Good Riddance to Merrill CEO

The so-called subprime crisis did evolve on its own and was not directly caused by any one individual or even small group of individuals, but what is clear is that absentee management at a wide range of Wall Street firms aided and abetted the growth and deterioration of the whole subprime credit bubble. The CEOs of these firms may not have led the charge into the swamp, but they were certainly AWOL when it came to supervising the kids who were leading the charge. I am glad to see that the board of directors of Merrill Lynch is at least belatedly recognizing their own responsibility and reportly in the process of sacking their CEO, Stan O'Neil, according to an article in The Wall Street Journal by Randall Smith entitled "O'Neal Out as Merrill Reels From Loss - Startled Board Ditches A Famously Aloof CEO; The Revenge of 'Mother'."

The real kicker is that none of this would have happened if Merrill Lynch had "stuck with its knitting" and focused on its brokerage and wealth management businesses instead of fantasizing that they were an investment bank of the likes of Goldman Sachs. It was the same kind of sloppy thinking that led them into investment banking that in turn led them down the slippery slope to gambling their own money on subprime mortgages. And that sloppiness of thinking in turn led them to placing really large bets on subprime securities.

My advice to Merrill's board: dismember the company and refocus on the core brokerage and wealth management business.

My advice to the incoming Merrill CEO: sack and replace the entire board of directors with one that is laser-focused on brokerage and wealth managment. Rebuild a brand name that Main Street America can respect rather than perpetuate one of the shameless Wall Street "club" members.

-- Jack Krupansky

Cheap home mortgages continue to be readily available

Mortgage rates haven't changed dramatically since the big Federal Reserve rate cut over a month ago. This confirms my long-held view that mortgage rates a priced more due to supply and demand and the amount of liquidity in the pockets of investors than the actual Fed interest rate or even the 10-year Treasury Note yield.

Despite all the talk of a credit crunch, people with good credit and a documented income can still get reasonable size mortgages (under $417,000) at quite cheap rates. The latest weekly mortgage survey from Freddie Mac shows the average rate offered for 30-year fixed-rate home mortgage is 6.33% (down from 6.40% last week) and the average for the 15-year fixed-rate home mortgage is 5.99% (down from 6.08% last week.) These are truly great rates and are cheaper than the rates of a year ago.

Sure, people with lousy credit or without documented income or money for a deposit are on shaky ground, but that's the way it should be anyway. Jumbo mortgages for expensive homes (above $417,000) may be somewhat more problematic, but still available depending on local conditions.

So much for being able to depend on the media for information about finance and the economy.

-- Jack Krupansky

Fed futures remain rather cloudy

I'll continue to hold off from offering any more forecasts of Federal Reserve interest rate action until it becomes more clear what principles and criteria the Fed is being guided by. Before the middle of August everything was clear, but now the Fed has headed off into uncharted territory and left us with no guidance as to how they will respond to developments in the real economy and financial markets.

I will continue to predict that six months from now (March or April) the Fed will be defending itself against accusations that it overreated in August and September. Although pumping liquidity into the financial system was the right thing to do, the lowering of the discount rate back in August was simply not necessary and merely exacerbated the panic mentality.

The good news is that the Fed does now have the leeway to leave rates unchanged this month. The Fed may cut again if it feels that confidence in the economic outlook is at risk, but the real economy (outside of housing) has been holding up reasonably well over the past month.

A lot of people are betting on a quarter-point cut at the FOMC meeting on Wednesday, but another half-point cut is a possibility as well. To me, holding rates would be the sensible thing to do, but few would blame the Fed for going with a quarter-point cut.

-- Jack Krupansky

Euro stays above its recent trading range

The euro managed to stay above its recent trading range of $1.40 to $1.43 this past week, with the December euro futures contract rising to $1.4396 on Friday from $1.4311 a week ago, a gain of 0.85 cents. The gain was probably drive by an expectation that the Fed would be cutting rates again on Wednesday.

Where the euro goes from here is up in the air since we no longer have a solid consensus on what the Fed will do with interest rates, where the overall U.S. economy is headed, or how deep-pocketed the speculators are who have been pushing up the euro.

As far as where speculators think the euro may be headed, euro futures out at March 2009 were only at $1.4405 on Friday, so there isn't exactly a lot of "slam dunk" enthusiasm for betting on an aggressive ongoing upwards trend, so far.

The good news about the decline of the dollar is that it puts downwards pressure on imports and upwards pressure on exports which combine to put upwards pressure on GDP. It also puts upwards pressure on the revenue and earnings of multinational companies.

-- Jack Krupansky

ECRI Weekly Leading Index indicator falls modestly and suggests a sluggish outlook

The Weekly Leading Index (WLI) from the Economic Cycle Research Institute (ECRI) fell modestly (-.26% vs. -0.21% last week) and the six-month smoothed growth rate fell modestly (from -0.3 to -0.5), modestly below the flat line, suggesting that the economy will be somewhat lackluster and rather sluggish in the months ahead, neither booming nor busting.

According to ECRI, "After plunging in August, WLI growth has flattened out, suggesting that while economic growth will indeed slow, a recession is not likely."

A WLI growth rate of zero (0.0) would indicate an economy that is likely to run at a steady growth rate, neither accelerating nor decelerating. A WLI fluctuating in a range from +1.5% to -1.5% would seem to forecast a relatively stable "Goldilocks" economy.

The current reading for the smoothed growth rate is too close to zero to discern with any great confidence whether the economy is really trending downwards or upwards. We may need another month or even two before the trend becomes clear.

If I were looking at this one indicator alone, I would say that the Fed is succeeding at its goal of moderating the economy to a sustainable growth rate.

I will offer the caveat that the Weekly Leading Index and its smoothed growth rate do not tell us how strong the economy will be six or nine months from now, but do tell us whether whether weakness or strength is more likely a few months from now. It works best to tell us whether a "gathering storm" might be lurking just around the corner, but presently indicates relatively "clear weather" for the next few months, even if the interval is occasionally punctuated with financial market "gyrations."

-- Jack Krupansky

Cheap home mortgages continue to be readily available

Mortgage rates haven't changed dramatically since the big Federal Reserve rate cut over three weeks ago. This confirms my long-held view that mortgage rates a priced more due to supply and demand and the amount of liquidity in the pockets of investors than the actual Fed interest rate.

Despite all the talk of a credit crunch, people with good credit and a documented income can still get reasonable size mortgages (under $417,000) at quite cheap rates. The latest weekly mortgage survey from Freddie Mac shows the average rate offered for 30-year fixed-rate home mortgage is 6.40% (unchanged from last week) and the average for the 15-year fixed-rate home mortgage is 6.08% (up from 6.06% last week.) These are truly great rates and are close to the rates of a year ago.

Sure, people with lousy credit or without documented income or money for a deposit are on shaky ground, but that's the way it should be anyway. Jumbo mortgages for expensive homes (above $417,000) may be somewhat more problematic, but still available depending on local conditions.

So much for being able to depend on the media for information about finance and the economy.

-- Jack Krupansky

Ben Stein on the economy and the mortgage mess

I'm not particularly a fan of Ben Stein, but his article in The New York Times entitled "The Gloomsayers Should Look Up" seemed to agree with a lot of my views of the current economic and financial situation. He tells us that:

The economy is basically in fine shape. Not perfect, but darned good. Almost all mortgages are not in default. Almost all workers in the labor force who care to work are not unemployed. The largest percentage ever of American household units, what were called "families" in the old days, own their own homes.

The stock market, in both absolute terms (the number on the Dow) and relative terms (the relationship of price to earnings), reflects optimism and an extraordinary, robust level of profits.

On a more sophisticated note of analysis, the spread between the interest rate paid on risk-free Treasury issues and on the Merrill Lynch master junk-bond index is far, far less than it was in the dark days of the tech meltdown from 2000 to 2002. (This data comes from Marty Fridson of FridsonVision, le dernier cri when it comes to junk.) This is a sign of less than horrific fear about high-risk debt.

Newspapers (which often sell on fear, not on fact) talk frequently about a mortgage freeze. However, for all but the least qualified buyers, mortgage money is plentiful, and in fact the potential borrower is bombarded with offers. Hotels and airplanes are full. Casinos in Las Vegas are jam-packed. There is still a long waiting list for Bentleys in Beverly Hills.

This country does not look like a country in economic trouble. Nevertheless, some extremely worrisome things have happened and are now being revealed, and worse are to come.

He then descends into a riff about the mortgage mess, most but not all of which I agree with. He says:

... I could easily be wrong, but I suspect that at the end of the day, you and I will be bailing out the hundred-million-a-year finance titans who messed this up in the first place... And we stockholders and taxpayers foot the bill, of course. But even this is not the worst part: there are still lots of people who can say with a straight face that the world of finance is overregulated, that we should trust the power players to do the right thing, that if we put finance under a microscope, or allow financial miscreants to be sued for misconduct, America will be harmed. There are still people, and I know many of them well, who believe that old myth that you can trust the markets to fix everything — that old magical thinking that some thieves will stop other thieves from robbing the sheep like us. That's the really sad part. Some babies never learn.

Actually I do disagree with that. In truth, the taxpayers are more likely to profit from a government bailout (ala Chrysler) since the problem is not the assets themselves, but the fact that he assets are heavily undervalued due to uncertainty about their risk. If the government were to buy out all of the "bad" mortgages and simply convert them to cheap fixed-rate mortgages the foreclosure problem would completely vanish in an instant with a stroke of a pen. The whole point of the non-government bailout is that the terms of the assets could remain intact and extremely profitable for the banks. I actually do trust the markets to fix this mess and it will only get worse if in fact the government steps in to "fix" it since a fix would not correct the behavior that led to the problems in the first place. Eventually, the banks will wise up and start converting the bulk of the problem mortgages to terms which will be both profitable for the banks and at least marginally bearable by homeowners. The whole point of the bailout in the near-term is to compensate for a lack of liquidity that is interfering with market pricing of the securities while we wait for them to be restructured so that their risk is reduced and made transparent.

-- Jack Krupansky

Enron redux

I'm amazed that the media hasn't not yet picked up on the Enron angle with respect to the bailout superfund for bank structured investment vehicles (SIV), in particular for Citibank, since there is such a strong similarity. In both cases we have massive amounts of debt being kept off-balance-sheet. Why would banks be using these massive "conduits" if all of the transactions were sensible and well-capitalized? The answer has to be that the banks knew that the transactions were risky and were simply trying to set up a firewall to attempt to prevent any "blowback" if the transactions ever got into trouble, which they finally did. The real problem seems to be that they simply did not apply enough legal talent to engineer the legal firewall to be strong enough to keep up with the "innovation" on the part of the financial "quant" rocket scientists.

I'm also amazed that nobody is even hinting at accusing Citibank of engaging in fraud by failing to adequately inform their shareholders of the raw magnitude of the risk they were facing.

And what about the Federal Reserve and "banking supervision"? Can it really be true that by putting all of these transactions into off-balance-sheet "vehicles", they magically are no longer within the Fed's jurisdiction? Really?

Finally, I really am wondering where former Treasury Secretary Bob Rubin was while Citibank's wizards were "Enronning-up" their corporate structure. How could he not have known the magnitude of Enronesque risk that Citibank was taking on? What kind of advice was he giving his employer?

-- Jack Krupansky

Is your money safe in the PayPal Money Market Fund?

An October 17, 2007 Reuters article by Tim McLaughlin entitled "EBay customers' cash linked to risky assets" suggests that there is some significant risk to money that customers may have in the PayPal Money Market Fund, but I would challenge that assertion, if for no other reason than there is some confusion over terminology. I personally went through the list of holdings in the most recent PayPal Money Market Fund report back on August 19, 2007 and although there is a fair amount of commercial paper, that is normal and typical, and fairly safe since it is all short-term stuff, and much of the holdings in the report would already have matured by now. It is important to distinguish the difference between an SIV (Structured Investment Vehicle) and the assets that an SIV produces and markets. Even for most of the SIVs in the news, the problem is that there is no sense of the overall credit quality and pricing for the totality of assets in the SIV, not a problem with specific assets in the SIV or created and marketed by the SIV, most of which are fine anyway. Short-term commercial paper is almost literally as good as cash and is not the source of the SIV problems.

The article does almost hint at that distinction at one point:

Cheyne Finance LLC, a SIV run by British hedge fund Cheyne Capital Management Ltd., had $145 million of its commercial paper in the Barclays-run money market master portfolio at midyear. Since then, Cheyne Finance has liquidated assets and wound down operations just weeks after its AAA-rated ratings were affirmed.

In other words, the SIV has created and marketed the commercial paper and the money market fund is investing in that paper and not in the overall SIV itself. My law (SEC regulation), retail money market funds are required to invest in only short-term assets (397 days or 13 months), so by definition no retail money market could invest in an SIV itself. Yes, an SIV can contain a lot of bad apples, but money market funds are not permitted to go near most of those bad apples. Yes, the PayPal fund did have some (small amount of) money in CDOs and asset-backed securities, but once again that was only short-term assets, not the kind of risky subprime mortgages that are causing SIVs to be such heartburn.

The article opens by telling us that:

EBay Inc (EBAY.O: Quote, Profile, Research) customers who park extra cash in a nearly $1 billion PayPal money market fund are exposed to the same type of assets targeted for an emergency bailout by the largest U.S. banks, regulatory filings show.

PayPal Money Market Fund, whose popularity has mushroomed with online consumers, is invested in a portfolio that contains structured investment vehicles, or SIVs, linked to troubled subprime loans and other debt.

The risk surrounding these illiquid assets has forced the largest U.S. banks to attempt to create a roughly $80 billion rescue fund to prevent SIV assets from plummeting in value.

The PayPal fund was No. 2 among 248 first-tier retail funds over the past five years as of September 30, according to iMoneyNet. Many other money market funds are also exposed to risky assets in the hunt for better returns, experts said.

To be crystal clear, the so-called bailout is targeting SIVs, not all of the assets contained in or created and marketed by SIVs. Banks have exposures to SIVs and it is those bank exposures that is being bailed out. To repeat, SIVs have a nebulous range of quality in assets and it is the risky, unpriceable assets that are the problem, not the short-term commercial paper that money market funds invest in.

It is absolutely 100% incorrect to claim that "Many other money market funds are also exposed to risky assets" since there is negligible risk due to the short-term nature of the assets that money market funds can invest in. Money market funds are not exposed in any way to the riskier assets in SIVs.

It is absolutely 100% categorically false to claim that "PayPal Money Market Fund... is invested in a portfolio that contains structured investment vehicles" since by definition no SIV would be "contained" in any money market fund. The whole point of an SIV is to create and market short-term assets such as commercial paper in order to finance the riskier long-term securities. Neither PayPal nor any other money market fund invests in any SIV. It is categorically incorrect to confuse the concept of an SIV and the specific assets held by and marketed by an SIV. The correct statement would be that "PayPal Money Market Fund... is invested in a portfolio that contains short-term commercial paper issued by structured investment vehicles." To repeat, the problem is not with that short-term commercial paper, but with the overall valuation of the SIV itself due to the riskier long-term securities.

Oddly, the article does not even bother to quantify the alleged exposure to "risky assets."

The answer to my headline question is that Yes, your money is quite safe in the PayPal Money Market Fund. Shame on Mr. McLaughlin for such a lame attempt to unfairly frighten consumers.

That said, I would note that the 7-day yield for PayPal has now dropped somewhat below 5%, making PayPal uncompetitive with Fidelity.

-- Jack Krupansky

Euro rises modestly above its trading range

After being stuck in a trading range between $1.40 and $1.43 for a while, the euro finally rose modestly above that range with the December euro futures contract rising to $1.4311 on Friday from $1.4192 a week ago, a gain of 1.19 cents.

Where the euro goes from here is up in the air since we no longer have a solid consensus on what the Fed will do with interest rates, where the overall U.S. economy is headed, or how deep-pocketed the speculators are who have been pushing up the euro.

As far as where speculators think the euro may be headed, euro futures out at March 2009 were only at $1.4323 on Friday, so there isn't exactly a lot of "slam dunk" enthusiasm for betting on an aggressive ongoing upwards trend, so far.

-- Jack Krupansky

ECRI Weekly Leading Index indicator falls modestly and suggests a sluggish outlook

The Weekly Leading Index (WLI) from the Economic Cycle Research Institute (ECRI) fell modestly (-.34% vs. +0.50% last week) and the six-month smoothed growth rate fell slightly (from -0.3 to -0.4), remaining very modestly below the flat line, suggesting that the economy will be somewhat lackluster and rather sluggish in the months ahead, neither booming nor busting.

According to ECRI, "With WLI (annualized) growth now hovering near one-year low, a broad-based slowdown in U.S. economic growth is likely but a recession is not."

A WLI growth rate of zero (0.0) would indicate an economy that is likely to run at a steady growth rate, neither accelerating nor decelerating. A WLI fluctuating in a range from +1.5% to -1.5% would seem to forecast a relatively stable "Goldilocks" economy.

The WLI smoothed growth rate had registered above zero in recent weeks, but some unknown adjustment(s) (possibly money supply growth) shifted the past six weeks to very modestly negative, with a low point in the first week of September.

The current reading for the smoothed growth rate is too close to zero to discern with any great confidence whether the economy is really trending downwards or upwards. We may need another month or even two before the trend becomes clear.

If I were looking at this one indicator alone, I would say that the Fed is succeeding at its goal of moderating the economy to a sustainable growth rate.

I will offer the caveat that the Weekly Leading Index and its smoothed growth rate do not tell us how strong the economy will be six or nine months from now, but do tell us whether whether weakness or strength is more likely a few months from now. It works best to tell us whether a "gathering storm" might be lurking just around the corner, but presently indicates relatively "clear weather" for the next few months, even if the interval is occasionally punctuated with financial market "gyrations."

-- Jack Krupansky

Euro stuck in a trading range

Since running into a wall after the quite decent monthly employment report a week ago, the euro is now stuck in a trading range between $1.40 and $1.43. No longer is it "clear" that the Federal Reserve will continue to cut interest rates. The December euro futures contract rose to $1.4192 on Friday from $1.4158 a week ago, a gain of 0.34 cents.

Where the euro goes from here is up in the air since we no longer have a solid consensus on what the Fed will do with interest rates, where the overall U.S. economy is headed, or how deep-pocketed the speculators are who have been pushing up the euro.

As far as where speculators think the euro may be headed, euro futures out at March 2009 were only at $1.4243 on Friday, so there isn't exactly a lot of "slam dunk" enthusiasm for betting on an aggressive ongoing upwards trend, so far.

-- Jack Krupansky

Cheap home mortgages continue to be readily available

Mortgage rates haven't changed dramatically since the big Federal Reserve rate cut over three weeks ago. This confirms my long-held view that mortgage rates a priced more due to supply and demand and the amount of liquidity in the pockets of investors than the actual Fed interest rate.

Despite all the talk of a credit crunch, people with good credit and a documented income can still get reasonable size mortgages (under $417,000) at quite cheap rates. The latest weekly mortgage survey from Freddie Mac shows the average rate offered for 30-year fixed-rate home mortgage is 6.40% (up from 6.37% last week) and the average for the 15-year fixed-rate home mortgage is 6.06% (up from 6.03% last week.) These are truly great rates and are close to the rates of a year ago.

Sure, people with lousy credit or without documented income or money for a deposit are on shaky ground, but that's the way it should be anyway. Jumbo mortgages for expensive homes (above $417,000) may be somewhat more problematic, but still available depending on local conditions.

So much for being able to depend on the media for information about finance and the economy.

-- Jack Krupansky

Structured Investment Vehicles (SIVs) are NOT a threat to the economy

One of the most annoying "qualities" of the general media and even the financial media is an unhealthy willingness to act as a mere mouthpiece to promote vested interests. You can usually tell when this is happening when you hear a "reporter" spouting a "line" that has been fed to them by a vested interest without even the slightest pretense of investigating the veracity of the "line" being touted. A great example is the article in The New York Times by Eric Dash entitled "Banks May Pool Billions to Avert Securities Sell-Off" which does indeed report on an effort by the U.S. Treasury to help a group of banks and unnamed hedge funds to bail out their positions on so-called structured investment vehicles, known as SIVs. I found the article quite illuminating, until I got to the "line" being mouthpieced by the reporter:

The fear is that problems with these vehicles could infect the broader economy.

The article never did lay out a convincing scenario for how a sensible accounting of SIVs would "infect the broader economy."

The article does clue us in to the two key culprits who I suspect are behind this "story":

Analysts say that investors have all but stopped buying SIV-affiliated commercial paper, and the worry is that the 30 or so SIVs will unload billions of dollars of mortgage-related assets all at once. That would put intense pressure on prices. As Wall Street firms and hedge funds mark value of similar investments they held to their new lower values, they face potentially huge hits to their profits.

Ah yes, those sacred "profits." That is what this is all about, not the overall, mainstream economy, but protecting the already-outrageous profits of a few well-connected Wall Street firms.

The article does lay out an unsubstantiated claim:

Still, the impact on the biggest banks is even more severe. In times of crisis, they are committed -- either legally or to maintain their reputations -- to stepping in to buy those securities. Banks have already been buying significant amounts of commercial paper in recent weeks, even though they did not have to. But if they are forced to bring those assets onto their balance sheets, they might be less willing to lend to businesses and consumers. That could set off a credit crunch and thrust the economy into a recession.

That's the "claim", but the reporter appears to have done nothing to verify whether the claim holds up at all. Even if it is true that banks would have to take such securities onto their balance sheets, what is so wrong with that? Answer: It is those sacred profits again. Let the banks take the balance sheet and profit hit, and then the Federal Reserve can consider stepping in and providing whatever extra liquidity might be needed to keep credit flowing.

There is absolutely zero evidence that forcing Wall Street firms to clean up their own mess is somehow likely to lead to a credit crunch or recession.

This is a clear cut case of Wall Street firms demanding yet another free lunch.

There is plenty of demand for high-quality short-term commercial paper from money market funds. No Wall Street bailout is needed for high-quality commercial paper.

Let Wall Street clean up its own mess.

As far as this spurious claim that fixing up their balance sheets would make banks less willing to loan money, that is complete nonsense. Banks make a huge chunk of their profit from loans, so it would make no sense for them to want to walk away for such a cash cow. Hypothetically, adjustments to their balance sheets could reduce the amount of money available for loans, but no evidence has been presented to show that this would be any more than a very modest reduction at worst.

Most importantly, the reporter has done nothing to verify the bank claims. This story is all about vested interests, but the reporter has done nothing to challenge the truth of the claims of vested interests.

Besides, as even the reporter notes, this is really only a niche problem: "a pocket of the commercial paper market remains under siege."

In short, there is no evidence that structured investment vehicles (SIVs) are a "threat" to the overall economy.

-- Jack Krupansky

Victor Niederhoffer - The Blowup Artist

There is a fascinating article in The New Yorker by John Cassidy entitled "The Blow-Up Artist - Can Victor Niederhoffer survive another market crisis?" which recounts Victor's most recent financial "blow-up", in the context of his entire life-story, to date. I had read his book, The Education of a Speculator, which is very interesting, but ultimately not very useful from an investment perspective other than as cautionary tale of what to avoid. The article is a shorter reminder of the same story. In theory, we are supposed to learn from the kind of mistakes that resulted in Victor's 1997 financial "blow-up", but even though he did bounce back nicely, his mini-empire was one of the casualties of this Summer's financial turmoil.

He maintains an eclectic blog site entitled Daily Speculations - The Web Site of Victor Niedhofer and Laurel Kenner: Dedicated to Value Creation, Ballyhoo Deflation, and Applying the Scientific Method in Finance. His latest contribution, Complex Variation, dated October 11, 2007:

I've been studying complex variables lately because I find the imaginary very important these days, and I had to brush up on them for one of my daughters.

It led me to consider the imaginary part of the moves during a day or week, and the real part... (more)

-- Jack Krupansky

ECRI Weekly Leading Index indicator rises moderately and suggests a stable albeit lackluster outlook

The Weekly Leading Index (WLI) from the Economic Cycle Research Institute (ECRI) rose moderately (+0.48% vs. -0.12% last week) and the six-month smoothed growth rate rose slightly (from 0.9 to 1.0), remaining very modestly above the flat line, suggesting that the economy will be somewhat lackluster but stable in the months ahead, neither booming nor busting.

A WLI growth rate of zero (0.0) would indicate an economy that is likely to run at a steady growth rate, neither accelerating nor decelerating. A WLI fluctuating in a range from +1.5% to -1.5% would seem to forecast a relatively stable "Goldilocks" economy.

If I were looking at this one indicator alone, I would say that the Fed is succeeding at its goal of moderating the economy to a sustainable growth rate.

I will offer the caveat that the Weekly Leading Index and its smoothed growth rate do not tell us how strong the economy will be six or nine months from now, but do tell us whether whether weakness or strength is more likely a few months from now. It works best to tell us whether a "gathering storm" might be lurking just around the corner, but presently indicates relatively "clear weather" for the next few months, even if the interval is occasionally punctuated with financial market "gyrations."

-- Jack Krupansky

AARP financial literacy quiz

See how you do on the AARP Financial Literacy Quiz:

How Money-Savvy Are You?

Many people have a hard time answering the most basic questions about their personal finances and retirement plans. With Social Security in crisis, knowing such information can go a long way in helping plan for the future. Take our exclusive Bulletin financial literacy quiz to find out how much you know—or don't know—about personal finance.

FWIW, I scored only 79%, but that is still better than the majority of people who took the online quiz.

-- Jack Krupansky

The Greenspan Show

The good news about former Federal Reserve Chairman Alan Greenspan's book tour is that it is giving all of us a steady supply of timely commentary, as opposed to his secret private presentations which only partially leaked out to the real world. An article on Reuters entitled "Greenspan says U.S. economic growth slowing" summarizes the latest commentary by Greenspan in an interview on CNN's "Late Edition with Wolf Blitzer":

... Greenspan said on Sunday that the rate of U.S. economic growth was slowing, but the odds of a recession are less than 50 percent.

... turmoil caused by the subprime mortgage crisis was easing and financial markets were beginning to go back to normal.

... Americans should be "cautious" about the economy, but not necessarily nervous.

... the best way of putting it is that the American economy's rate of growth is definitely slowing down ... the odds of a recession are less than 50/50.

... there was not much that lawmakers and the Federal Reserve should be doing to avoid a downturn ... we have a very complex, self-calibrating, self-adjusting economy.

I would forgive him for his secret private presentations to Wall Street firms if only he would just do a one-hour interview every week as well. Fair is fair. That would allow him to earn a healthy income from the secret private presentations and assure that Wall Street firms are not given yet another unfair "edge" over the general investing public.

-- Jack Krupansky

Risk management for fixed-income trading

As the fallout and after-shocks of this Summer's mini-crisis in credit markets continue to unfold, there is one term that keeps popping up: risk management. It is easy to understand how coping with risk can be very tricky with inherently complex investments such as venture capital, distressed debt, or corporate bailouts, but how on earth can risk management for fixed-income trading be so difficult and how badly can you really screw it up even if you wanted to? Somehow, even the biggest and "best" banks on Wall Street were unable to manage the risks of their own fixed-income trading.

This morning I was reading an article in The New York Times by Eric Dash and Landon Thomas Jr. entitled "The Man in Citi's Hot Seat" which tells us that:

But the $600 million loss in fixed-income trading still raises questions about the bank's controls. Risk models did not malfunction, Citigroup managers say, and Mr. Prince has called the trading losses an aberration. He has commissioned a report to learn what mistakes were made.

Hmmm... they are saying that the risk models failed to predict or mitigate huge losses but in the same breath they are saying that those models did not "malfunction." Exactly what distinction are they trying to draw between failure and malfunction? A loss is a loss, right? One would expect that all failures are aberrations, right? Well, apparently not. I guess the idea is that any given model only factors in a specific subset of risks and "malfunction" does not apply to "risks" which were not explicitly included in the models and in fact may have been explicitly excluded. Sounds like a typical insurnace policy.

I read this amusing piece of logic:

Citigroup executives concede that $5.9 billion is a substantial number but say they are certain that they properly managed risk...

What??? I wonder how they are defining "risk" that they can claim with a straight face that a $6 BILLION loss is well within the range of expected "proper risk management." Wow, what is wrong with this picture!

Now, in truth, I myself cannot even imagine what kind of believable "risk model" could ever be developed which would realistically encompass all forms and ranges of risk which an investment manager needs to be prepared to encounter over say a fifty-year time horizon. I'm no Einstein, but even a person of relatively average intellect should be able to recognize when a "model" is promising to deliver results beyond comprehension.

There is clearly a level of intellectual dishonesty here, or maybe the lawyers in fact have some hidden fine print that actually says that the risk models are for "information only" and should not be construed as actual "investment advice."

On top of all of this are two basic questions:

1. How can fixed-income trading be so risky?
2. Why are big Wall Street banks engaged in fixed-income trading in the first place?

The latter is the elephant standing in the middle of the room that nobody wants to talk about.

Just to be clear, when we (or the banks) talk about "fixed-income trading", we are not talking about the banks acting as brokers for customers wishing to buy or sell bonds. Rather, we are talking about proprietary, inhouse trading desks that are using the banks own money to place bets. The bank itself is betting on the movements of interest rates and supply and demand for debt securities. Whereas a true investor customer will be making investment decisions on the yield and risk of the debt security, the bank is seeking to buy and sell debt securities on a short-term basis based on their perception of change of market prices with very little regard to the actual yield or even the actual credit risk (since the security is not likely to be held long enough to be exposed to the actually credit risk events.) In most cases, they are simply trading off of the normal volatility of prices, with volatility further exacerbated by all of the short-term trading of the banks themselves. Like hedge funds, they will also engage in heavily-leveraged trades. For all intents and purposes, these inhouse trading desks are effectively hedge funds.

The real problem is not that there is a high risk of loss on the average fixed-income trade, but that so many of them are low-risk and are very profitable, so that the banks are lulled into a sense of complacency by their own great past success.

One technical problem traders encounter is that as everybody runs up the same learning curve and profit opportunities with short-term trades get skimpier, traders begin "reaching for yield" and gradually turn into medium-term speculators or even longer-term investors and more highly-leveraged where they less-skilled and are now exposed to things like actual credit risk events (e.g., bankruptcies and foreclosures) and illiquid markets. The beauty of short-term trades is that they can be quickly unwound for only modest losses. The ugliness of medium and longer-term "trades" is that they cannot be unwound quickly if at all and losses can be very large. The lesson here, as it has always been, is that "reaching for yield" really sucks as a strategy from a risk management perspective.

In truth, maybe the big banks are simply not being honest and upfront about risks and those risk models. I suspect that there is more than enough statistical data available that would have told bank executives that a blowup and loss of this magnitude can be expected every once in a while and that the proper attitude is to amortize such losses over the vast number of trades that were very profitable over a number of years. If that is their thinking, they certainly haven't been upfront about it.

My point is not that banks are unable to cope with these risks, but simply that it is highly inappropriate for such "pillars of the community" to be taking such risks in the first place. Sure, allow banks to engage in limited fixed-income trading to the extent that it is necessary to facilitate the transactions of the customers of the bank, but this concept of proprietary inhouse trading desks is a wild distraction from the true goal of providing banking services. If executives want to run a hedge fund, let them leave do so out side of the bank, not under the umbrella of "banking."

-- Jack Krupansky

Risk management for fixed-income trading

As the fallout and after-shocks of this Summer's mini-crisis in credit markets continue to unfold, there is one term that keeps popping up: risk management. It is easy to understand how coping with risk can be very tricky with inherently complex investments such as venture capital, distressed debt, or corporate bailouts, but how on earth can risk management for fixed-income trading be so difficult and how badly can you really screw it up even if you wanted to? Somehow, even the biggest and "best" banks on Wall Street were unable to manage the risks of their own fixed-income trading.

This morning I was reading an article in The New York Times by Eric Dash and Landon Thomas Jr. entitled "The Man in Citi's Hot Seat" which tells us that:

But the $600 million loss in fixed-income trading still raises questions about the bank's controls. Risk models did not malfunction, Citigroup managers say, and Mr. Prince has called the trading losses an aberration. He has commissioned a report to learn what mistakes were made.

Hmmm... they are saying that the risk models failed to predict or mitigate huge losses but in the same breath they are saying that those models did not "malfunction." Exactly what distinction are they trying to draw between failure and malfunction? A loss is a loss, right? One would expect that all failures are aberrations, right? Well, apparently not. I guess the idea is that any given model only factors in a specific subset of risks and "malfunction" does not apply to "risks" which were not explicitly included in the models and in fact may have been explicitly excluded. Sounds like a typical insurnace policy.

I read this amusing piece of logic:

Citigroup executives concede that $5.9 billion is a substantial number but say they are certain that they properly managed risk...

What??? I wonder how they are defining "risk" that they can claim with a straight face that a $6 BILLION loss is well within the range of expected "proper risk management." Wow, what is wrong with this picture!

Now, in truth, I myself cannot even imagine what kind of believable "risk model" could ever be developed which would realistically encompass all forms and ranges of risk which an investment manager needs to be prepared to encounter over say a fifty-year time horizon. I'm no Einstein, but even a person of relatively average intellect should be able to recognize when a "model" is promising to deliver results beyond comprehension.

There is clearly a level of intellectual dishonesty here, or maybe the lawyers in fact have some hidden fine print that actually says that the risk models are for "information only" and should not be construed as actual "investment advice."

On top of all of this are two basic questions:

1. How can fixed-income trading be so risky?
2. Why are big Wall Street banks engaged in fixed-income trading in the first place?

The latter is the elephant standing in the middle of the room that nobody wants to talk about.

Just to be clear, when we (or the banks) talk about "fixed-income trading", we are not talking about the banks acting as brokers for customers wishing to buy or sell bonds. Rather, we are talking about proprietary, inhouse trading desks that are using the banks own money to place bets. The bank itself is betting on the movements of interest rates and supply and demand for debt securities. Whereas a true investor customer will be making investment decisions on the yield and risk of the debt security, the bank is seeking to buy and sell debt securities on a short-term basis based on their perception of change of market prices with very little regard to the actual yield or even the actual credit risk (since the security is not likely to be held long enough to be exposed to the actually credit risk events.) In most cases, they are simply trading off of the normal volatility of prices, with volatility further exacerbated by all of the short-term trading of the banks themselves. Like hedge funds, they will also engage in heavily-leveraged trades. For all intents and purposes, these inhouse trading desks are effectively hedge funds.

The real problem is not that there is a high risk of loss on the average fixed-income trade, but that so many of them are low-risk and are very profitable, so that the banks are lulled into a sense of complacency by their own great past success.

One technical problem traders encounter is that as everybody runs up the same learning curve and profit opportunities with short-term trades get skimpier, traders begin "reaching for yield" and gradually turn into medium-term speculators or even longer-term investors and more highly-leveraged where they less-skilled and are now exposed to things like actual credit risk events (e.g., bankruptcies and foreclosures) and illiquid markets. The beauty of short-term trades is that they can be quickly unwound for only modest losses. The ugliness of medium and longer-term "trades" is that they cannot be unwound quickly if at all and losses can be very large. The lesson here, as it has always been, is that "reaching for yield" really sucks as a strategy from a risk management perspective.

In truth, maybe the big banks are simply not being honest and upfront about risks and those risk models. I suspect that there is more than enough statistical data available that would have told bank executives that a blowup and loss of this magnitude can be expected every once in a while and that the proper attitude is to amortize such losses over the vast number of trades that were very profitable over a number of years. If that is their thinking, they certainly haven't been upfront about it.

My point is not that banks are unable to cope with these risks, but simply that it is highly inappropriate for such "pillars of the community" to be taking such risks in the first place. Sure, allow banks to engage in limited fixed-income trading to the extent that it is necessary to facilitate the transactions of the customers of the bank, but this concept of proprietary inhouse trading desks is a wild distraction from the true goal of providing banking services. If executives want to run a hedge fund, let them leave do so out side of the bank, not under the umbrella of "banking."

-- Jack Krupansky

Cheap home mortgages continue to be readily available

Mortgage rates haven't changed dramatically since the big Federal Reserve rate cut over two weeks ago. This confirms my long-held view that mortgage rates a priced more due to supply and demand and the amount of liquidity in the pockets of investors than the actual Fed interest rate. The Fed rate cut probably also caused inflation expectations to rise which in turn caused longer-term Treasury yields to rise which in turn put a little upwards pressure on mortgage rates.

Despite all the talk of a credit crunch, people with good credit and a documented income can still get reasonable size mortgages (under $417,000) at quite cheap rates. The latest weekly mortgage survey from Freddie Mac shows the average rate offered for 30-year fixed-rate home mortgage is 6.37% (down from 6.42% last week) and the average for the 15-year fixed-rate home mortgage is 6.03% (down from 6.09% last week.) These are truly great rates.

Sure, people with lousy credit or without documented income or money for a deposit are on shaky ground, but that's the way it should be anyway. Jumbo mortgages for expensive homes (above $417,000) may be somewhat more problematic, but still available depending on local conditions.

So much for being able to depend on the media for information about finance and the economy.

-- Jack Krupansky

Euro runs into the wall with the employment report

The quite decent monthly employment report on Friday brought the euro to a screeching halt. No longer is it "clear" that the Federal Reserve will continue to cut interest rates. The December euro futures contract fell to $1.4158 on Friday from $1.4293 a week ago, a loss of 1.33 cents.

Where the euro goes from here is up in the air since we no longer have a solid consensus on what the Fed will do with interest rates, where the overall U.S. economy is headed, or how deep-pocketed the speculators are who have been pushing up the euro.

As far as where speculators think the euro may be headed, euro futures out at March 2009 were only at $1.4217 on Friday, so there isn't exactly a lot of "slam dunk" enthusiasm for betting on an ongoing upwards trend, so far.

-- Jack Krupansky

Fidelity Money Market Fund yield falls to 5.09% as of 10/6/2007

This will be my final regular posting of money market fund information since I have decided to focus my money market investment on the Fidelity Money Market Fund (SPRXX). It does have a hefty $25,000 minimum to open (which I just barely reached only recently), but does usually pay a modestly higher yield than the Fidelity Cash Reserves fund (FDRXX) and most other money market funds. In fact, this week it even managed to come in at #1 in the iMoneyNet Top Prime Retail Money Funds* (as of 10/2/07) list. Of course, all of this is subject to change on a weekly if not daily basis, especially in an environment where the Federal Reserve is monkeying with interest rates and concerns about credit quality are adding significant volatility to interest rates in general. But for now, I am content to leave the bulk of my cash in the Fidelity Money Market Fund on auto-pilot for now. Sure, I'll leave smaller piles in other funds and accounts, including PayPal and T-bills, but I may in fact consolidate those piles into the big pile as well over time. Note: I would be doing the same, but with Fidelity Cash Reserves (FDRXX) if I wasn't able to meet the minimum opening requirement.

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Note: PayPal is acting up again and did not pay a dividend yield for September that was anywhere near the yield range they had been quoting all through the month. I earned an annualized simple yield of 4.65% which is a far cry from the 5.20% 7-day yield range I had seen published for PayPal for the entire month. I saw this problem in July as well and complained then, but PayPal has yet to acknowledge that there is a problem. OTOH, the dividend for August was effectively a 5.77% annualized yield, so the average over both August and September works out to a 5.14% annualized yield, which is quite reasonable. Maybe the only problem with PayPal is that the dividends are "lumpy." For now, I'll leave the modest pile of cash that I have in PayPal where it is since overall I have gotten a decent return. But, I will no longer actively highlight or promote PayPal since they have been a frustrating experience and may be suited only for those actively doing other business with PayPal or who are truly adventurous.

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Despite the chatter about the so-called "credit crunch" and "subprime crisis" and the potential risk of even money market funds, money market funds are still an extremely safe place to park cash.

The good news is that a number of money market fund yields are higher as their existing short-term commercial paper matures and rolls over into new commercial paper that is getting a higher yield since supposedly nobody wants any of this commercial paper, or so the story goes.

Note: In theory, money market fund and CD rates should go down after the Fed lowers its target rate, but not necessarily immediately nor in lockstep with the Fed. Even as the Fed lowers its rate the yield on short-term commercial paper could stay high or even rise further, helping to keep money market fund yields relatively high.

It is too soon to tell, but so far there has been no dramatic impact to money market fund yields as a result of the Fed rate cut, but the impact will take weeks if not months to play out as the fund poltfolios incrementally mature and roll over into lower-yield assets, not to mention whatever further changes the Federal Reserve makes to interest rates. Note, for example, that money market funds invest in a lot of CDs whose yield is fixed for the term of the CD regardless of what the Fed does. Finally, entities with less than very high credit ratings will continue to have to offer significantly above average yields to attract capital and money market funds are an important source of short-term capital for such entities.

Here are some recent money market mutual fund yields as of Saturday, October 6, 2007:

• iMoneyNet average taxable money market fund 7-day yield fell from 4.54% to 4.52%
• GMAC Bank Money Market account rate remains at 4.78% or APY of 4.90% (only $500 minimum for that rate)  -- Note: This is an FDIC-insured bank deposit account, not a money market fund 
• Vanguard Prime Money Market Fund (VMMXX) 7-day yield fell from 5.06% to 5.05%
• Vanguard Federal Money Market Fund (VMFXX) 7-day yield fell from 4.92% to 4.91%
• AARP Money Market Fund 7-day yield rose from 4.97% to 4.99%
• TIAA-CREF Money Market (TIRXX) 7-day yield rose from 4.79% to 4.89%
• PayPal Money Market Fund 7-day yield rose from 5.10% to 5.21%
• ShareBuilder money market fund (BDMXX) 7-day yield fell from 4.51% to 4.49%
• Fidelity Money Market Fund (SPRXX) 7-day yield fell from 5.12% to 5.09% ($25,000 minimum)
• Fidelity Cash Reserves money market fund (FDRXX) 7-day yield remains at 5.05%
• Fidelity Prime Reserves money market fund (FPRXX) 7-day yield fell from 4.56% to 4.53%
• Fidelity Municipal Money Market fund (FTEXX) 7-day yield fell from 3.42% to 3.38% or tax equivalent yield of 5.20% (down from 5.26%) for the 35% marginal tax bracket and 4.69% (down from 4.75%) for the 28% marginal tax bracket -- this is a very decent yield for "core cash" in a checking-style account
• Fidelity Tax-Free Money Market fund (FMOXX) 7-day yield fell from 3.40% to 3.37% or tax equivalent yield of 5.18% (down from 5.23%) for the 35% marginal tax bracket and 4.68% (down from 4.72%) for the 28% marginal tax bracket
• 4-week (1-month) T-bill investment rate rose from 3.33% to 3.58%
• 13-week (3-month) T-bill investment rate rose from 3.92% to 3.94%
• 26-week (6-month) T-bill investment rate remains at 4.15%
• Treasury I Bond composite earnings rate (semiannual compounded annually) for new I Bonds is 3.74% (down from 4.52%), with a fixed rate of 1.30% (down from 1.40%) and a semiannual inflation rate of 1.21% (down from 1.55%) -- updated May 1, 2007, next semiannual update on November 1, 2007
• ING Electric Orange checking account remains at 3.50% APY for balances under $50,000 (FDIC insured)
• ING Orange CD 6-month APY remains at 4.90%
• ING Orange CD 12-month APY remains at 4.90%
• Bankrate.com highest 6-month CD APY remains at 5.41% (Countrywide Bank with $10,000 minimum)
• Bankrate.com highest 12-month CD APY remains at 5.50% (Countrywide Bank with $10,000 minimum)

Note: APY yield is worth somewhat less than the same 7-day yield. See my discussion and table for Comparing 7-day yield and APY.

I am tempted to go after those juicy CD rates that are still available, but regretfully my financial and employment situation is not solid enough for me to reduce the liquidity of my rainy day fund.

DISCLAIMER: I am not an investment adviser, so my opinions and the data presented here should not be considered as advice for where to invest your money. You should examine this and other available data before deciding how to invest your money. And, seriously, past returns should not be construed as a guarantee or even an indication of future returns.

-- Jack Krupansky

ECRI Weekly Leading Index indicator falls very slightly and suggests a stable albeit lackluster outlook

The Weekly Leading Index (WLI) from the Economic Cycle Research Institute (ECRI) fell very slightly (-0.06% vs. +0.21% last week) and the six-month smoothed growth rate was unchanged (at +0.9), remaining very modestly above the flat line, suggesting that the economy will be somewhat lackluster but stable in the months ahead, neither booming nor busting.

A WLI growth rate of zero (0.0) would indicate an economy that is likely to run at a steady growth rate, neither accelerating nor decelerating. A WLI fluctuating in a range from +1.5% to -1.5% would seem to forecast a relatively stable "Goldilocks" economy.

If I were looking at this one indicator alone, I would say that the Fed is succeeding at its goal of moderating the economy to a sustainable growth rate.

I will offer the caveat that the Weekly Leading Index and its smoothed growth rate do not tell us how strong the economy will be six or nine months from now, but do tell us whether whether weakness or strength is more likely a few months from now. It works best to tell us whether a "gathering storm" might be lurking just around the corner, but presently indicates relatively "clear weather" for the next few months, even if the interval is occasionally punctuated with financial market "gyrations."

-- Jack Krupansky