Harry Newton's In Search of The Perfect Investment
Technology Investor. Harry Newton
AM EST, Friday, July
17, 2009. It all started when J.P. Morgan Chase wanted
to move "risk" off its balance sheet in order to make more loans. The
regulators insisted on reserves" being put aside. But those reserves could,
if freed up, make more loans. At a party where most of the attendees were drunk,
someone mused "Let's get someone else to insure our loans don't go bad. This
way we don't have to hold reserves against them. And we can use those reserves
to make more loans."
someone was AIG. It was the biggest in insurance. Insurance was its cup of tea.
And so credit default swaps were born. They were incredibly profitable. You
got fees ( aka premiums) to insure something that had never gone bad. Not once.
Moreover since you had a triple-A rating, you didn't need to set aside reserves
for a rainy day. So, your fees were your profits. And the more profits, the
more you could pay your employees. All this was good for AIG and all the banks.
So you wrote more "business." You insured anything and everything
-- from business loans to bundles of the worst subprime mortgages.
ironic twist to the whole pack of cards was that it wasn't AIG that paid
out when the loans soured, it was the Federal Government that saved AIG who
then paid its customers, including Goldman Sachs. Meantime, the AIG employees
and others had taken their bonuses and there is apparently no way to "claw
Of course, things
are different now. All the investments and loans on the financial companies'
books are recorded at what they're worth today.
all loans and investments are carried on the books at their cost. Which means
the loans are written down only as the loans are repaid, or if they go into
arrears or default.
A friend is writing
a paper in which he quotes the last annual reports of companies like Citigroup,
AIG, Goldman, Lehman Brothers, Bear Stearns before the proverbial dodo hit the
fan. He told me all the annual reports have sections from management
assuring stockholders that the company understood "risk" and had made
more than sufficient provision for anything going wrong. And they meant anything
Of course, things
are different now, Goldman, Citi, BofA and others are reporting great earnings.
Their stocks are flying, and will fly more -- if you believe the old mantra
about buying financials first as we emerge out of a recession.
Why am I so cynical?
Clearly, it hurts
to have missed the March Rally.
Should we all
be edging more in?
The simple answer
is Yes. The chance of the market re-testing its March 6 lows seems increasingly
remote -- and each day it rises, it seems even more remote. Look at the chart.
Now ead Doctor
Gloom. The rule is get into the market nine months before the economy
turns. By this rule, now is right -- perhaps even a little late:
Dr. Gloom, Professor Nouriel Roubini
been widely reported today that I have stated that the recession will be over
this year and that I have improved my economic outlook.
Despite those reports - however my views expressed today are no different
than the views I have expressed previously. If anything my views were taken
out of context.
said on numerous occasions that the recession would last roughly 24 months.
Therefore, we are 19 months into that recession. If, as I predicted, the recession
is over by year end, it will have lasted 24 months with a recovery only beginning
in 2010. Simply put I am not forecasting economic growth before years
last year I argued that this will be a long and deep and protracted U-shaped
recession that would last 24 months. Meanwhile, the consensus argued that
this would be a short and shallow V-shaped 8 months long recession (like those
in 1990-91 and 2001). That debate is over today as we are in the 19th month
of a severe recession; so the V is out the window and we are in a deep U-shaped
recession. If that recession were to be over by year end as I have
consistently predicted it would have lasted 24 months and thus been
three times longer than the previous two and five times deeper in terms
of cumulative GDP contraction than the previous two. So, there is nothing
new in my remarks today about the recession being over at the end of this
also consistently argued including in my remarks today - that while
the consensus predicts that the US economy will go back close to potential
growth by next year, I see instead a shallow, below-par and below-trend recovery
where growth will average about 1% in the next couple of years when potential
is probably closer to 2.75%.
also consistently argued that there is a risk of a double-dip W-shaped recession
toward the end of 2010, as a tough policy dilemma will emerge next year: on
one side, early exit from monetary and fiscal easing would tip the economy
into a new recession as the recovery is anemic and deflationary pressures
are dominant. On the other side, maintaining large budget deficits and continued
monetization of such deficits would eventually increase long term interest
rates (because of concerns about medium term fiscal sustainability and because
of an increase in expected inflation) and thus would lead to a crowding out
of private demand.
the recession will be over by the end of the year the recovery will be weak
given the debt overhang in the household sector, the financial system and
the corporate sector; and now there is also a massive re-leveraging of the
public sector with unsustainable fiscal deficits and public debt accumulation.
as I fleshed out in detail in recent remarks the labor market is still very
weak: I predict a peak unemployment rate of close to 11% in 2010. Such large
unemployment will have negative effects on labor income and consumption growth;
will postpone the bottoming out of the housing sector; will lead to larger
defaults and losses on bank loans (residential and commercial mortgages, credit
cards, auto loans, leveraged loans); will increase the size of the budget
deficit (even before any additional stimulus is implemented); and will increase
there is light at the end of the tunnel for the US and the global economy;
but as I have consistently argued the recession will continue through the
end of the year, and the recovery will be weak and at risk of a double dip,
as the challenge of getting right the timing and size of the exit strategy
for monetary and fiscal policy easing will be daunting.
will soon release our updated U.S. and Global Economic Outlook. A preview of
the U.S. Outlook is available on our website: www.rgemonitor.com
am I not surprised -- 1. From the New York
largest public pension fund has filed suit in California state court in connection
with $1 billion in losses that it says were caused by wildly inaccurate
credit ratings from the three leading ratings agencies, The New York Timess
Leslie Wayne reported.
The suit from
the California Public Employees Retirement System, or Calpers, a public fund
known for its shareholder activism, is the latest sign of renewed scrutiny
over the role that credit ratings agencies played in providing positive reports
about risky securities issued during the subprime boom that have lost nearly
all of their value.
filed late last week in California Superior Court in San Francisco, is focused
on a form of debt called structured investment vehicles, highly complex packages
of securities made up of a variety of assets, including subprime mortgages.
Calpers bought $1.3 billion of them in 2006; they collapsed in 2007 and 2008.
that in giving these packages of securities the agencies highest credit
rating, the three top ratings agencies Moodys Investors Service,
Standard & Poors and Fitch made negligent misrepresentation
to the pension fund, which provides retirement benefits to 1.6 million public
employees in California.
The AAA ratings
given by the agencies proved to be wildly inaccurate and unreasonably
high, according to the suit, which also said that the methods used by
the rating agencies to assess these packages of securities were seriously
flawed in conception and incompetently applied.
P.S. It was only
when the rating agencies downgraded AIG from a triple-A to a double-A that their
world fell apart. They now had to set aside reserves against all that delicious
insurance (also called credit default swaps). They couldn't. They simply didn't
have the money.
am I not surprised -2? Beijing says Rio Tinto
bribed virtually every major Chinese steel maker -- 16 in total -- to buy its
iron ore. China's iron and steel business is thoroughly corrupt helped along
by weird Chinese government pricing rules. Big makers pay less for iron ore
than little companies. For more, click here.
stockmarket on a tear.
Comments by Chart of the Day:
With much of
the global economy under severe stress, today's chart focuses on one pocket
of strength China. In the midst of what is one of the most severe economic
downturns of the past century, China's economy managed to grow by 7.9% for
the year ending in Q2 2009. For some perspective, today's chart focuses on
Chinese stocks and presents the current trend of the iShares FTSE/Xinhua China
25 Index (FXI). As today's chart illustrates, Chinese stocks have endured
what amounts to an extremely wild ride since 2005. The FXI trended upward
at an ever accelerating rate (i.e. parabolic) from 2005 to Q4 2007. As the
credit bubble began to unravel, so too did Chinese stocks with the FXI trending
downward at an ever accelerating rate from Q4 2007 to Q4 2008. However, Chinese
stocks found their footing and have surged over 100% since their 2008 trough
(8% GDP growth will do that for you) and are currently trading near the upper
end of a nine-month trend channel.
eyeglasses -- Part 2: From reader Charlie McChesney,
I suggest that your readers try ennioptical.com.
if they want to see rock bottom prices. After an extended go round with my
local Target store optical department, I tried these guys. I am wearing the
pair I bought, They work well and I am very satisfied with them. The scuttlebutt
on the web is equivocal, some love them and some hate them, but at the prices
they charge, you can buy a pair of $8 glasses and if they are not OK, you
do not lose much...
My progressive, impact resistant, photochromic polycarbonate lenses with an
anti-reflective coating and a full rim frame cost about $75 delivered to me
vs. the price at Target's optical department of over $300. A pair of single
vision anti-reflective coated glasses costs $18 including shipping.
This company is apparently getting the optical work done in China so the waiting
time is about 2-3 weeks for single vision pairs and for bifocals and progressive
pairs 3-4 weeks.
my Canadian friends. You Know You're Canadian When:
+ You design
your Halloween costume to fit over a snowsuit.
+ You have more
miles on your snow blower than your car.
+ Driving is
better in the winter because the potholes are filled in with snow.
+ The local
paper covers national and international headlines on two pages, but requires
six pages for hockey.
+ Your town
buys a Zamboni before a bus.
+ You use a
red pen on your textbooks and fill in the missing u's from labor, honor, color,
recent New Yorker cartoons:
This column is about my personal search for the perfect
investment. I don't give investment advice. For that you have to be registered
with regulatory authorities, which I am not. I am a reporter and an investor.
I make my daily column -- Monday through Friday -- freely available for three
reasons: Writing is good for sorting things out in my brain. Second, the column
is research for a book I'm writing called "In Search of the Perfect
Investment." Third, I encourage my readers to send me their ideas,
concerns and experiences. That way we can all learn together. My email address
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