Harry Newton's In Search of The Perfect Investment, Technology Investor. Harry Newton
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6:00
AM EDT, Friday, November 6, 2009: I'm bugged
by one question. How is Wall Street able to make so much money and pay
such huge bonuses this year? IPOs aren't hot. Investment banking is slow.
Managing rich people's money is less profitable, as rich people are less rich.
So where are the profits coming from?
It's
coming from The Carry Trade. Before you dismiss this as self-evident,
bear with me for a moment.
The
Fed has reduced interest rates to basically nothing. It is making money cheap
so that businesses will borrow, build factories, employ people and get the economy
going again. At least that's its theory. Here's the chart.
But, Harry, no
one can borrow at these bargain rates. Why the pretty chart?
Wrong, someone
can. They're called banks and investment banks. They can go to the Fed and borrow
Fed money at basically nothing -- maybe 0.025% a year. Now what to do with the
money? The theory is they'll lend it to businesses to employ people. That's
hard work. The easiest thing to do is to buy government and high quality bonds
paying between 4% and 7%.
Figure it. Borrow
a million at 0.025% a year. That will cost you the grand sum of $2,500 for a
year. Now, let's say you buy a corporate bond yielding 7%. You've earned $70,000.
But you have interest expenses of $2,500. That gives you a net profit of $67,500
for doing basically nothing. Borrow a billion, and you've just made $67.5 million.
That's a simple
trade. This can get much more "interesting" if you're an aggressive,
arrogant bond trader. Let's say you borrow the money from the Fed and buy Australian
dollars and Aussie bonds. You earn a nice return on Australian bonds (Australia
keeps raising its interest rates) plus you get the appreciation of the
Australian dollar (also called the depreciation of the American dollar). This
transaction is more typical of what we know as The Carry Trade. For a
good explanation of it, there's a really good video from the Financial
Times.
But, Harry, there's
got to be a limit to this. The banks can't just keep on borrowing forever. True,
because all the big investment banks are now banks and hence "regulated,"
they can't borrow more than a certain amount of their own capital. In the old
days when we had serious regulation, the banks couldn't borrow more than 12
times their own capital. But that rule disappeared (after heavy lobbying in
Washington a few years ago). The figure presently appears to be anywhere from
30 to 40 times their capital. (This, of course, was the leverage that brought
Lehman Brothers down and nearly killed Wall Street. Nothing has changed in regulation
since. Heavy lobbying accomplished that. All those investment bankers relocating
to run Washington financial institutions, like the Fed and the Treasury, helped,
too.
Anybody who's
been reading this column knows I don't counsel investors to finance their investments
with OPM -- other people's money. Things go awry. You get margin calls. They're
always at the worst possible time. And you get wiped out.
But this is different.
First of all, our Government doesn't make margin calls. Better yet, it saves
banks by giving them more money to mess around with. Second, the Fed has said
it's keeping interest rates ultra-low for a long, long time. (It said that earlier
this week.) So, one risk is removed. Your costs of borrowing won't rise. They're
staying ultra-low. The only thing you got to do is not to be too greedy and
use this borrowed money to make ultra-risky bets -- like speculating in the
equities of emerging countries. I mean, it isn't as though the temptation isn't
there.
Let's say you've
borrowed a billion. Your emerging equities rise 50% . You've just made $499,975,000
without using one penny of your own money. Heck, this is better than working
for a living.
The downside to
this is your bet is wrong and emerging equities drop. So what. You're not in
trouble. The bank that lent you the money is in trouble. Would it want to look
really stupid that taxpayer money is being used to gamble? Can it afford another
financial crisis? Would it bail you out? Heck yes. It owns a printing press.
Just print more and more of it.
Writing earlier
this week Nouriel
Roubini wrote:
Since March
(2009) here has been a massive rally in all sorts of risky assets equities,
oil, energy and commodity prices a narrowing of high-yield and high-grade
credit spreads, and an even bigger rally in emerging market asset classes
(their stocks, bonds and currencies). At the same time, the dollar has weakened
sharply
Guess what's causing
the rally? Fed Government money financing The Carry Trade. Roubini
argues eventually prices will unravel. Says Roubini,
"The
Fed and other policymakers seem unaware of the monster bubble they are creating.
The longer they remain blind, the harder the markets will fall."
Hence, why I'm feeling
very very cautious at the present time. This asset bubble can't last.
A
reader emails: "The market is climbing a wall of worry." Investopedia
explains:
When
stock prices are rising regardless of market uncertainties, the stock market
is said to be climbing a wall of worry. These worries may include political
or economic risks. Once the perceived risks have been resolved or have past,
average market share prices tend to decline.
Stop
press: My rich friend tells me the private wealth division of a major
bank is lending him money at 1.25% a year. He's using the money to invest in
private equity funds. I asked, "This seems insane. Your private equity
funds are totally illiquid. What will you do if your bank wants its money back?
"They won't.,"
He answered, "I've got the money for as long as I want it."
"How did
you get money so cheap?" I asked.
"I ride on
the coattails of the bank's billionaire customers."
I'm guessing the
bank itself borrowed the money at 0.025% APR from the Fed. So, it''s even making
money on lending it at 1.25%. This is bizarre.
I don't make
this stuff up.
Nouriel
Roubini is not Dr. Doom. They call him Dr.
Gloom for his (accurate) economic predictions. But the man is anything but.
He probably runs the best and most famous parties in New York City. According
to friends who've been to his parties, they range from sedate 40-person sit-down
dinners to 400-person party-through-the night orgies. This is an amusing piece
from Gawker.com:
The
Secret Pleasures of Dr. Doom
One can tell the world's condition is dire because the practitioners
of that famously dismal science, the economists, are the new celebrities.
Putting aside Princeton's Paul Krugmanwho this week won the Nobel prize
for economicsone academic has emerged with a reputation of a seer, Nouriel
Roubini. The NYU professor's once-mocked warningsof a real-estate collapse,
equity market slaughter, the systemic bust of the banking systemhave
largely come to pass.
It's no wonder Roubini has earned the nickname Dr. Doom. One website suggests
a Halloween mask of his unsmiling visage. And the New York Times chose a photograph
(left) of the Stern School 'permabear' to go with this description. "With
a dour manner and an aura of gloom about him, Roubini gives the impression
of being permanently pained, as if the burden of what he knows is almost too
much for him to bear. He rarely smiles, and when he does, his face, topped
by an unruly mop of brown hair, contorts into something more closely resembling
a grimace."
It's time to
call bullshit. The image of Dr. Doom may satisfy the needs of the media and
partygoers this Halloweenbut Roubini is anything but dour. The 50-year-old
Iranian-Jewish economist is a promiscuous Facebook friend who draws a cosmopolitan
crowd to the frequent parties at his Tribeca loftan apartment with walls
indented with plaster vulvas, incidentally. As this party photograph shows
(right), the professor's gloomy public image is entirely at odds with his
playboy lifestyle. In a Facebook message, Roubini makes no apology:
"Dear
Nick, I work very very hard and I also enjoy life. My home is also partially
a cultural salon where I host book parties, debate and election night events,
independent film screnings, live music nights, theater/performance acts,
fashion shows, dinner parties and even plain old fashioned dance parties.
I have this
professional Dr Doom nickname but I am quite a cheerful person with a few
close friends and eclectic group of friends who, like most New Yorkers,
are members of the creative class. The innovations of lawyers and bankers
can be as creative as those of visual or performing artists, at times too
creative you may say given the current financial meltdown. So I live life
to its fullest. To paraphrase Seinfeld; anything wrong with that?"
In another Gawker.com
piece, there's this dialog:
So, what makes
his parties so great? we asked.
"Fun people
and beautiful girls," Roubini said, grinning.
"I look for ten girls to one guy."
His friend Bill
Clinton, he added, is a fan of this ratio.
How
to buy gold coins -- part 23 (or whatever). My
friend likes Gold American Eagles. He buys them from American Precious Metals
Exchange. He says they give excellent service. Click here.
The
value of gold. The following story rings true. My
father and mother escaped Nazi Germany. Father had converted all his assets
into raw diamonds. Mother carried them out in that special place women have.
Now to the story.
Moisha Rabinowitz
in the late 1930s fled his native land of Germany.
He sold all his
assets and converted it to gold and then had 5 sets of solid gold false teeth
made.
When he arrived
in New York the customs official was perplexed as to why anybody would have
5 sets of gold teeth.
So Moisha explained:
"We Orthodox Jews have two separate sets of dishes for meat products and
dairy products but I am so kosher and religious I also have separate sets of
teeth."
The customs official
shook his head and said, "Well that accounts for two sets of teeth. What
about the other three?"
Moisha then said,
"Vell us very religious Orthodox Jews use separate dishes for Passover,
but I am so religious I have separate teeth, one for meat and one for dairy
food."
The customs official
slapped his head and then said, "You must be a very religious man with
separate teeth for food and dairy products and likewise for Passover. That accounts
for four sets of teeth. What about the fifth set?"
"Vell to
tell you the truth, once in a while I like a ham sandwich."
Going
overseas until Wednesday November 18. My sister,
a travel agent, has organized a little tour for herself, her husband, Susan
and myself around Hungary, Austria, Poland and Germany. Highlights of the trip
will be Budapest, Vienna, Auschwitz, Dresden and Berlin. What about a carry
trade on the Polish Zloty? You think I"m crazy, the Zloty has been rising
strongly.
My
next column will be Wednesday November 18. I'll be on email all the time, however,
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 is .
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