Larry Doyle’s Dollars and Sense “Central Station”

As we have people boarding and getting settled, I will put out a few potential topics for discussion. While I put these topics out, you the riders truly drive this train so please don’t hesitate to take the lead.

A few potential topics might be:

1. where do I see hints or concerns of inflation?

2. what did we learn from Microsoft’s and GE’s earnings this week?

3. will it be politics as usual in the upcoming debate over the economic stimulus plan?

4. if stocks are down 40+ % since the beginning of 2008, care to venture a guess as to the decline in the value of major shipping freighters?

5. how about currency fluctuations? what does all that mean?

6. in the realm of personal finance, what happened to mortgage rates this week? why?

7. what do you think about Tim Geithner’s confirmation?

8. who is offerring a mortgage at 3.99%?

9. whatever is on your mind…

Aaaaaaaaaaaaall Aboard!!

LD – CNBC had a segment on corporate bonds and made the point that they might / tend to be a leading indicator whenever the economy picks up.

In a way, one might speculate that if cash is sitting on the sideline until the government runs out, and if the stock market runs flat for a while, Treasuries remain stagnant for interest, it might be be corporate bonds might be the place to go.

Also with the history of the rating agency’s on Residential Mortgage Backed Securities, is there any reason to believe any rating they give a corporation when assessing buying a corporate bond. Obviously they were paid off in the RMBS, why wouldn’t they be on the hook for a corporation?

Any thoughts?

FiscalLiberal…

If we look at the performance of the corporate sector to date it is very evident that institutional money managers believe that the corporate sector does represent the best value in the market.

The lowest credits in the corporate sector (high yield, also known as junk bonds) are up 3-4% on the year while the stock market is down 8% on average. We will get to a point where the risk reward is more balanced or even skewed towards stocks over bonds but I do not believe that we are there yet.

In regard to ratings, I do not put tremendous credence into them. Away from the fiasco within the mortgage space, if anybody were to tell me that GE is currently a AAA rated entity I’d tell them that I’d like to talk about selling them a bridge.

If an investor does not truly know or understand what is going on within a corporation or have at least a fair sense, they should think twice or three times before buying into it.

Good question. Thanks.

hey LD, thanks for doing this…

a couple questions:

1. do you think the economy and job market will pick up at all this year?

2. has the stock market kind of bottomed out or is their a real chance it could plummet further? I know people that are going into a panic, I personally think it is unfounded.

3. How low do you think mortgage interest rates could go? I am at 6.25% and would refinance if the rates decreased enough to make it worth my while.

thanks

Hi LD. Do you have any thoughts on the situation in Britain? I heard that they have officially declared a recession is in progress there. Their banks were nationalized and the pound is very low. Will this affect us? what of the stability of our curency?

Q. What do you think about the U.S. gov’t. possibly actually “nationalizing” some banks? (I.e., – not just holding some shares with the bailout, without stakeholder say, or oversight.) Heard some of that discussed on Bill Moyer’s show (admittedly switching around channels)

Wodiej,

Good morning.

1 and 2. IMO, the economy will not pick up this year. We may stop sliding further as we move through the year but I do not see a turnaround. I found it VERY interesting that both Microsoft and GE would not provide clarity on projections for the full year 2009. Why? They do not know what the economy will do.

In regard to jobs, this quarter will actually see an accelaration in the pace of unemployment. I am not overly optimistic.

On both these topics, all eyes are looking towards Washington and the Obama stimulus package. Initial reads on the package is that the real impact will not be felt until later into 2010 and 2011.

Add it up and it is tough to see the stock market doing substantially better. We may and probably will have periods where “day traders” get overly short and we get vicious short covering rallies but we need to be careful and not misread those.

3. We saw mortgage rates move higher this week. The national avergae for a 30yr fixed is now back up near 5.5%. Why?? The longer end of the government yield curve moved higher due to 1. increased concerns about the deficit 2. government bond auctions 3. concerns over inflation amidst a declining currency 4. Geithner’s comments about the need for the Chinese to let their yuan increase in value concerns market participants that the Chinese may respond by purchasing less of our debt….add it all up and our longer term government rates (5yr on out) moved up substantially this week and mortgage rates moved higher as well.

LD I very much enjoy what you do here,thanks. Do you think the days of “buy and hold’ are over.? Where does a young person invest today?

Lizzy,

The UK is actually in tougher shape than we are right now. They have taken majority stakes in the larger of their banks (the government owns 70% of Royal Bank of Scotland).

Given that, the pound has been declining against the dollar, the Euro, and mostly against the Japanese yen.

Given that the UK is largely considered to be our closest ally the situation there will and already is impacting us.

I do think that our dollar will decline in value vs the yen and the Swiss franc. Honestly I project that global currencies will lose value versus hard assets, including real estate. That currency devaluation is actually a tool that countries use to attempt to promote exports (that works by trying to make goods cheaper for foreigners to purchase…do you understand that ?). As inflation picks up the cost of repaying debt actually diminishes because the borrower is paying back with a currency that has cheapened. Do you follow that? This is a VERY important point. If anybody does not follow it, please do not be bashful and I will try to simplify.

The WSJ has a great article on your question this morning. I will attach.

http://online.wsj.com/article/SB123253882759202161.html

Liberty Belle…..

I am not ducking your question but am going to answer by attaching an extensive piece we had yesterday which FULLY addresses this topic.

In short I do think that we will see some form of nationalization. In fact, I believe that in large measure Citigroup already has been nationalized although nobody would publicly make that statement.

Please review this story. If you have questions after that, I am happy to further address.

http://www.noquarterusa.net/blog/2009/01/23/nationalizing-a-bank-you-really-should-read-this/

Sunup…

Good to have you on board!!

In many ways the market has changed. Allow me to expound. Over the last 5-10 years the market has seen an explosion of “day trading” activity that was promulgated with the enormous increase in hedge funds and levered trading activity (meaning trading with borrowed money).

On the heels of that the cottage industry of tracking the markets has also exploded. There are a handful of shows that highlight the daily market volatility. For those who make a living day trading, those shows may be helpful and beneficial.I don’t pay too much attention to them. I believe Bloomberg TV is the best on TV and the WSJ and financial times are the best written deliveries.

From my standpoint, that is not the Wall Street that I know and appreciate. Over and above that approach is not consistent with long term investing. The renowned John Bogle, the founder of mutual fund company Vanguard, equates this day trading (buy, buy, buy….sell, sell, sell….Fast Money) to a casino. Well, if one goes into a casino I always believe you only play with money that you can afford to lose.

in summary, if the market has taken on a casino style, then true investors probably should be taking less risk because of the increased volatility. Does that make sense?

I do also believe though that given this current debacle that some of this casino-type approach will be taken out of the market and that the tried and true method of real investing with a longer term aapproach supported by strong fundamental analysis of companies will come back into vogue. This changed approach may take a few years but I do think that we will get there.

Add it up and what should a young investor do?

Develop the DISCIPLINE of regular saving. Building principal from a very early age is the key to real long term success.

Hope this helps. Look forward to seeing more of you on our train.

Do you think that BO will institutionalize his system of listening to all suggestion from every side of the issues and then outlawing any opposition to his solutions?

LD – do you have any idea regarding a bank examiner knowing about the Special Purpose Vehicles using short term borrowing to cover purchase of long term securities, primarily RMBS? Esentially these are off the books like they did in Enron.

I suspect they know very well what is the risk of what is on the books, so they can comment on adequate reserves.

Is this Enron all over again?

Lark….good to hear from you. BO is very sharp and only time will tell to see how he truly evolves. IMO he is a very smart politician, but with the greater emphasis on “politician.”

Develop the DISCIPLINE of regular saving. Building principal from a very early age is the key to real long term success.

Forgive me but that sounds like a very stupid conclusion to what the summary outlined.

Otherwise I would have to interpret discipline of regular savings with discipline to save oneself from investing in stocks, no? Because it seems obvious from what you said that if one would save 1 million during the span of 10 years, it would not be difficult to loose it in a week or even a day in the stock market, no?

Savings. Saving does not have any logic in the way our economy works – anymore; or does it? Why? Because any uncertainty is usually multiplied exponentially with several other uncertainties, no?

Fiscal….Enron clearly engaged in fraudelent and criminal activities and the executives overseeing the entities that were formed were criminally charged and convicted. (Ken Lay, Jeff Skilling, Andrew Fastow…and a handful of others as well. I know that there were bankers from Merrill Lynch who went away for facilitating a sham transaction).

In regard to the SIVs that were established I do not think that there were criminal activities going on here. I know for a fact that JP Morgan established some SIVs that primarily purchased AAA credit card receivables. That was a longstanding busines of the bank.

While I do not think the SIVs themselves nor the investments that went into them were criminal in nature, the simple fact is that the banks TOTALLY!!!!! miscalculated the degree of risk that they were taking. The rest is history.

My comment here is not to say that there were not or could not have been criminal activities going on within divisions that may have managed the SIVs or funds like them but IMO the SIVs themselves were not criminal activites.

All this said, the regualtors were clearly WAAAAY behind the curve in understanding and tracking activities within these banks. For that very reason Senators Schumer and Shelby are proposing $110 million in increased funding for hiring qualified staff at SEC, FBI, and DOJ to monitor the banks. (One other point, not surprisingly given that Schumer is from NY but he has received HUGE sums from Wall Street over the course of his career.)

IMO, these steps are necessary but the party is over. Now these individuals will be charged with cleaning up some of the mess and monitor future parties to make sure they are more in the mode of “pin the tail on the donkey” vs “frat house blowouts.”

Forgive me but that sounds like a very stupid conclusion to what the summary outlined.

————————————-

So – what would be your clear advice to a young person?

Lark…I will try to make this as SIMPLE as possible.

Save…save…save…

Invest regualrly across a very diversified pool of assets….stocks, bonds, cash…

understand and appreciate the risks in all of the above…

How we doing?

You don’t have to put all your money in equities. You have to keep changing your allocations depending on your age (the number of earning years you have left.)

I am 56 and I reallocated my assets away from equities two years ago. I lost money but not as much as other people I know.

I agree with your comments. However my interest is: Where were the regulators in assessing risk.

Wich raises the question: did the examiners know about it and did the examiner have access to the information to make the risk assessment.

Some how a examinors question (in writing), do you have any off book entities which affect the profits or losses of the bank.

Fiscal…I should have also written that the rating agencies and regulators also had NO appreciation for the degree of risk involved in these SIVs.
Honestly, with all due respect to people at the rating agencies and regulators the people “on the street” (at the banks) had much more experience and were typically far sharper.

Yes, the examiners would have access to the vehicles.

Gee – our checks and balances do not work

Thanks for adding that color. Your point about reallocating as your overall profile changes is very well taken.

Ultimately it becomes a question of understanding risk. The risks implicit in each asset class and how that risk can be mitigated.

In my estimation, the financial planning industry does not do a good job at educating investors on this topic because the margins in higher risk products motivate them.

Thanks again for furthering the dialogue.

Thanks LD for the clear explanations of the situation in Britain. I read the WSJ link; it was helpful. With all the money we have been throwing at bailouts and stimulus I am concerned about hyperinflation. Your explanation helped me integrate these concerns with our international trade and borrowing.

That’s right!!

Lizzy,

I am also very concerned about hyperinflation.

Gold and oil both moved up appreciably this week. Our 30 yr Treasury bond which is the bond most influenced by long termn inflation had its single biggest weekly decline this past week since 1982!!!!

I believe that these market moves are indicating inflation concerns as well!!

We’ll be watching.

LD,

Do you agree with this statement?

The Federal Reserve System is bankrupt.

Also, Paul Volker and our new Secretary of the Treasury, Tim Geithner, have both recently indicated that the manner in which the Fed has been operating in recent months is far outside its charter. … What, in your view, is the proper role of the Federal Reserve in the current situation?

Great Central Station today, I’m impressed with the wide range of intelligent questions, answers, and discussion. Maybe they should always be earlier in the morning on the weekends, when the chicken little loonies are still sleeping.

Definitely looking forward to the radio show tomorrow night as well to see what insight “the Man to see” has to offer!

Engineering. Is that sufficiently clear. It is as clear as I can make it. Think about it. Engineering is about reducing uncertainty through design.

How we doing?

Very bad.

Substitute the word ‘save’ for ‘think.’ Substitute ‘invest’ for ‘design.’ Substitute ‘assets’ for ‘objects or goods.’ Substitute ‘stocks, bonds, cash’ for ‘staples, necessities, commodities.’ Substitute the word ‘risk’ for ‘waste.’ What’s important is to stop waste and change waste into capital. In other words, change waste into cash, stock and bond it to recovery, expansion and savings.

Gary,

Honestly, I would be stretching my sphere of knowledge to offer a strong opinion on this topic.

I would really need to review the Fed’s charter to see its’ mandate.

The Fed’s management of monetary policy has clearly been expanded given this tsunami. Have they overstepped their bounds in the process. I am not hearing that from many corners and have not seen those comments from Geithner or Volcker. I need to look those up and listen more closely.

I do view the Fed’s actions, though, in the context of “all hands on deck” as the waves are pouring over the side. The Fed and especially Bernanke has extensive experience and thus impact on our markets and the economy.

I do not believe that the Fed is bankrupt.

The Fed is charged with managing monetary policy and given that they have run out of room in changing the “multiplier” (growth in money supply) via a change in interest rates, I personally do not have an issue with their use of “quantitative easing” techniques (purchase of assets to influence interest rates). I do believe the lesson that Bernanke feels we should have learned from the Great Depression is that the governmetn intervention was not great enough.

We could debate this long and hard. I do not pretend to have the answer.

I hope what comes out of this is an emphasis on “private markets with strong and rigorous regulatory oversight.”

Sorry for the long winded response.

MPC…good to have you on board again. Thanks for the plug.

I do think we will try to have a regular Saturday morning “departure” to accomodate people’s schedules.

Yes, you will not want to miss tomorrow night’s chat with “the man to see”, Mr. Maloney.

I will use this as an opportunity to let people know that they can listen to every show here at NQ on tape and on iTunes via podcast.

Thanks for the prompt!!

It’s hard to believe that $1=88 yen. When I was in Japan in the 80′s, it was 1/250. Is the yen really that much weaker, or is the dollar up overall? I see that the pound is in free fall as well.

LD: Recognizing the global nature of the issues which are facing us, are there any counties, in your humble opinion, which were better prepared to deal with these economic-political issues before they developed, or which have dealt with them better in the past year. Several weeks ago on the radio program, Kevin Doyle referenced the leader of the Canadian banking system as someone he keeps an eye on. Have you had a chance to look at that gentleman, or consider how Canada seemed to have been better prepared so that apparently they have not had as many significant issues with their banks as this country.

LD is absolutely right. Also, take the trouble to UNDERSTAND what you have. It’s boring, but read your prospectuses. If you don’t understand it, don’t put money in it. Caveat emptor. Education is all.

Allimom99….reading currency valuations is always tricky. A reading of 1/88 means that the dollar buys fewer yen thus the dollar is weaker and the yen is stronger. Think of it the other way, you actually need fewer yen (88) to buy one dollar.

Yes, the pound is also much weaker.

Again, currency valuations are a function of:

1. interest rate policies within the country..
2. current account deficit…(exports minus imports)
3. perceived credit risk of the government (typically reflective of the government deficit)

Bill….

Good to have you on board. I have read a little about Mark Carney, the head of the Bank of Canada, since he was referenced by Mr. Kevin Doyle.

Mr. Carney has been aggressive in promoting the principles of disciplined and prudent lending. Seems fairly simple when you boil it down but that’s what it is.

While so many countries around the world have been swept up into this economic meltdown, two countries that I have not heard about (and which I need to review) are Sweden and Finland. Each of those countries had major banking crises in the early 90s (as did we).

I need to review before offering an opinion but I have not heard about them having major issues so I am going to guess that the lessons learned from then may have benefitted them now.

The countries that have saved (fiscal discipline) and lent judiciously (monetary discipline) are not suffering as much. Slow and steady wins the race!!

Thanks to all our riders today.

We will be checking the back cars to make sure that nobody nodded off.

If anybody wants to leave a question for the conductor I will be checking later for any “stragglers.”

Thanks again.

LD

Just to share my analysis from across the Pond. The UK has official definitions of slowdown and recession. It is now officially in recession as it has had two quarters of falling gdp (negative economic growth). The last quarter to December was the largest fall since 1980.

The UK nationalised Northern Rock Bank. Northern Rock exposed the World to the house of cards that is sub prime (here they are called self declared mortgages). The near collapse made bankers re-examine the liar loans. Then came Fannie and Freddie.

The value of the equity that allowed people to obtain these loans and also buy large 4x4s essentially disappeared. Our car sales are down 50% and there are no loans available to buy cars ith – even if secured against the home. One of the mortgage schemes that was designed purely on rising equity were “buy to let loans”, where people could use potential rental income to obtain the mortgage and rising capital values to repay it. Those loans disappeared overnight (they are now definitely loans and not mortgage as to qualify for the remaining ones an 85% deposit is needed).

As part of the UK bank bail out (and we have put in as much money as the US despite being a much smaller economy), the UK Government has taken stock options for the money. It wants the money back at some point. It is not taking day to day management decisions (although some feel they should).

This is a property price crash caused because of a collapse in global banking. For those that call for more regulation, banking is now like the internet. Legislation will hit the small home owner it will not effect the giants such as HSBC. There has never been a global banking system like this before. This requires World wide solutions.

What Government can and should do is control their own monetary and inflation policy. From 1993 in the US and from 1998 in the UK, both Governments removed from the rate of inflation, house prices. This hid from inflation the (and thus wage rate negotiations) the property booms. People felt “wealthier” if not better off because their house was worth more. This had the effect of lowering real wage rates, lower levels of interest rate disguised the effect of this as houses were sold on the same basis of a loan £xxx per month, and not 3 x salary. More could afford to buy, but could only do so if they lied about their salary. That forced the price up, which meant the next person had to lie. The Government gained through increased property taxes.

Banks want to return to Xx salary. House prices will have to fall much lower for that to happen. Which means cars remain unaffordable which causes more recession. As prices fall, banks will want more security and all the current bail out does is recapitalise the loans out there, not new ones.

No one can say how big a drop there will be. The bail out put a piece of ply wood across the Grand Canyon and the banks are asking the World economy to cross it.

Economic assumptions rely on two participating agents a buyer (potential borrowers) and a seller (the banks). The banks have our money but are no longer willing to participate unless the borrower is AAA+ with 100% deposit. How do you force them?

Whew! I finally found platform 9 1/2.

Us muggles have so many challenges ahead.
(from WSJ-what to do when banks fail)

….

As a result, nationalization would not solve the pressing problem of potential bank failures, particularly among small banks. Consumers who have deposits in such banks would still be dependent on the FDIC to return their money during a failure, and such a process could be lengthy and involve a lot of red tape.

.

As the week flew by, I heard one economist speak of “The coming depression” and another speak of real investment opportunities ….

LD, the casinos have no clocks. The mental disposition of so many is to “talk down” the market. BO is doing this. While no one in their right mind can argue this not FUBAR, I think it does not help in keeping a rational frame of reference, continually saying the sky is falling.
It does get dicey when an article says even though your money is insured, one may have a hard time getting it. So many people live pay check to pay check.
The art of saving is a dream to many.

Probably the only time I will agree with Lark. However how or where does this young investor save?

In the UK some bank shares have dropped 90%. They were pretty safe bets. How about those that lost their money at Lehman? They were a safe bank? There is supposedly no risk if you put your money in a savings account.

The banking crisis has fully undermined the economy for years.

Lord forbid I awake in Mountauk.

I own RBS preferred stock. Will the nationalization of RBS mean that preferred stock dividends will be suspended or be made worthless?

I agree with MPC that the tone of this recent thread is particularly good and informative. I particularly enjoyed UKforDem’s on-the-ground views of what going on in Britain.

Reading through, it occurred to me that the problem (we have to recognize a problem before we deal with a solution, etc.) is a many headed hydra, but my what struck me as important is fiscallibral’s comment about the failure of rating rating agencies to correctly perform their stated functions, to properly access the risk of investments.
In my line of business, construction, we have non-governmental testing agencies. They ascertain where a product produced by a company meets certain standards (also determined by independent, (also non-governmental) institutions (i.e. ASTM). To my knowledge, there have been no instances where a testing agency has ever mis-evaluated a company’s product or more appropriately, fudged a certification in lieu of more comprehensive information.
Now I know building product specification is not the same as rating the soundness of a company’s finances, but I can’t help wondering why companies continue to enjoy assessments of risk outside the realm of reasonable speculation (read Enron). Is anything being done to address this issue, to reform the system? Is it even realized as a problem outside of financial blogs and articles? Can we have a system similar to the construction trades where a risk can be accurately and impartially evaluated? Although such a system of internal checks is onerous, is it not in the best interest, bankers, investors, government and ultimately, the general public?

I am not, by the way, suggesting that internal, private rating assessments supplant or diminish governmental regulation. There is a crying need to refurbish both. Maybe at some future date you could have interview someone with insights on how rating agencies (Moody’s, Standard & Poor’s) currently operate and how they might be “reformed” in the future.

Thank you, LD. I’ll have to read it and catch up with your postings here! (Busy with work and life, so not always able to keep up with one of my most favorite blogs.)

Wow….thanks evry much for providing all of these insights. Truly awesome color.

I hope that we can get peopel from other parts of the world to do the same.

Thanks again.

I should have added further color to my answer.

While I emphasised the need to save, I did that for the very reason that if one saves more then they can actually take less risk in their investments.

For example, if I save $1000 instead of $500 then I only need to invest in an instrument that generates 5% return to earn $50 vs putting money in an investment that may earn 10% to generate that same amount.

While initially that thought process may not impact how a person invests over time the value of increased savings has an ENORMOUS impact on how one invests.

That said, I would encourage a young investor at this point to invest in the following:

1. Total Stock Market Index Fund (use a large mutual fund family such as Vanguard)

2. Total Bond Market Index Fund

3. Short Term Govt Fund

I would use a weighting of probably 60% stocks, 30% bonds, 10% short term…

Use a dollar cost averaging technique, which means instead of making a lump sum investment, put in a fixed dollar amount per month.

Consistency is the key.

Then track the markets on an ongoing basis so you understand what is happening in the economy and why.

Buy index funds which represent the entire market versus individual stocks. Also the index fund has a very low expense ratio.

Sorry for the incomplete answer previously.

Hope this helps.

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