Monthly Archives: September 2008

Now What – Is The US Economy Doomed?

Posted on by Nirav
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Well the $700 billion bailout plan was defeated. Wall Street didn’t like it and the market dropped a jaw-dropping 777 points. Was the bailout that vital to the health of the US economy?

Jim Rogers didn’t think so. Here’s a news report from the 25th of September ago:

Treasury Secretary Henry Paulson’s proposed bailout plan is “astonishing, devastating, and very harmful for America,” internationally-known investor Jim Rogers told The New York Sun.

Rogers says the current monetary climate in Washington reminds him of when then-Fed Chair Arthur Burns refused to let anyone fail.

Rogers insists Washington is making the same mistake again.

“We’re in for the worst recession since World War II, as well as higher long-term interest rates, higher inflation, higher taxes, a weaker dollar, and substantially lower stock prices,” Rogers says.

Even worse, Rogers believes it’s “embarrassing to see how little the presidential candidates know or grasp what’s going on, just like the current administration.”

But what about the almost 779-point boost in the Dow Jones Industrial Average that lasted for two days? “It’s only a matter of time before reality sets in and the market heads down again,” Rogers says.

“I wouldn’t buy now because it’s insane,” says Rogers, who believes investors “were foolishly sucked in by hysteria and a buying panic.”

Rogers, who bought dollars a couple of months ago, now thinks the greenback rally may have come to an end. He’s now buying more Chinese shares.

I’ve been insanely busy with college so I wasn’t even sure how the dynamic duo of Paulson & Bernanke came up with $700 billion. What were the calculations that led to that number? I couldn’t really find anything about it – most reports were rather vague. And if the risk-analysis departments of banks couldn’t figure out the worth of the toxic assets they owned, how did batman and robin figure them out?

A lot of people believe that printing money and turning on the cheap, easy credit spigot will keep the US from experiencing a 30s-style Depression. I really wonder if that is a likely scenario. It doesn’t seem to be working for Japan (although to be fair, they have cultural differences such as their not letting businesses fail, which is probably distorting their business cycle). Also, if its true that excess liquidity and cheap credit caused much of these problems in the first place, how can the solution be the same as the cause?

Here’s what Ron Paul said on the issue over the weekend:

This is Wall Street in big trouble and sucking in Main Street…and dumping all the bills on Main Street. You can’t solve the problem of inflation, which is the creation of money and credit out of thin air, by creating more money and credit out of thin air…

What they’re doing now, they’re propping up a failed system so the agony lasts longer. They’re doing exactly what we did in the Depression.

Saddling the American Taxpayer with an additional Trillion Dollars of Debt doesn’t seem like a good way of boosting the economy. The way things are going, the national debt is set to increase by a Trillion Dollars per year until 2017, after which it should increase by two Trillion a year!

If you still believe that bailing out foolish and greedy bankers is the right thing to do, check out my comments in  a previous post.  It’s a pretty interesting discussion.

So now that the bailout plan failed, is the US economy doomed? I don’t think so. Here’s an interesting article from the Heritage Foundation which suggests that the government is on a partially correct path regarding the financial markets.

And if you want something that’s even more optimistic about the US economy, I suggest reading Reality Check: The Unreported Good News About America by Dennis Keegan. He’s a hedge fund manager and he actually came and gave a speech to my class last week. While I don’t fully share his gung-ho optimism, he’s worth many millions and I’m not, so that should give you a good idea of whom to listen too! But he did say that chaos brings opportunities and people still make money in bad times, which I fully agree with.

And finally, Citi announced that it would be buying Wachovia. Isn’t that kind of strange considering that Wachovia was thinking of buying Morgan Stanley a week or two ago!

How To Save The US Economy

Posted on by Nirav
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Will the $700 Billion bailout save the US economy? I don’t think so, mainly because I’m not really sure where the money is going – I don’t think even congress understands how it’s supposed to work.

Keith Fitzgerald, investment director of Money Morning, wrote an interesting hypothetical letter to Ben Bernanke about what steps he ought to take to save the US economy.

Dear Dr. Bernanke,

I’m sorry to hear that you don’t know what to do about the credit crisis. That must be terrifying to you. I can tell you, it is certainly that frightening to the hundreds of millions of Americans who have seen their homes plunge in value and who now are watching their investment portfolios get vaporized.

Ben, you’re fighting the wrong battle and you have been since Day One, when you took over from your predecessor, Alan Greenspan.

You’ve been printing money on the assumption that this action will stimulate demand. That’s great in theory, but it’s clearly not working.

Here’s why.

Every dollar you print devalues every other dollar in circulation. What’s more, each new dollar you print also stokes inflation, which is why Americans are feeling pinched right now.

Forget the housing crisis or the consumer confidence statistics that you and elected leaders seem to be so focused on: These are the byproducts of the monetary problems I’m referring to – and aren’t the root cause.

The credit crisis began because there was too much money available. Not having enough money has never been an issue.

What is at issue – and what’s causing such pain in global markets at the moment – is that banks and other financial institutions will no longer lend to each other.

Americans – and, indeed, consumers worldwide – are caught in the middle. That’s why they’re unhappy. Of course consumer confidence is at all time lows, housing is melting down and wages are stagnating. But, again, those are byproducts, and not causal factors.

Here’s a five-step plan that I believe will help sort this out. It’s simple, but it’s decisive, and that’s what’s needed right now.

Step 1: Stop printing so much money. Take steps to restrict the monetary supply, including limiting how much “fantasy” currency the credit card companies can create. This is money that’s not backed by anything except the companies that created it. I’m sure you see the irony here, since it’s the companies that created the collateralized debt, the special-investment vehicles (SIVs) and other derivatives that caused the trillion-dollar problem roiling the markets right now.

Step 2: Create incentives for institutions to lend to each other, a strategy that includes raising interest rates. You could argue, as will many who read this, that this will stifle demand. I’ll concede that this might happen in the short run. But in the long term, this will provide a natural hedge that will selectively weed out those companies that shouldn’t have been in the game in the first place.

Think of it as a form of “financial Darwinism” and, by all means, talk to Paul Volcker to get his perspective. Many people thought he would kill the economy in the early 1980s when he raised interest rates to the sky to kill inflation, but that didn’t happen. In fact, you could argue that he set the stage for one of the greatest bull markets in history.

Step 3: Stop socializing debt. The public treasury is not a proxy for handouts, so stop treating it as such. We do not need the current credit crisis fiasco turned into social debt that will burden our country and every American for countless generations in the future.

The latest surveys reveal that up to 80% of Americans think the financial institutions that got us into this mess should be allowed to fail. So why are you pandering to the politicians who insist on bailing them out? Nobody will bail me out if I fail to make my debt payments anymore than they will assume your personal debts, either.

The fruit picker in Southern California making $17,500 a year who reportedly “qualified” for a $700,000 adjustable-rate mortgage (ARM) should receive a “stupidity premium” on his next tax return and the mortgage representatives who handled and processed the paperwork should be prosecuted in criminal court for predatory lending – if not for “credit-rating homicide.”

Step 4: Let the free-markets work freely. Contrary to the “Chicago school of economics” free-market strategies that you and your entourage profess to employ, the markets really do want you to take active steps to fix this mess.

Providing more money to stimulate demand presumes that the financial institutions handling it will be healthy enough to do so [or wise enough to deploy it properly – an assumption I find hard to agree with, at this point]. Since I can argue that these financial firms are neither healthy nor wise enough to do so, it’s probably a mistake for you to assume that the new money will rescue weak institutions that shouldn’t be in business in the first place.

If a person is addicted to drugs, and then runs out of the cash they need to finance their habit, they go into withdrawal. You don’t solve that problem by giving them more cash, or more drugs. You do an intervention and send the poor person to rehab.

Similarly, with an economy that has abused credit the way the United States has, you don’t address withdrawal [the U.S. credit crisis] by firing up the financial printing presses – which is tantamount to a federally sanctioned credit-line extension. Again, it’s time for an intervention that stops consumers from abusing credit.

Step 5: Tell the American people the truth. The Federal Reserve Act of 1913 requires the Fed to promote stable prices. You’ve got a once-in-a-generation opportunity to do so … and to make a difference.

Let those idiots on Capitol Hill know that their actions are interfering with your ability to do your job. Point out to them what “Everyday Joes” already know, and what you know – that “the emperor has no clothes.”

This is not a political issue for either party and you need to make that clear when you draw your line in the sand.

This is a generational crisis. Every single one of us is responsible for the path ahead – but precious few folks besides you are in a position where they can truly make a difference.

President John F. Kennedy once said that “the hottest places in Hell are reserved for those who in a period of moral crisis maintain their neutrality.”

In other words, sir, don’t damn yourself.

In closing, people do not write books about Captains of Industry who don’t know how to take charge any more than they will write about Fed chairmen who have no clue about how to fix things.

But history does look back favorably on decisive leaders who act with conviction. You have the chance to play that role right now – regardless of who’s in the White House. And I urge you to grab that chance.

Best regards,

Keith Fitz-Gerald

Note that this letter was originally published back in March, 2008!

 

The Trillion Dollar Bailout

Posted on by Nirav
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In the last post I speculated that the bailouts would end up costing the taxpayers upto $1 Trillion. It looks like that has become reality. Here’s an email I recieved from Asif Suria, of SINLetter:

In an unprecedented move, the current administration unveiled a simple three page plan on Saturday that will provide the treasury with $700 billion to buy toxic assets off the balance sheets of financial institutions. Combining this bailout plan with the $85 billion loan to AIG and the $200 billion to rescue Fannie and Freddie, we the taxpayers are eventually likely to incur a bill of $1,000,000,000,000. In case you did not have the time to count all those zeros and calculate what you might be liable for, that is $1 trillion and works out to a little over $3,250 for every man, woman and child living in the United States.

We have come a long way in this crisis that has devoured most of the independent mortgage lenders and left just 3 out of the 6 investment banks that started this year. Almost every weekend there is news of yet another small bank going under and real estate shows no signs of turning around. Nearly 47% of all homes sold in the state  of California last month were foreclosures and the median home price in the San Francisco bay area fell from $655,000 in August 2007 to $447,000 last month.

Following in the footsteps of our neighbors across the pond, the SEC temporarily banned short selling in the stocks of 799 financial institutions in an orchestrated effort to shore up markets. While I felt that the SEC’s move to ban naked short selling was a good move, I think a ban on short selling of any kind makes no sense. Essentially we can only buy stocks to go long or sell our existing positions but cannot hedge our portfolios by selling stocks that may be overvalued?

[Cartoon of Wall Street Bailout]

Short selling is an activity that even noted British economist John Maynard Keynes indulged in as far back as 1919 and is not the evil activity it is being painted out to be in the media. Try telling fund managed Ken Heebner who graced the cover of Fortune magazine just a few months ago that he has to change the structure of his 130/30 fund (130% of assets are invested in long positions and 30% are invested in short positions) because he can no longer sell short even if he identifies overvalued or mismanaged companies in the financial sector.

In its press release regarding the short selling ban the SEC admits, “Under normal market conditions, short selling contributes to price efficiency and adds liquidity to the markets.”. Clearly this action is targeted towards institutions that were aggressively short selling financial stocks and unless extended, it should end on Oct 2, 2008. Thankfully naked put options and the ultrashort ETFs, our instruments of choice to hedge the SINLetter model portfolio, were not included in the ban.

We are already beginning to see the dollar weaken against other currencies and the best way to play this (besides shorting the dollar) could be to take long positions in other currencies through ETFs like Currency Shares Australian Dollar Trust  (FXA), Currency Shares British Pound Sterling Trust  (FXB), Currency Shares Canadian Dollar Trust  (FXC) or Currency Shares Swiss Franc Trust (FXF). If picking a specific currency is too daunting a task (it is for me), then the “carry trade” ETF PowerShares DB G10 Currency Harvest Fund (DBV) could provide a useful alternative. The simple premise of this ETF is that higher yielding currencies tend to outperform lower yielding ones and hence this ETF goes long the highest yielding currencies while simultaneously shorting the lowest yielding currencies. You can learn more about the carry trade and DBV from this BusinessWeek article titled Trade Currencies Like A Hedge Fund.

Bond prices have also dropped in anticipation of the U.S government issuing more debt to finance this bailout. Most homeowners tend to either move or refinance their homes within a 10 year period. Hence 30 year mortgages are closely correlated to the 10 year Treasury note and have already jumped last week in response to this bailout plan. Not only are financial institutions being given a “get out of jail free” card but responsible first time home buyers who waited out the real estate bubble are going to pay the price immediately through increased financing costs.

So Who’s Really Bailing Out The Financial Industry?

Posted on by Nirav
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I started writing this post on Sunday but never got a chance to finish it. (On the other hand my first 3 days of the UCLA MBA program have been AWESOME!) I  know there’s been a lot of commotion in the stock market over the past few days and the Government just announced a bail-out of insurance company AIG. (But between spending 12 hours at school and reading 40 pages of papers a night, its been impossible to keep up). So anyway, here’s my delayed posting – its still relevant.

Last week the government announced a bailout of Fannie Mae and Freddie Mac. The US taxpayer now owns 79.9% of the outstanding shares. Before you go around congratulating them on their outstanding stock picking skills, just remember that the government is now explicitly backing the mortgages held by the two institutions.

While certain government officials have said that the bailout will end up costing the taxpayer as much as $300 Billion, the actual figures could be as high as $1 Trillion. When you consider that several major banks, the FDIC (Federal Deposit Insurance Corporation) and the PBGC (Pension Benefit Guaranty Corporation) will all need to be bailed out at some point, the official cost to the US tax payer will probably be well over a $1 Trillion.

Where is the government going to get this kind of money? Our national debt is already running at $9.68 Trillion and we have future debt obligation of another $45 Trillion.

Will the government raise taxes or just print more money to cover this shortfall?

Raising taxes is never a popular thing to do and most politicians try to avoid it if they can. The easiest thing to do is just print more money! However, this has the effect of devaluing the existing dollars in circulation. This typically leads to more inflation. Someone even said that inflation was like taxation without representation!

Basically, the average US tax payer is on the hook for all these bailouts. It will come at the cost of higher taxation, or higher inflation. Both will lead to a somewhat lower standard of living than we’ve been used to for the past two generations!

Despite the severe correction in gold and silver prices, this instability in the currency should cause their prices to jump.Even gold and silver stocks, which have been massively punished, should do well in the long term and are currently great buys right now.

Passive Income Update For August 2008

Posted on by Nirav
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Finally got some time to add up all the passive income for the month of August. While June was a record breaking month with over $3,300 in passive income, July and August have been pretty lackluster in comparison. July’s income was $2,115.61 and August’s total was hardly any better with $2,134.57.

Maybe I can use the same excuse that government statistians use when talking about the economy and blame on seasonal variations! But the fact is that revenue dropped due to 2 main reasons. I pre-sold annual advertising in June that rightly should have been ammortized over the year (according to Generally Accepted Accounting Principles). Also, since I was busy with my move to Los Angeles, I didn’t really have time to look for advertisers or respond in a timely fashion to those that contacted me.

But the good news is that traffic to the site didn’t drop off, and apart from direct advertisers, revenue that was dependent on traffic remained almost constant. And of course, my dividend income was pretty stable despite the recent large drop in equity prices and the strengthening dollar which caused a 5-8% drop in the value of my foreign dividends.

Here’s the breakdown:

A reader emailed me a few days ago asking what’s the best way to start generating online income. I told him to start blogging about something he was passionate about. That way, he’d be able to keep up his motivation during the initial few months when he probably wouldn’t be making any money. Once he had written a few dozen articles or posts, he should start seeing some search engine traffic. If you’re in a highly competitive niche, you’ll need to make sure you have a lot of other sites linking back to you. Do a search for creating a back-link campaign to find out how to do this.

Once you see search engine traffic you should include ads in your site.  I include ads from Comission Junction, Adsense, Linkworth, Text-Link-Ads, ADSDAQ and Kontera. While individually they aren’t significant amounts, the income is consistent and together it all ads up.

Amazon affiliate income has dropped a lot since the beginning of this year. Not sure if this is seasonal since there are more sales between Thanksgiving and Christmas, but I’ve finally gotten around to adding an affiliate link prominently on the site and I expect this to have a positive effect. How much of a positive effect remains to be seen.

The affiliate income from Ebay has been growing steadily. It’s up nearly 7-fold in the past 5 months. Last month I added a storefront on this website which focuses on business, cheap real estate, gold coins and other income producing ventures and this has already started producing referrals. Some of the other sites are .info sites that I bought for $0.99 from GoDaddy and they were created using BANS. For a little more info on how to generate passive income from sites, look at the 2nd half of this post (look for the section on Niche Sites).

RevResponse did well last month, partly due to a $50 bonus. They basically provide free publications and white papers on various topics ranging from finance and banking to search engine optimization and car detailing. Check out the Free Financial Magazines link. Bloggers might also want to check out the Sales & Marketing articles too. Mature programmers might remember a famous programming magazine called Dr. Dobb’s Journal. Well, it’s available for free too. And the best part is I get paid for providing my readers with free useful information! Yes, you can  money selling magazines! (well, technically you’re giving them away).

A lot of oil and gold stocks have been beaten down recently. My portfolio of Canroys wasn’t spared either, but I’m not going to panic and sell them right now. I’m getting a decent amount of dividends each month and I’m happy to keep on holding them for a while. We’ve seen some pretty bizzare events in the financial markets lately and I’m sure not going to panic after everyone else already has (the time to panic is before everyone else!).

Anyway, its time to wind up this post. I have the last 6 hours of Math camp tomorrow! It’s a lot more fun than I thought it would be!

Why You Shouldn’t Flirt When You’re Drunk!

Posted on by Nirav
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No, I haven’t abandoned my blog. I’ve just been busy packing up and moving to Los Angeles and settling in to my new digs in Westwood, which is close to UCLA. And it’s incredibly difficult to pack (or even sleep for that matter) when you’ve sprained a back muscle, especially the serratus posterior superior muscle. Don’t even know how I sprained it. Probably from too much partying around the Labor Day Weekend.

Anyway, I’m all settled in and I start pre-term Math, Accounting and Excel courses tomorrow followed by week-long Orientation and Leadership classes. After 3 weeks of this, the the regular MBA courses start and it’s going to be an incredibly hectic first quarter where I’ll be taking 5 core courses in just 10 weeks.

So I’ve been spending the past couple of days front-loading my recreation and have been hanging out at bars and pubs, networking with my future MBA classmates and other friends. One such networking event entailed going to a bar and drinking imported beers for nearly 7 hours! While I stopped drinking after 3 hours, one of my friends (who’s actually a medical doctor) kept on going. Around midnight, after he had been drinking and flirting with another drunk chick for several hours, he convinced her to pepper spray him! Luckily, it didn’t get as bad as it could have, but it made for a hilarious near-riot. So if you’re prone to thinking you’re invincible when you’re drunk, you might not want to flirt or get into argument with other drunks! (There, that’s one thing they won’t teach at business school!)

And while drinking in bars and pubs is a lot more expensive than drinking at home, it is definitely a lot more fun! Looks like business school is going to end costing a lot more than I expected!