authorized, subject to supervision by the Secretary, to purchase mortgage-related assets and issue obligations; and
(5) issuing such regulations and other guidance as may be necessary or appropriate to define terms or carry out the authorities of this Act.
Sec. 3. Considerations.
In exercising the authorities granted in this Act, the Secretary shall take into consideration means for–
(1) providing stability or preventing disruption to the financial markets or banking system; and
(2) protecting the taxpayer.
Sec. 4. Reports to Congress.
Within three months of the first exercise of the authority granted in section 2(a), and semiannually thereafter, the Secretary shall report to the Committees on the Budget, Financial Services, and Ways and Means of the House of Representatives and the Committees on the Budget, Finance, and Banking, Housing, and Urban Affairs of the Senate with respect to the authorities exercised under this Act and the considerations required by section 3.
Sec. 5. Rights; Management; Sale of Mortgage-Related Assets.
(a) Exercise of Rights.–The Secretary may, at any time, exercise any rights received in connection with mortgage-related assets purchased under this Act.
(b) Management of Mortgage-Related Assets.–The Secretary shall have authority to manage mortgage-related assets purchased under this Act, including revenues and portfolio risks therefrom.
(c) Sale of Mortgage-Related Assets.–The Secretary may, at any time, upon terms and conditions and at prices determined by the Secretary, sell, or enter into securities loans, repurchase transactions or other financial transactions in regard to, any mortgage-related asset purchased under this Act.
(d) Application of Sunset to Mortgage-Related Assets.–The authority of the Secretary to hold any mortgage-related asset purchased under this Act before the termination date in section 9, or to purchase or fund the purchase of a mortgage-related asset under a commitment entered into before the termination date in section 9, is not subject to the provisions of section 9.
Sec. 6. Maximum Amount of Authorized Purchases.
The Secretary’s authority to purchase mortgage-related assets under this Act shall be limited to $700,000,000,000 outstanding at any one time
Sec. 7. Funding.
For the purpose of the authorities granted in this Act, and for the costs of administering those authorities, the Secretary may use the proceeds of the sale of any securities issued under chapter 31 of title 31, United States Code, and the purposes for which securities may be issued under chapter 31 of title 31, United States Code, are extended to include actions authorized by this Act, including the payment of administrative expenses. Any funds expended for actions authorized by this Act, including the payment of administrative expenses, shall be deemed appropriated at the time of such expenditure.
Sec. 8. Review.
Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.
Sec. 9. Termination of Authority.
The authorities under this Act, with the exception of authorities granted in sections 2(b)(5), 5 and 7, shall terminate two years from the date of enactment of this Act.
Sec. 10. Increase in Statutory Limit on the Public Debt.
Subsection (b) of section 3101 of title 31, United States Code, is amended by striking out the dollar limitation contained in such subsection and inserting in lieu thereof $11,315,000,000,000.
Sec. 11. Credit Reform.
The costs of purchases of mortgage-related assets made under section 2(a) of this Act shall be determined as provided under the Federal Credit Reform Act of 1990, as applicable.
Sec. 12. Definitions.
For purposes of this section, the following definitions shall apply:
(1) Mortgage-Related Assets.–The term “mortgage-related assets” means residential or commercial mortgages and any securities, obligations, or other instruments that are based on or related to such mortgages, that in each case was originated or issued on or before September 17, 2008.
(2) Secretary.–The term “Secretary” means the Secretary of the Treasury.
(3) United States.–The term “United States” means the States, territories, and possessions of the United States and the District of Columbia.
I especially love Section 8, complete legal immunity for everything. Beyond the usual CYA tactics, you have to wonder why that needs to be explicitly outlined.
Also, the verbage surrounding the 700 billion "outstanding at any one time" I find interesting. This could end up being manipulated to put us into a lot more than 700 billion of actual debt, dependent upon how the distressed assets are inherited, repackaged, and eventually sold off for cents on the dollar. For instance, once a distressed asset is repackaged and sold, it may technically no longer be applicable against the 700 billion limitation, because the asset was sold off the government books. Fun fun!
So, we are certainly living in interesting times. I came upon an interesting tidbit of information yesterday that I wasn't previously aware of. Apparently, in 2003 Chris Cox, who runs the SEC or Securities Exchange Commission, changed the leverage regulations for the large investment houses. Previously, the i-banks were limited to 12:1 leverage ratios. The change made under the current administration's watch effectively allowed unlimited leverage ratios for the five largest i-banks. Lehman Brothers died with a 32:1 leverage ratio. Care to guess who the five largest i-banks are? Here's the list: Bear-Stearns, Lehman Brothers, Merrill Lynch, Goldmann Sachs, and Morgan Stanley. Boy, that list sounds awfully familiar doesn't it? These are the exact same five i-banks that are now on the ropes so to speak, three of which no longer even exist in their original forms, with other two not looking so good. In hindsight, de-regulating the large i-banks without introducing additional oversite was not a good move on the part of the Bush 43 administration in my view.
More later folks! :-)
Wednesday, September 17, 2008
Do the taxpayer's now own AIG?
Well, as I suspected, AIG was deemed "too big to fail" in that a potential bankruptcy filing on the part of AIG would have brought into question the stability of the entire global financial system itself.
So, last night, Treasury Secretary Paulson, Ben Bernanke and select Congress members authorized the Federal Reserve to float a bridge loan to the tune of some 90 billion of our tax dollars to keep AIG afloat in the short term. What will happen in the long term is a bit murky at this point as details are still coming out on precisely the nature of the deal that was struck. In my view, this problem could have been avoided entirely, had the credit rating agencies done their jobs and downgraded AIG's credit ratings several months ago, instead of doing so on the same day that one of the largest investment banks in our history, Lehman Brothers, filed for chapter 11 bankruptcy protection. The simple truth is that we have known for some time that the mark to market values of the complex securities and derivative insurance contracts held by AIG weren't worth nearly what the company's management wants to believe they are worth. Had the credit agencies downgraded AIG's creditworthiness 6-9 months ago, it is very likely that we the taxpayers would not have had to bail out AIG in the first place. Unfortunately, the credit rating agencies waited until the entire U.S. financial system was in much more dire straits before taking action. Therefore any ability for the private sector to generate an additional 70-90 billion in financial backing for AIG was all but impossible given even the commercial banks themselves are hesitant to lend to one another right now, as the interbank LIBOR rate spreads clearly demonstrate, and most certainly will not lend to investment houses or insurance companies as a result. This would not have been the case 6-9 months ago when capital was still more readily available as compared to current circumstances.
As I said, the AIG bailout should be more of a short term problem. The bridge loan should be temporary in nature given AIG has over a trillion dollars in assets, most of which is tied up in AIG's very profitable insurance subsidiaries. The short term financing is necessary due to AIG's credit rating downgrades which, almost overnight, required tens of billions of dollars in additional collateral. Let's be clear here, AIG as a company isn't insolvent, they are simply short on cash, hence the bridge loan. This situation, while certainly much more complex from an AIG perspective, is much the same as a bridge loan used when a consumer purchases a new home before selling their old home, and when the old home sells, the bridge loan is paid back with interest. Over the next several months, AIG will need to liquidate some of their assets to repay the bridge loan and generate the additional collateral monies required due to the actions of the credit ratings agencies. Personally, I see this as an excellent time to buy into AIG stock if you have monies that you can afford to lose, given AIG will most likely not fail, and eventually the government will be out of the AIG business altogether, hopefully within the next year or so, and at a paltry 3.xx dollars per share, this stock has fallen over 95% from it's 52 week highs. I see a lot of upside here long term.
Keep a watch out on WaMu, quite possibly the next financial company on the perverbial chopping block. It will be interesting to see, if WaMu takes a turn for the worse, whether or not the guv'mint will step in. I've maintained to date that the decision point on guv'mint intervention has to do with CDS market exposure. To the best of my understanding, WaMu does not have much exposure to the CDS markets, meaning that the potential failure of one of the nation's largest S&L's will not result in a crisis of confidence on credit default swaps. The failure of WaMu has more to do with bad mortgage lending and mortgage investment practices that have brought on major mark to market write downs over the past year, and write downs will most likely continue over the next 12-15 months at least given WaMu does have exposure to Alt-A mortgage securities which are currently seeing 16% 60-day delinquency rates on mortgage payments, coupled with the fact that many of these same Alt-A mortgages are due to experience rate resets to prevailing market rates over the next 1-2 years. This means that 16% delinquency number is going to rise quite a bit since people already cannot afford their current "discounted" teaser rate mortgage payments. In many cases the monthly mortgage payments increase by a factor of 50-100% when the introductory discount rate period comes to an end. Could you afford that today? Yeah, neither could I. :-)
So, last night, Treasury Secretary Paulson, Ben Bernanke and select Congress members authorized the Federal Reserve to float a bridge loan to the tune of some 90 billion of our tax dollars to keep AIG afloat in the short term. What will happen in the long term is a bit murky at this point as details are still coming out on precisely the nature of the deal that was struck. In my view, this problem could have been avoided entirely, had the credit rating agencies done their jobs and downgraded AIG's credit ratings several months ago, instead of doing so on the same day that one of the largest investment banks in our history, Lehman Brothers, filed for chapter 11 bankruptcy protection. The simple truth is that we have known for some time that the mark to market values of the complex securities and derivative insurance contracts held by AIG weren't worth nearly what the company's management wants to believe they are worth. Had the credit agencies downgraded AIG's creditworthiness 6-9 months ago, it is very likely that we the taxpayers would not have had to bail out AIG in the first place. Unfortunately, the credit rating agencies waited until the entire U.S. financial system was in much more dire straits before taking action. Therefore any ability for the private sector to generate an additional 70-90 billion in financial backing for AIG was all but impossible given even the commercial banks themselves are hesitant to lend to one another right now, as the interbank LIBOR rate spreads clearly demonstrate, and most certainly will not lend to investment houses or insurance companies as a result. This would not have been the case 6-9 months ago when capital was still more readily available as compared to current circumstances.
As I said, the AIG bailout should be more of a short term problem. The bridge loan should be temporary in nature given AIG has over a trillion dollars in assets, most of which is tied up in AIG's very profitable insurance subsidiaries. The short term financing is necessary due to AIG's credit rating downgrades which, almost overnight, required tens of billions of dollars in additional collateral. Let's be clear here, AIG as a company isn't insolvent, they are simply short on cash, hence the bridge loan. This situation, while certainly much more complex from an AIG perspective, is much the same as a bridge loan used when a consumer purchases a new home before selling their old home, and when the old home sells, the bridge loan is paid back with interest. Over the next several months, AIG will need to liquidate some of their assets to repay the bridge loan and generate the additional collateral monies required due to the actions of the credit ratings agencies. Personally, I see this as an excellent time to buy into AIG stock if you have monies that you can afford to lose, given AIG will most likely not fail, and eventually the government will be out of the AIG business altogether, hopefully within the next year or so, and at a paltry 3.xx dollars per share, this stock has fallen over 95% from it's 52 week highs. I see a lot of upside here long term.
Keep a watch out on WaMu, quite possibly the next financial company on the perverbial chopping block. It will be interesting to see, if WaMu takes a turn for the worse, whether or not the guv'mint will step in. I've maintained to date that the decision point on guv'mint intervention has to do with CDS market exposure. To the best of my understanding, WaMu does not have much exposure to the CDS markets, meaning that the potential failure of one of the nation's largest S&L's will not result in a crisis of confidence on credit default swaps. The failure of WaMu has more to do with bad mortgage lending and mortgage investment practices that have brought on major mark to market write downs over the past year, and write downs will most likely continue over the next 12-15 months at least given WaMu does have exposure to Alt-A mortgage securities which are currently seeing 16% 60-day delinquency rates on mortgage payments, coupled with the fact that many of these same Alt-A mortgages are due to experience rate resets to prevailing market rates over the next 1-2 years. This means that 16% delinquency number is going to rise quite a bit since people already cannot afford their current "discounted" teaser rate mortgage payments. In many cases the monthly mortgage payments increase by a factor of 50-100% when the introductory discount rate period comes to an end. Could you afford that today? Yeah, neither could I. :-)
Tuesday, September 16, 2008
AIG to survive?
So, the latest company on the perverbial chopping block is AIG, one of the largest insurers and reinsurers in the world. Rumors abound this afternoon that the Fed and the Treasury are busily working on behind the scenes type deals similar to the JP Morgan/Bear Stearns bailout. What is the difference between Lehman Brothers and AIG you may ask? Great question, and honestly one I'm not sure what the answer is. I'd suspect the difference is that one company was a global investment house with an emphasis on bond investments, the other is a global insurer with significant ties to the CDS markets. While Lehman Brothers will without a doubt have a negative impact on the CDS markets, the failure of one of the largest CDS market participants and one of the largest insurers in the world, would at the very least have far reaching negative financial consequences and, worst case, could lead to a financial meltdown similar to the 1930's. So, while I'm not a fan of enabling Wall Street's continued bad behaviors, I think AIG is one player that is indeed too big to fail. Therefore, don't be surprised if we see deal announced after normal trading hours either tonight or tomorrow night that includes either a direct investment on behalf of the Federal Reserve and/or the U.S. Treasury, or a deal that allows another player to prop up AIG with backing from the Fed, similar to what happened with Bear Stearns. Bear Stearns was another global investment bank that had significant CDS market exposure were it to fail. In fact, Bear Stearns held some 40% of JP Morgan's CDS contracts, so it is no surprise that the Fed stepped in given the failure of Bear Stearns would have led to serious capitalization and solvency concerns for JP Morgan itself. Since JP Morgan is one of the largest commercial banks in the world, the failure of such a bedrock banking institution would lead to crisis of confidence in the financial sector that would contribute to the systemic risk of a serious financial meltdown. I've always felt that the key decision factor on whether any bailout would retain Fed backing will be tied to CDS market exposure. If confidence in the CDS markets, nominally valued at some 60 trillion dollars of insurance investment contracts, is called into question, we will almost without question see a systemic problem that will lead to a systemic financial meltdown that will in turn lead to a major recession at the very least, and quite possibly a depression. This would occur regardless of the failsafes that are available to prevent relatively minor failures on occasion within the financial system itself, i.e. the failsafe institutions were never meant to serve as a backdrop to a major financial meltdown, these institutions, just like the banks themselves, are not properly capitalized to be able to prevent such large scale problems from occurring.
The Fed held steady on the fed funds and discount rates today. I believe this was also wise on the part of Ben Bernanke given we still have latent inflationary economic pressures that the Fed must remain concerned about. It will be most interesting to see if the Fed does move into unprecedented territory if no entity in the private sector steps up to bail out AIG, meaning if some type of lending window will be opened up to include insurers such as AIG. Already, the Fed expanded the TAF and created the TSLF that enabled non-commercial banking institutions to either obtain liquid funds from the TAF, or trade in essentially toxic securities as collateral and to receive Treasury bonds in return. This is a fancy way, in my view, of allowing the investment houses to trade in worthless securities and receive investment grade T-bonds in return to help shore up their balance sheets. In many cases, it appears on the surface at least that the Fed is, for example, taking billions of dollars of nominally valued derivative contracts onto it's books, and handing back like amounts of T-bonds in return. Trouble is, those derivative investments are likely worth no where near the amounts stated. So, who eats the loss? I don't have a real answer to that question, but my sense is it's us, the U.S. taxpayers, eventually, one way or another. This is just a masked form of a bailout that isn't as obvious to those that don't understand the complexities of the dealmaking that is ongoing behind the scenes.
Well, time to hang it up for now. More on the various exciting finance topics when I can find the time! :-)
The Fed held steady on the fed funds and discount rates today. I believe this was also wise on the part of Ben Bernanke given we still have latent inflationary economic pressures that the Fed must remain concerned about. It will be most interesting to see if the Fed does move into unprecedented territory if no entity in the private sector steps up to bail out AIG, meaning if some type of lending window will be opened up to include insurers such as AIG. Already, the Fed expanded the TAF and created the TSLF that enabled non-commercial banking institutions to either obtain liquid funds from the TAF, or trade in essentially toxic securities as collateral and to receive Treasury bonds in return. This is a fancy way, in my view, of allowing the investment houses to trade in worthless securities and receive investment grade T-bonds in return to help shore up their balance sheets. In many cases, it appears on the surface at least that the Fed is, for example, taking billions of dollars of nominally valued derivative contracts onto it's books, and handing back like amounts of T-bonds in return. Trouble is, those derivative investments are likely worth no where near the amounts stated. So, who eats the loss? I don't have a real answer to that question, but my sense is it's us, the U.S. taxpayers, eventually, one way or another. This is just a masked form of a bailout that isn't as obvious to those that don't understand the complexities of the dealmaking that is ongoing behind the scenes.
Well, time to hang it up for now. More on the various exciting finance topics when I can find the time! :-)
Monday, September 15, 2008
Black Sunday?
Well,
It has been entirely too long since my last post! :-)
Family-wise, we are all very busy. This summer was rather on the boring side for the Baldwin family what with still supporting two mortgages in this down housing market. Times are tight especially given the significant increases in food and energy prices of late. Still, we are managing to keep our collective heads above water financially, at least for the time being. I am mega-busy on the job as we are now knee-deep in our Lotus Notes to Microsoft Exchange email migration, which I am entirely responsible for. This project will hopefully be complete before the Thanksgiving holiday, at which point we'll be able to dial it down a notch or two and breath a little bit. Until then, I will have no life.
Finances, you know I love to talk about finance and economics.
Yesterday, Lehman Brothers, the 150 year old brokerage house, announced chapter 11 bankruptcy filing after several failed attempts to either obtain funding or find someone to buy them last week. The market responded by dropping 4.5% or over 500 points in a single day. Not good. Remember Black Monday from way back in 1987? Today may indeed end up being called Black Sunday in the history books folks. AIG, one of the largest insurers in the world, is quite likely next on the Wall Street chopping block, with likely followers such as WAMU (Washington Mutual) - the largest S&L in the United States mind you, along with several other large regional and national banks with significant risk exposure to derivative investments gone bad - such as CDO's, CLO's, RBMS's, CMBS's, and various other acronyms that most folks don't have much familiarity with (which is probably part of the problem in all honesty - too much unregulated complexity). For those who don't really understand what is going on here, all you have to understand is that we are beginning the process of enduring what will become the largest unraveling of the financial system since the Great Depression itself. The risks at this point, while sounding somewhat alarmist, are systemic in nature, meaning the entire system is at risk, because everything has become so intimately and complexly intertwined that the biggest problem is that we won't really know just how systemic the effects will be until it's too late.
What is behind all of this? Why all of the doom and gloom on my part? Well, perhaps I'll spend a few minutes and attempt to describe in relative lamen's terms what's happening here. While this all, on the surface, may seem to be related to the subprime mortgage debacle, that whole problem was more symptomatic than anything else. The underlying problem is that we've forgotten the basic fundamentals of finance. Proper capitalization is key. What caused the Great Depression back in the 1930's? A massive credit contraction due to irresponsible lending, too much leverage, and greed. The credit contraction brought about asset price deflation, meaning declines in asset prices, including real estate, and of course, the legendary stock market crash. What is causing today's financial meltdown? A credit contraction due to irresponsible lending, too much leverage, and greed. The credit contraction, which initially reared it's ugly head with the subprime mortgages, is continuing to rear it's ever larger head, with Alt-A mortgages being the next major "problem" we've yet to really see. Look for more bad news in the coming months given 16% of all Alt-A mortgages are currently beyond 60 days late at this point in time, and getting worse by the month, and most of these Alt-A mortgages haven't reset to prevailing rates yet! So, the credit contraction will continue, in fact in many ways it is just getting started. In short, it is going to get worse before it gets better. We are already seeing asset deflation in home prices and commercial real estate prices. The de-leveraging process is now under way. We've written down roughly 520 billion dollars so far, with estimates ranging from 1-2 trillion before we're out the woods. So, at best, we're half way through the asset price deflations from a securities perspective, at worse, we're only 25% of the way down this road less travelled.
Banks take your deposit monies and then leverage those monies, making loans against assets such as cars, houses, commercial real estate properties, and banks also invest your monies in other investments which earn a higher rate of return than they pay you. SEC regulations require banks to retain a 10:1 capital reserve ratio. Put another way, for every $10.00 that a bank has leveraged, it must have $1.00 in capital reserves. Capital reserves are extremely important to the solvency of any financial institution. What we're really seeing right now as part of this whole financial meltdown, is that most of the banks and brokerage houses aren't properly capitalized. Lehman Brothers leverage ratio was 32:1 today, the day it claimed bankruptcy. Too much leverage works well, as long as asset prices rise, but the second asset prices start declining, it is all but guaranteed that capital reserves won't be sufficient to cover the margin calls that assuredly will come a knockin, and sure enough, as the de-leveraging process moves forward, Lehman Brothers, just like Bear Stearns, will not be the last major financial company to fail. These failures will have global implications. Japanese banks held a great deal of Lehman Brothers debt for instance, and now those same Japanese banks, who were already in bad shape, have nothing to show for their Lehman Brothers investments. Not good.
For certain, no one really knows just exactly what's going to happen tomorrow, next week, next month or next year. From my cheap seats though, things look worse than they ever have, much worse than the last time I took the time to post anything to my blog. When you see names such as AIG, Citicorp, WAMU, GM/GMAC, Ford, and Wachovia all with similar financial balance sheet problems, all of which are potentially on the perverbial chopping block, it doesn't bode well for the U.S. economic situation. Of one thing I am certain, we will get through this, somehow or another, we'll all get through what appears to be an increasingly dismal financial meltdown.
I won't even start to discuss the Fannie/Freddie situation, I could write paragraphs on how the government bailout is in fact a sign of just how dire things really are, and how things will get worse as a result of said bailout. All I'll say is that anyone who thinks that Fannie and Freddie would ever do anything BUT fail, need only to look at the capitalization ratio of these two firms, who hold a paltry 160 billion in assets to cover some 5.4 trillion dollars in mortgages. Last I checked, a 10:1 capital reserves ratio would mean these two agencies should have held some 540 billion in reserves. 160 doesn't even come close, so you end up with the same problem described above. When asset prices deflate, in this case the American dream, our homes, neither Fannie nor Freddie held the required capital reserves to cover the losses. Once again, we've strayed away from solid fundamentals, and we're going to pay the piper sooner or later.
There's an old adage that time heals all wounds. The Fannie/Freddie bailout will make the S&L crisis look like child's play in comparison. What we really need is time. Same as with the S&L crisis, we need a way to allow our major financial institutions to remain solvent, even though many of them are technically insolvent right now, until such time as they can de-leverage, re-capitalize, and perform the required write-downs over a period of many years. That's exactly what we did when South America defaulted on all of it's debt back in the 1980's at which point just about every U.S. financial institution became insolvent overnight. Rather than let a systemic problem produce massive bank failures, we changed the regs and allowed banks to gradually absorb massive write-downs of the South American debt defaults over many years. This is basically the same thing we need this time around. Opponents will argue moral hazard. We'll have some of that too, as today's demonstration of allowing Lehman Brothers to fail clearly demonstrated.
There are many more complexities that we could talk about, the most important of which is probably the effects on the CDS markets. Credit Default Swaps. Look them up on Wikipedia when you find a few spare moments. You will be hearing more about the CDS market, which is valued literally in the ten's of trillions of dollars. Not bad considering CDS's didn't even exist until the mid 1990's! The CDS market allows companies to build a contract to cover risk assessments against all sorts of securities. It's all very complex. Think of it this way. Let's say you were to consider buying ten million of CDO contracts, but you were worried about the risk. You could go to the CDS markets and essentially buy insurance for your 10 million dollars of CDO contracts, for say, a hundred grand. For that hundred grand, someone (the buyer of the CDS itself) will guarantee that you will continue to get paid if the CDO contracts default for any reason. It's a fancy way of allowing investors to essentially buy insurance policies on the underlying investments, which allows them to mitigate the risk inherent in the contract, or specifically the potential for the investment to default. Put another way, it allows the investor to swap the risk in return for making insurance payments on the contract, hence the words credit default swap.
The failure of Lehman Brothers will result in quite a large number of defaults on some 620 billion in outstanding debts. Think about what that will mean for the CDS market that I just wrote about above. Most of those bad debts are secured with CDS contracts. Trillions of dollars of nominal CDS contract values are at stake, and the process of unravelling the complexities of who all holds the 620 billion in derivatives that just went worthless due to the Lehman Brothers bankruptcy filing is just getting under way as a result. Those who hold the hundreds of billions of dollars will want those who promised to keep making the payments to, well, keep making the payments. The trouble is, it's a big ponzi scheme, as the sellers and buyers of the CDS contracts are the very same players, meaning the banks and brokerage houses (a guy at JP Morgan was the creator of CDS's back in 1995 if memory serves) that are already enduring huge write-downs and insolvency issues. Does anyone really think that any of these banks, brokerage houses, or insurance companies are in a currently in a well capitalized position to honor the payments on trillions of dollars of nominal contract values? Yeah, I didn't think so either.
Hang on to your collective hats folks, we are living in VERY interesting times!
It has been entirely too long since my last post! :-)
Family-wise, we are all very busy. This summer was rather on the boring side for the Baldwin family what with still supporting two mortgages in this down housing market. Times are tight especially given the significant increases in food and energy prices of late. Still, we are managing to keep our collective heads above water financially, at least for the time being. I am mega-busy on the job as we are now knee-deep in our Lotus Notes to Microsoft Exchange email migration, which I am entirely responsible for. This project will hopefully be complete before the Thanksgiving holiday, at which point we'll be able to dial it down a notch or two and breath a little bit. Until then, I will have no life.
Finances, you know I love to talk about finance and economics.
Yesterday, Lehman Brothers, the 150 year old brokerage house, announced chapter 11 bankruptcy filing after several failed attempts to either obtain funding or find someone to buy them last week. The market responded by dropping 4.5% or over 500 points in a single day. Not good. Remember Black Monday from way back in 1987? Today may indeed end up being called Black Sunday in the history books folks. AIG, one of the largest insurers in the world, is quite likely next on the Wall Street chopping block, with likely followers such as WAMU (Washington Mutual) - the largest S&L in the United States mind you, along with several other large regional and national banks with significant risk exposure to derivative investments gone bad - such as CDO's, CLO's, RBMS's, CMBS's, and various other acronyms that most folks don't have much familiarity with (which is probably part of the problem in all honesty - too much unregulated complexity). For those who don't really understand what is going on here, all you have to understand is that we are beginning the process of enduring what will become the largest unraveling of the financial system since the Great Depression itself. The risks at this point, while sounding somewhat alarmist, are systemic in nature, meaning the entire system is at risk, because everything has become so intimately and complexly intertwined that the biggest problem is that we won't really know just how systemic the effects will be until it's too late.
What is behind all of this? Why all of the doom and gloom on my part? Well, perhaps I'll spend a few minutes and attempt to describe in relative lamen's terms what's happening here. While this all, on the surface, may seem to be related to the subprime mortgage debacle, that whole problem was more symptomatic than anything else. The underlying problem is that we've forgotten the basic fundamentals of finance. Proper capitalization is key. What caused the Great Depression back in the 1930's? A massive credit contraction due to irresponsible lending, too much leverage, and greed. The credit contraction brought about asset price deflation, meaning declines in asset prices, including real estate, and of course, the legendary stock market crash. What is causing today's financial meltdown? A credit contraction due to irresponsible lending, too much leverage, and greed. The credit contraction, which initially reared it's ugly head with the subprime mortgages, is continuing to rear it's ever larger head, with Alt-A mortgages being the next major "problem" we've yet to really see. Look for more bad news in the coming months given 16% of all Alt-A mortgages are currently beyond 60 days late at this point in time, and getting worse by the month, and most of these Alt-A mortgages haven't reset to prevailing rates yet! So, the credit contraction will continue, in fact in many ways it is just getting started. In short, it is going to get worse before it gets better. We are already seeing asset deflation in home prices and commercial real estate prices. The de-leveraging process is now under way. We've written down roughly 520 billion dollars so far, with estimates ranging from 1-2 trillion before we're out the woods. So, at best, we're half way through the asset price deflations from a securities perspective, at worse, we're only 25% of the way down this road less travelled.
Banks take your deposit monies and then leverage those monies, making loans against assets such as cars, houses, commercial real estate properties, and banks also invest your monies in other investments which earn a higher rate of return than they pay you. SEC regulations require banks to retain a 10:1 capital reserve ratio. Put another way, for every $10.00 that a bank has leveraged, it must have $1.00 in capital reserves. Capital reserves are extremely important to the solvency of any financial institution. What we're really seeing right now as part of this whole financial meltdown, is that most of the banks and brokerage houses aren't properly capitalized. Lehman Brothers leverage ratio was 32:1 today, the day it claimed bankruptcy. Too much leverage works well, as long as asset prices rise, but the second asset prices start declining, it is all but guaranteed that capital reserves won't be sufficient to cover the margin calls that assuredly will come a knockin, and sure enough, as the de-leveraging process moves forward, Lehman Brothers, just like Bear Stearns, will not be the last major financial company to fail. These failures will have global implications. Japanese banks held a great deal of Lehman Brothers debt for instance, and now those same Japanese banks, who were already in bad shape, have nothing to show for their Lehman Brothers investments. Not good.
For certain, no one really knows just exactly what's going to happen tomorrow, next week, next month or next year. From my cheap seats though, things look worse than they ever have, much worse than the last time I took the time to post anything to my blog. When you see names such as AIG, Citicorp, WAMU, GM/GMAC, Ford, and Wachovia all with similar financial balance sheet problems, all of which are potentially on the perverbial chopping block, it doesn't bode well for the U.S. economic situation. Of one thing I am certain, we will get through this, somehow or another, we'll all get through what appears to be an increasingly dismal financial meltdown.
I won't even start to discuss the Fannie/Freddie situation, I could write paragraphs on how the government bailout is in fact a sign of just how dire things really are, and how things will get worse as a result of said bailout. All I'll say is that anyone who thinks that Fannie and Freddie would ever do anything BUT fail, need only to look at the capitalization ratio of these two firms, who hold a paltry 160 billion in assets to cover some 5.4 trillion dollars in mortgages. Last I checked, a 10:1 capital reserves ratio would mean these two agencies should have held some 540 billion in reserves. 160 doesn't even come close, so you end up with the same problem described above. When asset prices deflate, in this case the American dream, our homes, neither Fannie nor Freddie held the required capital reserves to cover the losses. Once again, we've strayed away from solid fundamentals, and we're going to pay the piper sooner or later.
There's an old adage that time heals all wounds. The Fannie/Freddie bailout will make the S&L crisis look like child's play in comparison. What we really need is time. Same as with the S&L crisis, we need a way to allow our major financial institutions to remain solvent, even though many of them are technically insolvent right now, until such time as they can de-leverage, re-capitalize, and perform the required write-downs over a period of many years. That's exactly what we did when South America defaulted on all of it's debt back in the 1980's at which point just about every U.S. financial institution became insolvent overnight. Rather than let a systemic problem produce massive bank failures, we changed the regs and allowed banks to gradually absorb massive write-downs of the South American debt defaults over many years. This is basically the same thing we need this time around. Opponents will argue moral hazard. We'll have some of that too, as today's demonstration of allowing Lehman Brothers to fail clearly demonstrated.
There are many more complexities that we could talk about, the most important of which is probably the effects on the CDS markets. Credit Default Swaps. Look them up on Wikipedia when you find a few spare moments. You will be hearing more about the CDS market, which is valued literally in the ten's of trillions of dollars. Not bad considering CDS's didn't even exist until the mid 1990's! The CDS market allows companies to build a contract to cover risk assessments against all sorts of securities. It's all very complex. Think of it this way. Let's say you were to consider buying ten million of CDO contracts, but you were worried about the risk. You could go to the CDS markets and essentially buy insurance for your 10 million dollars of CDO contracts, for say, a hundred grand. For that hundred grand, someone (the buyer of the CDS itself) will guarantee that you will continue to get paid if the CDO contracts default for any reason. It's a fancy way of allowing investors to essentially buy insurance policies on the underlying investments, which allows them to mitigate the risk inherent in the contract, or specifically the potential for the investment to default. Put another way, it allows the investor to swap the risk in return for making insurance payments on the contract, hence the words credit default swap.
The failure of Lehman Brothers will result in quite a large number of defaults on some 620 billion in outstanding debts. Think about what that will mean for the CDS market that I just wrote about above. Most of those bad debts are secured with CDS contracts. Trillions of dollars of nominal CDS contract values are at stake, and the process of unravelling the complexities of who all holds the 620 billion in derivatives that just went worthless due to the Lehman Brothers bankruptcy filing is just getting under way as a result. Those who hold the hundreds of billions of dollars will want those who promised to keep making the payments to, well, keep making the payments. The trouble is, it's a big ponzi scheme, as the sellers and buyers of the CDS contracts are the very same players, meaning the banks and brokerage houses (a guy at JP Morgan was the creator of CDS's back in 1995 if memory serves) that are already enduring huge write-downs and insolvency issues. Does anyone really think that any of these banks, brokerage houses, or insurance companies are in a currently in a well capitalized position to honor the payments on trillions of dollars of nominal contract values? Yeah, I didn't think so either.
Hang on to your collective hats folks, we are living in VERY interesting times!
Wednesday, February 6, 2008
Politics and Economics...
Well, it has certainly been an interesting few weeks on the political and economic fronts. Today I'll attempt to relay my viewpoints on both topics.
First the political front. Super Tuesday just passed us by with some interesting results.
Clearly on the Republican side of the house, McCain has pulled out into the front of the pack, but still has quite a ways to go delegate-wise to win the game. The surprises came with Huckabee grabbing more states than was anticitipated beyond Arkansas, his home state, and equally surprising was the fact that Romney pretty much fell way short of expectations. Being a conservative myself (and please note I did not say Republican), ideally if I could combine aspects of all three leading candidates into one person, that is exactly what I would do. I like McCain's national security experience, I like Romney's economic experience, and I like Huckabee's stance on healthcare and the fact that he is a conservative Christian when it comes to being a values voter. Unfortunately, we cannot combine candidates into one person, so what's the best answer at least in my view? I think McCain will inevitably win the Republican nomination, it's almost a forgone conclusion at this point. The problem that remains, is that many a values voter is considering sitting out this election cycle if McCain wins the nomination. I believe this is a serious error in judgement on the part of my fellow conservatives, essentially we'd be cutting off our noses to spite our faces. Not good. So, McCain needs to do something to appeal to the evangelical base if he's going to have any chance of winning the Presidency. I think the best answer is to endorse Huckabee as his VP. Huckabee is a very well spoken somewhat moderate economic conservative, which matches him up well with McCain, yet has the conservative values that will appeal to values voters, especially in the south where McCain is most vulnerable. So, I vote for a McCain/Huckabee ticket. There you go.
What do I like about McCain? Well, as previously stated, I like his foreign policy experience and his national security experience. I also happen to agree with his approach on immigration. Many of my fellow conservatives disagree with McCain's approach on immigration policy, especially surrounding amnesty, but I think they disagree more from an idealistic perspective that is not grounded in reality. Short of agreement upon deportation of criminals, I believe that mass deportation is not only impractical (probably impossible in reality), it would also most likely result in a depression. Yes, not a recession, a depression. Like it or not, most of the 12 million people here illegally, have come here to work hard and to have a shot at the American dream. The fact that they have come here illegally at this point is largely irrelevant. If we were to forcibly remove and/or prevent 12 million people (and this number is most likely considerably higher BTW) from working, we would see a huge contraction in our economic output. Removing 12 million plus consumers, 12 million workers, 12 million debtors, etc., cannot be done and not have a dramatic negative effect on our economic system, our banking systems, our housing sectors, consumer sectors, and the list goes on. McCain knows this, that is why he supported the bill in question, and that's why the Z visa was included in the bill in question. Amnesty isn't pretty, but you know what, we had a chance to resolve this issue back in 1988 and we chose not to, and shame on us for doing so, but now we're going to have to take our medicine and realize that no matter how much we want to sit around the table and talk trash about mass deportation and massive fines against companies that have hired and employed illegals, doing so would take us from recession to depression. Let's be clear, EVERYONE in Congress knows this is the case, because they have economic experts testifying to this end. I know, because I've watched the testimony with my own eyes on C-SPAN. What we in fact have is a largely uneducated America who doesn't realize that we will cut off our nose to spite our face if we choose any policy that endorses mass deportation. Honestly, how could anyone argue otherwise given the vast majority of illegal immigrants do in fact contribute measurably to our economic output?
That said, many of my fellow conservatives have expressed outrage regarding the fact that many people have come here illegally at this point is largely irrelevant. They scream about law breaking, about setting a bad precedent, about stolen socsec numbers, about how illegals should have to adapt not the citizenry. To these points I say that they are all very valid arguments and points to be made, but they do not change the reality we must face economically. Given the dramatic economic consequences that are based in reality and not emotion surrounding the topic of illegal immigration, yes, these facts are largely irrelevant to any real solution. I'm not saying they did not break the law, etc., fact is illegals have, I'm saying that these people are largely integrated into our economic system, and shame on us for letting this problem fester for the last 30 years, now we have to live with the real consequences of our inaction, which is to embrace some form of amnesty when all is said and done.
What don't I like about McCain? Well, he's not very conservative economically. He voted against the Bush tax cuts, even if it was for good reason. He's also a recent convert of conservative social values, probably in an effort to appeal to values voters, meaning it's not a true change of heart on his part, it's about politics at this point in time.
On the democratic front, it's been interesting race to watch for sure. A number of months ago Hillary was all but a shoe-in for the Democratic nomination. Obama has since somehow managed to capture the hearts and minds of the young and the young at heart, as well as the African-American vote across the board. His marketing based upon hope and change resonates with many voters, even some conservative voters, much like John Kennedy did many years ago. After Super Tuesday, it seems delegate counts between Obama and Clinton are nearly equal, which is really saying something for Obama considering how powerful the Clinton political machine is here in the U.S. It definitely shows that our electorate is growing tired of the same old same old. My only real concern is that Obama resides much further to the left from a policy perspective than Hillary does. In this respect, I have to wonder what those big CHANGE signs really mean. Vote for Obama, vote for change, because that's all you're going to have left in your pockets when he's done in office (tax and spend).
Tax and spend has long been an argument used by the conservative Reagan coalition. Unfortunately, this argument has fallen flat on it's face because of runaway spending by Bush and his fellow conservatives in Congress. Fiscal irresponsibility was probably the single largest reason conservatives lost their majority in Congress in 2006. Going into a very important Presidential election, what does Bush do? He proposes the largest budget in the history of our nation. 3.1 trillion dollars, and Bush was the first President to cross the 2 trillion dollar line a few years ago. I don't think this helps the conservative Presidential candidates myself, and I believe proposing a budget of this magnitude demonstrates a serious lack of foresight on the part of the Bush administration. Myself, there is nothing more important to me than fiscal conservatism. We simply cannot continue to spend more than we generate economically and survive as a sovereign nation and as a world power. The fact that we seem to think we can, indicates a major flaw in our national psyche at least in my humble opinion. Every empire before us ultimately failed because of complacency and an increasing dependence on the national treasury to survive. If we think that solely because we are America that we will not ultimately suffer the same fate as nations and empires before us (including the recent demise of the USSR), then we are supremely naive.
On to economics, since I've already started talking about finances. :-) We are hearing a lot of talk about recession of late. A number of popular economic metrics that somewhat reliably predict recession are indicating we are either headed for recession or in some cases are already in recession. Recent numbers from the various guv'mint agencies provide mixed results. BLS numbers (Bureau of Labor Statistics for those who don't know - http://www.bls.org/) that track unemployment still look okay, but job growth numbers took a turn for the worst this month. For those who don't know, if job growth registers anything under, oh about 120,000 jobs per month, then in fact we have contracting overall job growth economically. Obviously, the last several months now, we've not seen numbers above 120k. Not good. Unemployment numbers "appear" to be okay, but if you take a look at how the BLS calculates national unemployment, you'll see that it uses rolling averages year over year. This type of approach yields more stable result sets over the long term, favoring statistical accuracy during steady growth or decline periods, but yields very inaccurate result sets during change periods, when we move from growth to decline, or from decline to growth in the number of jobs. Most of us can remember the democrats in Congress giving President Bush a hard time about slow job growth during years 2002-2004 when we were coming out of the last minor recession, seeing only 80-90000 jobs per month being added. Revisions to the numbers (and these historical numbers are revised very very often as new and more accurate data is gathered from the past 2-3 years of economic and job activities) now show we were actually seeing real job growth in excess of 200,000 jobs per month for that very same time period. Why so inaccurate you may ask? Because this was a change period for job growth, when we were emerging from a recession, from job decline to job growth. With these facts in mind, it becomes easy to explain why both the unemployment rate and the job growth statistics do not yet show recession. My guess is we will probably see revisions to these statistics over the next year or so that actually show greater job losses and higher unemployment than we currently see.
Real GDP fell significantly more than expected in Q4 2007, showing only a meager 0.6% increase. Keep in mind GDP is also subject to statistical anomalies and therefore Q4 2007 GDP could actually turn negative with revisions over the next six months or so as more concrete data becomes available (then again, it could also rise). If you'd like to check out the data for yourself, you can do so at http://www.bea.gov/ (the Bureau of Economic Analysis). My guess is that GDP will turn negative in Q1 2008 and may be revised to indicate economic contraction for Q4 2007 as well, though we probably won't see this revision occur until sometime in Q2 2008 at the earliest.
If you've ever walked down main street and thought to yourself that despite all of the rosy economic growth indicators that your real life experience just doesn't line up with these statistics, a cool site to bookmark is http://www.shadowstats.com/ published by John Williams. This site is chock full of interesting econometrics that show how our previously used econometrics stack up against the currently used econometrics in easy to understand graphical formats with explanations that are written in lamen's terms that most average folks can actually comprehend. I oftentimes refer to this site's data when discussing economic reality versus the statistics we see.
So, what's my point? Well, I believe we are heading into a recession, in fact I believe we are already in recession, and that the econometrics, as always, are slow to show this reality. Eventually they will show us in recession, it's just a matter of time. Yesterday a services sector growth report was released that had rather dismal numbers. Since the majority of our economic output is services based, this is further evidence that we are heading for recessions. The fact is that the housing and financial sectors are already in recession, and the manufacturing sector has been hit hard from foreign competition, though the recent demise of the dollar has helped our manufacturing exports somewhat. If indeed the services sector, the single largest component overall of our economic output next to consumer spending, is slowing down, then recession is but a certainty. I don't mean to be all doom and gloom, but I do count myself a realist in many respects, especially when it comes to economics.
What does this mean for us? It means that we're likely to see a bear market. We've already seen a market correction, defined as a 10% drop in market value (the Dow saw it's peak on Oct, 9, 2007 at around 14300), we're now hovering around the 12200 mark at present. A bear market is defined as anything greater than a 20% drop in market values. A couple more days like yesterday and we are there folks. Given the crisis in confidence brought on by the housing crisis and credit crunch, consumer spending is likely to slow down considerably, for many reasons beyond the two I just mentioned but won't go into again here. Suffice it to say that the U.S. consumer is just about tapped out of credit. Since consumer spending accounts for fully 70% of our real GDP, any slowdown in this sector will result in recession. Given the statistics already show a miserable holiday retail spending season, it is likely we will continue to see consumer spending level off for a while.
What does this mean for your investments? I'm no expert, but my view is that you should take a defensive position in your portfolios. This means a majority mix of cash and bonds for any short term investments. Long term retirement investments beyond ten years, it's really up to you to decide. Some folks will ride this out and wait for the next bull market. With dollar cost averaging, assuming you continue buying on the downswing no matter what, even if you stay majority equities, long term you'll probably do just fine. For those who are a bit more conservative, you may want to consider reverting back to money markets and bonds in the short term. While most folks interpret the words "bear market" to mean decreased market values of 20% or greater, and this is indeed true, that's not the whole story. In reality, bear markets mean increased volatility with an overall downside direction. Much like we are seeing over the past few weeks, seeing triple digit swings will be commonplace if we are indeed in a secular bear market, as I believe we are. In the investment world, the number one rule really is, don't lose money. For the consumer investor, this rule isn't generally discussed, because Wall Street wants you to stay fully invested. Many MANY mutual funds, hedge funds, value funds, growth funds, pension funds, pretty much any managed investment vehicle, have already taken defensive positions to cover for downside risk. Some investment managers do so via shorting the market (this is how George Soros made his fortune), others do so by holding higher percentages of cash, money markets, bonds, t-bills, etc. What you do is up to you. Myself I'm currently about 30% invested in money markets/bonds with 70% equities, with the majority of my 70% equity in foreign equity funds (because I don't feel the U.S. market is the place to be right now). To each his own though, I hope and pray that you ensure you are properly invested in the markets specific to your life circumstances.
Well, that's enough writing for now...see you all a bit later...
First the political front. Super Tuesday just passed us by with some interesting results.
Clearly on the Republican side of the house, McCain has pulled out into the front of the pack, but still has quite a ways to go delegate-wise to win the game. The surprises came with Huckabee grabbing more states than was anticitipated beyond Arkansas, his home state, and equally surprising was the fact that Romney pretty much fell way short of expectations. Being a conservative myself (and please note I did not say Republican), ideally if I could combine aspects of all three leading candidates into one person, that is exactly what I would do. I like McCain's national security experience, I like Romney's economic experience, and I like Huckabee's stance on healthcare and the fact that he is a conservative Christian when it comes to being a values voter. Unfortunately, we cannot combine candidates into one person, so what's the best answer at least in my view? I think McCain will inevitably win the Republican nomination, it's almost a forgone conclusion at this point. The problem that remains, is that many a values voter is considering sitting out this election cycle if McCain wins the nomination. I believe this is a serious error in judgement on the part of my fellow conservatives, essentially we'd be cutting off our noses to spite our faces. Not good. So, McCain needs to do something to appeal to the evangelical base if he's going to have any chance of winning the Presidency. I think the best answer is to endorse Huckabee as his VP. Huckabee is a very well spoken somewhat moderate economic conservative, which matches him up well with McCain, yet has the conservative values that will appeal to values voters, especially in the south where McCain is most vulnerable. So, I vote for a McCain/Huckabee ticket. There you go.
What do I like about McCain? Well, as previously stated, I like his foreign policy experience and his national security experience. I also happen to agree with his approach on immigration. Many of my fellow conservatives disagree with McCain's approach on immigration policy, especially surrounding amnesty, but I think they disagree more from an idealistic perspective that is not grounded in reality. Short of agreement upon deportation of criminals, I believe that mass deportation is not only impractical (probably impossible in reality), it would also most likely result in a depression. Yes, not a recession, a depression. Like it or not, most of the 12 million people here illegally, have come here to work hard and to have a shot at the American dream. The fact that they have come here illegally at this point is largely irrelevant. If we were to forcibly remove and/or prevent 12 million people (and this number is most likely considerably higher BTW) from working, we would see a huge contraction in our economic output. Removing 12 million plus consumers, 12 million workers, 12 million debtors, etc., cannot be done and not have a dramatic negative effect on our economic system, our banking systems, our housing sectors, consumer sectors, and the list goes on. McCain knows this, that is why he supported the bill in question, and that's why the Z visa was included in the bill in question. Amnesty isn't pretty, but you know what, we had a chance to resolve this issue back in 1988 and we chose not to, and shame on us for doing so, but now we're going to have to take our medicine and realize that no matter how much we want to sit around the table and talk trash about mass deportation and massive fines against companies that have hired and employed illegals, doing so would take us from recession to depression. Let's be clear, EVERYONE in Congress knows this is the case, because they have economic experts testifying to this end. I know, because I've watched the testimony with my own eyes on C-SPAN. What we in fact have is a largely uneducated America who doesn't realize that we will cut off our nose to spite our face if we choose any policy that endorses mass deportation. Honestly, how could anyone argue otherwise given the vast majority of illegal immigrants do in fact contribute measurably to our economic output?
That said, many of my fellow conservatives have expressed outrage regarding the fact that many people have come here illegally at this point is largely irrelevant. They scream about law breaking, about setting a bad precedent, about stolen socsec numbers, about how illegals should have to adapt not the citizenry. To these points I say that they are all very valid arguments and points to be made, but they do not change the reality we must face economically. Given the dramatic economic consequences that are based in reality and not emotion surrounding the topic of illegal immigration, yes, these facts are largely irrelevant to any real solution. I'm not saying they did not break the law, etc., fact is illegals have, I'm saying that these people are largely integrated into our economic system, and shame on us for letting this problem fester for the last 30 years, now we have to live with the real consequences of our inaction, which is to embrace some form of amnesty when all is said and done.
What don't I like about McCain? Well, he's not very conservative economically. He voted against the Bush tax cuts, even if it was for good reason. He's also a recent convert of conservative social values, probably in an effort to appeal to values voters, meaning it's not a true change of heart on his part, it's about politics at this point in time.
On the democratic front, it's been interesting race to watch for sure. A number of months ago Hillary was all but a shoe-in for the Democratic nomination. Obama has since somehow managed to capture the hearts and minds of the young and the young at heart, as well as the African-American vote across the board. His marketing based upon hope and change resonates with many voters, even some conservative voters, much like John Kennedy did many years ago. After Super Tuesday, it seems delegate counts between Obama and Clinton are nearly equal, which is really saying something for Obama considering how powerful the Clinton political machine is here in the U.S. It definitely shows that our electorate is growing tired of the same old same old. My only real concern is that Obama resides much further to the left from a policy perspective than Hillary does. In this respect, I have to wonder what those big CHANGE signs really mean. Vote for Obama, vote for change, because that's all you're going to have left in your pockets when he's done in office (tax and spend).
Tax and spend has long been an argument used by the conservative Reagan coalition. Unfortunately, this argument has fallen flat on it's face because of runaway spending by Bush and his fellow conservatives in Congress. Fiscal irresponsibility was probably the single largest reason conservatives lost their majority in Congress in 2006. Going into a very important Presidential election, what does Bush do? He proposes the largest budget in the history of our nation. 3.1 trillion dollars, and Bush was the first President to cross the 2 trillion dollar line a few years ago. I don't think this helps the conservative Presidential candidates myself, and I believe proposing a budget of this magnitude demonstrates a serious lack of foresight on the part of the Bush administration. Myself, there is nothing more important to me than fiscal conservatism. We simply cannot continue to spend more than we generate economically and survive as a sovereign nation and as a world power. The fact that we seem to think we can, indicates a major flaw in our national psyche at least in my humble opinion. Every empire before us ultimately failed because of complacency and an increasing dependence on the national treasury to survive. If we think that solely because we are America that we will not ultimately suffer the same fate as nations and empires before us (including the recent demise of the USSR), then we are supremely naive.
On to economics, since I've already started talking about finances. :-) We are hearing a lot of talk about recession of late. A number of popular economic metrics that somewhat reliably predict recession are indicating we are either headed for recession or in some cases are already in recession. Recent numbers from the various guv'mint agencies provide mixed results. BLS numbers (Bureau of Labor Statistics for those who don't know - http://www.bls.org/) that track unemployment still look okay, but job growth numbers took a turn for the worst this month. For those who don't know, if job growth registers anything under, oh about 120,000 jobs per month, then in fact we have contracting overall job growth economically. Obviously, the last several months now, we've not seen numbers above 120k. Not good. Unemployment numbers "appear" to be okay, but if you take a look at how the BLS calculates national unemployment, you'll see that it uses rolling averages year over year. This type of approach yields more stable result sets over the long term, favoring statistical accuracy during steady growth or decline periods, but yields very inaccurate result sets during change periods, when we move from growth to decline, or from decline to growth in the number of jobs. Most of us can remember the democrats in Congress giving President Bush a hard time about slow job growth during years 2002-2004 when we were coming out of the last minor recession, seeing only 80-90000 jobs per month being added. Revisions to the numbers (and these historical numbers are revised very very often as new and more accurate data is gathered from the past 2-3 years of economic and job activities) now show we were actually seeing real job growth in excess of 200,000 jobs per month for that very same time period. Why so inaccurate you may ask? Because this was a change period for job growth, when we were emerging from a recession, from job decline to job growth. With these facts in mind, it becomes easy to explain why both the unemployment rate and the job growth statistics do not yet show recession. My guess is we will probably see revisions to these statistics over the next year or so that actually show greater job losses and higher unemployment than we currently see.
Real GDP fell significantly more than expected in Q4 2007, showing only a meager 0.6% increase. Keep in mind GDP is also subject to statistical anomalies and therefore Q4 2007 GDP could actually turn negative with revisions over the next six months or so as more concrete data becomes available (then again, it could also rise). If you'd like to check out the data for yourself, you can do so at http://www.bea.gov/ (the Bureau of Economic Analysis). My guess is that GDP will turn negative in Q1 2008 and may be revised to indicate economic contraction for Q4 2007 as well, though we probably won't see this revision occur until sometime in Q2 2008 at the earliest.
If you've ever walked down main street and thought to yourself that despite all of the rosy economic growth indicators that your real life experience just doesn't line up with these statistics, a cool site to bookmark is http://www.shadowstats.com/ published by John Williams. This site is chock full of interesting econometrics that show how our previously used econometrics stack up against the currently used econometrics in easy to understand graphical formats with explanations that are written in lamen's terms that most average folks can actually comprehend. I oftentimes refer to this site's data when discussing economic reality versus the statistics we see.
So, what's my point? Well, I believe we are heading into a recession, in fact I believe we are already in recession, and that the econometrics, as always, are slow to show this reality. Eventually they will show us in recession, it's just a matter of time. Yesterday a services sector growth report was released that had rather dismal numbers. Since the majority of our economic output is services based, this is further evidence that we are heading for recessions. The fact is that the housing and financial sectors are already in recession, and the manufacturing sector has been hit hard from foreign competition, though the recent demise of the dollar has helped our manufacturing exports somewhat. If indeed the services sector, the single largest component overall of our economic output next to consumer spending, is slowing down, then recession is but a certainty. I don't mean to be all doom and gloom, but I do count myself a realist in many respects, especially when it comes to economics.
What does this mean for us? It means that we're likely to see a bear market. We've already seen a market correction, defined as a 10% drop in market value (the Dow saw it's peak on Oct, 9, 2007 at around 14300), we're now hovering around the 12200 mark at present. A bear market is defined as anything greater than a 20% drop in market values. A couple more days like yesterday and we are there folks. Given the crisis in confidence brought on by the housing crisis and credit crunch, consumer spending is likely to slow down considerably, for many reasons beyond the two I just mentioned but won't go into again here. Suffice it to say that the U.S. consumer is just about tapped out of credit. Since consumer spending accounts for fully 70% of our real GDP, any slowdown in this sector will result in recession. Given the statistics already show a miserable holiday retail spending season, it is likely we will continue to see consumer spending level off for a while.
What does this mean for your investments? I'm no expert, but my view is that you should take a defensive position in your portfolios. This means a majority mix of cash and bonds for any short term investments. Long term retirement investments beyond ten years, it's really up to you to decide. Some folks will ride this out and wait for the next bull market. With dollar cost averaging, assuming you continue buying on the downswing no matter what, even if you stay majority equities, long term you'll probably do just fine. For those who are a bit more conservative, you may want to consider reverting back to money markets and bonds in the short term. While most folks interpret the words "bear market" to mean decreased market values of 20% or greater, and this is indeed true, that's not the whole story. In reality, bear markets mean increased volatility with an overall downside direction. Much like we are seeing over the past few weeks, seeing triple digit swings will be commonplace if we are indeed in a secular bear market, as I believe we are. In the investment world, the number one rule really is, don't lose money. For the consumer investor, this rule isn't generally discussed, because Wall Street wants you to stay fully invested. Many MANY mutual funds, hedge funds, value funds, growth funds, pension funds, pretty much any managed investment vehicle, have already taken defensive positions to cover for downside risk. Some investment managers do so via shorting the market (this is how George Soros made his fortune), others do so by holding higher percentages of cash, money markets, bonds, t-bills, etc. What you do is up to you. Myself I'm currently about 30% invested in money markets/bonds with 70% equities, with the majority of my 70% equity in foreign equity funds (because I don't feel the U.S. market is the place to be right now). To each his own though, I hope and pray that you ensure you are properly invested in the markets specific to your life circumstances.
Well, that's enough writing for now...see you all a bit later...
Saturday, February 2, 2008
More words...
Ok, so, this house in the pictures, we are supposed to settle on 2/29/2008. We've had both the pool and the house inspected to date. Overall it is a very nice 22 year old colonial design People's built home. The roof was new in 2004. HVAC oil burner and heat pump was new in 2003. Windows, all high end vinyl units, all replaced in 2004. So the "majors" have been updated, which meets my requirements for serious consideration. The owner also had new entranceway double doors installed, fiberglass, with leaded glass inserts and side windows, and matching lighting. Very pretty, and there's a lighted brick laid sidewalk leading up to the front entrance which also adds a very nice touch. The french doors leading to the sunroom are also of similar quality to the entranceway doors. The home inspector commented today when we toured the house for the home inspection process that all the replacement materials used by the homeowner were of high quality, not cheap by any means, and workmanship was first rate. Overall, our home inspector said we should be able to move into this home and enjoy many years of maintenance free living, except for one major defect. When the owner replaced the exterior roof in 2004, he also replaced the soffits (the area under the roof overhangs) and gutters. The roof installed uses a ridge vent system, which means that the soffits need to have perforated sections, or vents, that must be baffled and unobstructed to provide continous ventilation to the ridge vent. Apparently, whomever did the roof work, either didn't baffle the soffit vents, or covered them completely over with blown insulation. One of the most important elements of the roof ventilation system is to ensure moisture does not stay trapped in the house. So, the one major defect is that mold has formed on some sections of the north side of the roof, on the underside of the plywood upon which the exterior roof is installed. So, the owner must repair this defect. Our real estate agent will submit an addendum accordingly, and we will of course have any work inspected after the fact to ensure the repair was done properly.
The inground pool, which was installed in 1991, is an Anthony gunnite pool with a plaster surface. The pool is very well maintained however all equipment is original as far as the pool inspector could tell. This means the plaster surface of the inground pool will most likely need to be updated in the relative near future, and the pump and filter, while top end units when originally installed, will be difficult to repair and parts will be hard to find given the age of the equipment. Still, the plaster, coping, tile work, and equipment looks as good as can be expected given the pool is coming up on 20 years of age. Of course, the children are excited about the prospect of having a pool to enjoy over the summer and to invite their friends over to enjoy along with them. Myself, now I have to become the resident pool maintenance expert! :-)
Well, gotta run just now, the kids need help with their homework and there is work to be done...
The inground pool, which was installed in 1991, is an Anthony gunnite pool with a plaster surface. The pool is very well maintained however all equipment is original as far as the pool inspector could tell. This means the plaster surface of the inground pool will most likely need to be updated in the relative near future, and the pump and filter, while top end units when originally installed, will be difficult to repair and parts will be hard to find given the age of the equipment. Still, the plaster, coping, tile work, and equipment looks as good as can be expected given the pool is coming up on 20 years of age. Of course, the children are excited about the prospect of having a pool to enjoy over the summer and to invite their friends over to enjoy along with them. Myself, now I have to become the resident pool maintenance expert! :-)
Well, gotta run just now, the kids need help with their homework and there is work to be done...
More pics and more words...
Ok, time for a few more pics...then I'll post another blog entry with more of the written word...
Den
Master Bedroom
Master Bedroom (other direction)
Sunroom (overlooking pool)
Wow...long time no type!
Well, it has been entirely too long since I've found the time to write! I guess in one way it was by design, given we had outstanding issues and complaints with our new home builder, and didn't want the builder to be aware what we were up to, hence the absence of posts on the blog. Though we originally put a deposit down to build a new home about 18 miles further south of where we currently reside, we have since decided that the development in question is just too far distance-wise from our places of work, coupled with what we feel was a less than honest representation of the community amenities promised by the builders in the golf course community in question. Our children's friends would also be even further away, so we set out to find a home closer to where we currently live.
Our search over the past several months was laborious yet fun. We quickly came to realize that new construction was not going to be an option, as the prices for new homes in our area are significantly more expensive than the prices down below the C&D canal where we were originally looking to build a new home, usually 70-100k more to build the same house, and it would have been difficult enough for us to have afforded a new home below the C&D canal already! For those who aren't familiar with New Castle County, Delaware, R.C. Peoples is one of the better known builders, especially when it comes to quality built homes. Given all three of our children currently attend Caravel Academy for school, we decided to look in developments close to school and, preferably, a Peoples built home. We toured a number of Peoples built homes over the past several months. We had a mix of requirements for any new home. Stacy had her list of requirements and I had my list. My list was comprised mostly of infrastructure concerns, since most of the best built Peoples homes in our area were built 20-25 years back now, I wanted updates to most of the important stuff for any house we would seriously consider purchasing, including roof, windows, HVAC (A/C and heat), water heater, kitchen appliances, kitchen counters, exterior doors, garage doors, etc. I also wanted four bedrooms (five would be awesome but this is hard to find even today), 2 1/2 bathrooms, living room, dining room, large den, two car oversized garage, exterior basement entrance, and a nice sized laundry area.
Over the Christmas holidays, we toured a few more homes, one of which had recently popped onto my radar via an internet search within a certain price range. I'd never seen the house in question before, so I figured it must have been new to the market, but came to understand that the owner had dropped the list price which fell into my search criteria, that the home was originally listed for quite a bit more but had been on the market for nearly six months without any movement. Well, Stacy really liked the house in question, so we put in a low ball offer and have gone back and forth for the past month with counter offers, and last Friday, we went to contract on our new home. Here are some pictures:
Our search over the past several months was laborious yet fun. We quickly came to realize that new construction was not going to be an option, as the prices for new homes in our area are significantly more expensive than the prices down below the C&D canal where we were originally looking to build a new home, usually 70-100k more to build the same house, and it would have been difficult enough for us to have afforded a new home below the C&D canal already! For those who aren't familiar with New Castle County, Delaware, R.C. Peoples is one of the better known builders, especially when it comes to quality built homes. Given all three of our children currently attend Caravel Academy for school, we decided to look in developments close to school and, preferably, a Peoples built home. We toured a number of Peoples built homes over the past several months. We had a mix of requirements for any new home. Stacy had her list of requirements and I had my list. My list was comprised mostly of infrastructure concerns, since most of the best built Peoples homes in our area were built 20-25 years back now, I wanted updates to most of the important stuff for any house we would seriously consider purchasing, including roof, windows, HVAC (A/C and heat), water heater, kitchen appliances, kitchen counters, exterior doors, garage doors, etc. I also wanted four bedrooms (five would be awesome but this is hard to find even today), 2 1/2 bathrooms, living room, dining room, large den, two car oversized garage, exterior basement entrance, and a nice sized laundry area.
Over the Christmas holidays, we toured a few more homes, one of which had recently popped onto my radar via an internet search within a certain price range. I'd never seen the house in question before, so I figured it must have been new to the market, but came to understand that the owner had dropped the list price which fell into my search criteria, that the home was originally listed for quite a bit more but had been on the market for nearly six months without any movement. Well, Stacy really liked the house in question, so we put in a low ball offer and have gone back and forth for the past month with counter offers, and last Friday, we went to contract on our new home. Here are some pictures:
Front
Back Yard
Backyard and back of house
Front Entranceway
Kitchen
Kitchen
Dining Room
Living Room
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