Can Turtles Fly?

Most people probably never heard of him but Dominic D'Alessandro succesfully runs Manulife Financial, a Canadian insurance giant. He says that mark-to-market accounting is hurting insurers : The same accounting rules that bank executives blame for exacerbating the financial crisis are going to make insurance more expensive for Canadians, says the chief executive officer of North America's biggest insurer. ... The rules exaggerate the tendency toward greed and short-term thinking in the financial system, Mr. D'Alessandro said. “One of the benefits that we've had here in Canada is we've been able to run our business constantly with the view as to what is the best economic decision, not what is the best accounting decision,” Mr. D'Alessandro said. “And we've been able to hold assets and invest our policy holders' money in a blend of assets which over the long term has delivered substantial value to them. Well, under the new accounting rules that have been f...

The bailout will likely pass in one form or another, now that presidential candidates John McCain and Barack Obama are asking for it to be supported . Some, such as Paul Krugman and John Hussman have argued that the Paulson plan misses the most important need: a need to provide additional capital to financial institutions. The linked article from John Hussman explains in clear layperson language why this bailout does not help the institutions in question, unless the government purposely overpays them. If the government does purposely overpay, it will raise ethical issues regarding who actually gets to make the decisions, who profits (or minimizes losses,) and so forth. A lot of left-leaning individuals, including me (I'm in Canada though,) have little faith the Bush administration. It already took the country on a totally ficticious war, fired attorneys that it did not like, formulated environmental policy in secret meetings influenced by industry, awarded very expensive military...

UPDATE: Added a chart from The Economist showing the deposit insurance in various countries. Some are calling for the FedRes to cut rates but, on top of potentially causing inflation problems down the road, it won't have much impact. Look at the yield curve in the US ( chart courtesy Bloomberg ): If banks can't make money off this, they never will. A rate cut will simply cause the likely bubble in US Treasuries to hit even more of an extreme, while credit costs in other areas of the economy (mortgages, credit cards, corporate bonds, etc) remain the same. While this bailout works its way through the government--they only need 20 votes and it should be doable--other solutions need to be considered. I don't generally agree with Jim Cramer but one of his latest arguments calling for the insured limits at banks to be increased from $100,000 to, say, $1 million is a small step that can help the banks. The threat right now is a run on these banks and a higher limit (assuming it i...

Needless to say, big sell-off in the market due to the US government voting down the bailout. Note that the sell-off is with short-selling bans of many of the key stocks on the exchanges. The market could have plunged even further if short-selling was allowed. This could be a short-term bottom but don't rely much on my short-term calls... (source: The Wall Street Journal , wsj.com; powered by SmartMoney.com) Although it was a surprise to me and the market, I guess it was always possible that the US government bailout would be voted down. If people like me, who has almost all his wealth invested (my net worth is very low though,) were skeptical, it's even harder to get the politicians on board. I am actually OK with the bill that was finalized. It's nowhere near perfect but it did address my two concerns: (i) immense power for the Treasury, and (ii) penalties for mistakes. The New York Times reports the final vote as the following : The vote against the measure was 228 to 20...

I have never invested in them but I always assumed they were low risk. I am referring to principal-protected notes. These consist of a diverse set of securities, often producing returns tied to some index. For example, a security that pays you returns based on the performance of the European Dow Jones STOXX Index. Some of these notes promise that the principal will be returned at maturity. I never realized that these were an unsecured claim on the issuer. Bloomberg points out how many investors of notes issued by Lehman Brothers have suffered : A brochure pitching $1.84 million of notes sold by Lehman Brothers Holdings Inc. in August, a month before the firm filed for bankruptcy, promised ``100 percent principal protection.'' Buyers had ``uncapped appreciation potential'' pegged to gains in the Standard & Poor's 500 Index, the brochure said. In the worst case, they would get back their $1,000-per-note investment in three years. Only the last in a list of 15 ris...

One of the things that has worried me over the years is the possibility of nearly all assets declining. I first came across this concern from Marc Faber, who has often pointed out that the bull market in the last 5 years has been very unique. Almost everything--US stocks, emerging market stocks, emerging market bonds, commodities, gold, junk bonds, real estate, art, collectibles--have gone up since the early 2000's. It is very unusual. Historically, if commodities prices went up, broad-market stocks went down. I don't think too many would have imagined that the S&P 500 would hit an all-time high while oil prices go up 5x from $20 to $100. The huge decline in the US$ is part of the reason but that alone cannot explain any of this. Although the situation may not turn out as dire, the possibility exists. I feel like some of what Marc Faber said in 2007 describes the current situation quite well. Let me quote his words from a Financial Sense Newshour interview with Jim Puplava ...

This is just an idea... somewhat wild and risky, as usual. I'm not sure if I will do anything because this one trades on the over-the-counter Grey Market (extremely thin volume--not suitable for large investors or funds) and I'm not sure if I have access to it from my discount broker. Ideally I want to hold it in my tax-sheltered account but I don't believe that broker supports the Grey Market so I'm down to my normal one (not sure if that supports it at a reasonal commission.) I'm thinking of investing in a super-long-term junk bond. The bond in question is Sears Roebuck Acceptance Corporation 7.4% note due in 2043 . You can find the IPO prospectus here (For those not familiar, QuantumOnline is the best free site for exchanged-traded debt/preferred instruments.) Here are some details of this issue: Security: Sears Roebuck Acceptance Corp., 7.40% Notes due 2/1/2043 Ticker: SBCKO (over the counter Grey Market) Issuer: Sears Roebuck Acceptance Corporation (subsidia...

There are some dark clouds gathering in the debt markets. The clouds have been building for a while now but the final fate may be near. The storms will be threatening... So far, the losers in the credit crisis that was started by the subprime virus have been shareholders. Many have suffered monumental losses, including yours truly, not to mention such illustrious ones as Hank Greenberg of AIG, who lost almost his entire net-worth of $3 billion . Not complaining here; it's the nature of markets and there is a reason we invest in equity. Bondholders of financials, in contrast, have sailed smoothly, albeit in rocky seas, for the most part. However, that is in the process of changing and it will have massive ramifications for the investing world. Credit markets--the bond prices, as well as CDS on those bonds--have been signalling losses but it never really happened on a large scale until recently. The collapse of Lehman Brothers was perhaps the first sign that bondholders are at real r...

By some accounts this has been the worst September in economics and finance in American history. Who knows how correct that description is but here are some articles I found interesting for the last weekend of September: Jim Grant on the bailout : I ran across the linked Jim Grant article from a Controlled Greed post . The key concern he raises is the future of the US$. I personally don't think it is as dire as it seems (but it depends on the details.) I think the US$ will only start to face problems if the US governemnt prints money rather than borrowing it. Forigners might demand slightly higher rates but it isn't anything big. Right now, I'm bullish on the US$ due to my belief that there will be capital flight into it (away from risky assets and markets, such as emerging markets.) Excessive leverage is the problem: Fortune has a basic article talking about the excessive debt that American financial firms took on in the last decade. A chart that is referenced shows Ameri...

Bloomberg has an interview with the CEO of Ambac, Michael Callen. As usual with these Bloomberg links, click on the link on the top-right (for some reason I can't link directly to the URL--it gets cut off in my post.) Just to quickly recap, he clearly isn't happy with the rating agencies. Ambac will be facing a tough situation if it gets downgraded. The insurance regulators, unlike many other regulators, are quite knowledgeable and are friendly to the bond insurers. They will let Ambac Assurance transfer some money to the investment business but I just don't want to be bugging them too much. Whenever Ambac runs up to the regulator, it sort of burns some good faith. Callen seems to pin a lot of hope on the government bailout; whereas I think it will only tangentially help the bond insurers. The problem, on top of the moral issues I have ranted about, is the fact that price discovery is still going to be elusive. Everyone seems to think that we will get liquidity and prices ...

The severity of any crisis can be judged by the size of the largest failure. Well, we just had the biggest failure in American history when Seattle-based Washington Mutual was taken over by the government : Washington Mutual, the giant lender that came to symbolize the excesses of the mortgage boom, was seized by federal regulators on Thursday night in the largest bank failure in American history. Regulators simultaneously brokered an emergency sale of virtually all of Washington Mutual to JPMorgan Chase. The remainder of WaMu, the nation’s largest savings and loan, will be operated by the government. Shareholders and some bondholders will be wiped out. WaMu deposits are guaranteed by the Federal Deposit Insurance Corporation up to the $100,000 limit for each account. WaMu customers are unlikely to be affected. Washington Mutual was the 6th largest bank in America, and had $310 billion in assets. It operates primarily in the west coast and hence was heavily exposed to the housing bubbl...

Bailing out failed institutions or those that would fail anyway is generally considered to be anti-free-market. Since all the true free market proponents have been separated from the fake ones--the fakers being ones that subscribe to what I call the Wall Street Journal form of capitalism--you don't hear too many arguments illustrating why they are against the free market. Well, the problem with free bailouts is that it rewards the failed institutions, their workers, their shareholders, and their bondholders. Want to see it in real time? Consider the argument from John Allison of BB&T Corporation, a bank : U.S. Treasury Secretary Henry Paulson's proposed $700 billion bank rescue aims to help ``poorly run'' companies and the primary beneficiaries would be Goldman Sachs Group Inc. and Morgan Stanley, said BB&T Corp. Chief Executive Officer John Allison in a critique of the plan. Treasury ``is totally dominated by Wall Street investment bankers'' and ``canno...

UPDATE: Fixed Bloomberg video link UPDATE II: I found some insightful nuggets in the Marc Faber interview with Bloomberg. Some may not like an extremist like him but he always presents a different perspective. While you are at it, if you feel like it, you might also want to check out this Jim Rogers rant . Nothing insightful except for his comment that he has covered all his shorts of homebuilders, Fannie, and financials, except the investment bank shorts. Since the only two investment banks left are Morgan Stanley and Goldman Sachs, I interpret this to mean that he thinks these two still have some ways to drop. I can see this happening because these two need to de-leverage and any such move will result in share price declines (instead of selling assets, you can try to take on more equity as Goldman Sachs recently did, but that dilutes shareholders.) Well, Marc Faber is super bearish right now but that's nothing new from Dr. Doom. Do note that he is sometimes wrong and macro call...

The massive bailout being debated the US government seems to have taken a turn towards the absurd. It seems an inordinate amount of time is being spent trying to negotiate a requirement to curb executive compensation. The fact of the matter is that executive pay is almost meaningless in the grand scheme of things. Lest one forget, employee compensation is set by the shareholders and if shareholders are happy paying their executives high compensation for blowing up their firms, they should be allowed to. The government meddling will only create a bigger mess in the future. Sadly, the Democrats seem to think the executive pay is a big deal, while the Republicans (Paulson and Bush in particular) think it is worth fighting for this. Both should just forget about this issue and move onto the following. The real issue is the risk taken on by the government and the proper compensation for that. The real discussion between the Democrats, who control the Congress and Senate, and the Bush admini...

I highly respect Warren Buffett but he is just like everyone else in attempting to profit off everything. His latest investment in Goldman Sachs seems to be nothing more than an attempt to profit off the latest government plan. As Calculated Risk points out , Buffett says he wouldn't have made the investment if he didn't think the government plan was going to come to fruition. I'm left-leaning so I am not as hostile as those on the right when it comes to government throwing around money. However, the $700 billion Paulson plan is very large and looks like it will benefit many firms that aren't even impacted much. Bloomberg had a story yesterday saying how Morgan Stanley and Goldman Sachs may be two of the biggest beneficiaries of the plan: Goldman Sachs Group Inc. and Morgan Stanley may be among the biggest beneficiaries of the $700 billion U.S. plan to buy assets from financial companies while many banks see limited aid, according to Bank of America Corp. ``Its benefit...

Although it seems minor, this is actually major news. Bloomberg is reporting that the State of New York is attempting to require CDS contracts to be treated as insurance if the CDS buyer owns the underlying bond as well. The state will treat contracts in which the buyer also owns the underlying security as insurance, Paterson said today in a news release. All such contracts would have to be purchased from regulated bond insurance companies, said David Neustadt, a spokesman for New York State Insurance Superintendent Eric Dinallo. Contracts in which investors buy protection against a default but don't own the actual security won't be treated as insurance, according to the release. I'm not sure which insurers would be willing to write the CDS-type insurance. Forays into CDS writing by the monoline bond insurers ended up in a huge disaster. American giant AIG also blew up due to its CDS contracts. Admittedly, all these blow-ups are with mortgage CDS-type insurance, so other a...

The Liberals in Canada are suggesting that they are going to scrap the income trust tax, giving life to whatever is left of the trusts. Stéphane Dion's Liberals are promising to scrap the Harper government's hefty tax on income trusts as they release their campaign platform today, a pledge that offers a potential new lease on life for an investment vehicle much beloved by older voters. I think this is a dumb idea and sounds like desperation. I hope they don't seriously pursue this. Some relief may be appropriate but allowing tax-avoiding trusts to be created is detrimental to the future of Canada. There is a reason such schemes are not prevalent in other countries, including USA. The fact of the matter is that many businesses will convert to a trust in order to avoid paying taxes, which also reduces re-investment in future growth and masks poor management. I have never been fan of income trusts. I took a look at them about 3 years ago and came to the conclusion that they a...

(Note: I'm not an American so this comment is simply my opinion of my neighbour to the South :) ) Ignoring the fact that I don't think the $700 billion US bailout plan is going to have much impact, I don't like the immense power being given to the Treasury. I'm not a fan of the Bush administration and we all know how much it loves to seize power. The bogus Iraqi war, started under complete lies is an example; another is the passing of the Patriot Act, which probably stripped more rights from Americans than the terrorists or the Nazis or anyone else that they faced before (fortunately, though, the Supreme Court isn't going alone.) Congress and Senate also play crucial roles in voting but the presidential administration is what sets the strategy. I think the government needs to be really careful about giving too much power to the Bush administration (and the subsequent one after that.) Preliminary drafts of the proposal seem to give the Treasury, being run by Henry Pa...

This is pretty much the end of the financial boom of the last 30 years. A boom that started in the early 80's has finally run its course. GaveKal termed it the financial revolution and I agree it has been one. There have been immense benefits--easier access to credit; ability for public to own financial instruments; ability of businesses to off-load financial risk; more efficient hedging of financial risk; and so on--but all this will slow down in the future. It should be pointed out that the change that I'm referring to will occur not just in mortgage finance but in the full financial sphere. Perhaps the best indication of the end is word that Goldman Sachs--the strongest investment bank in the world--and Morgan Stanely--another American giant in investment banking--are set to become bank holding companies . Although this does not mean that they will become a conventional bank, it does mean that the increased regulatory oversight will end their freedom. I anticipate two thing...

I have been harping for many months that mark-to-market accounting, aka fair-value accounting, will go down as a culprit in the current financial crisis. I have upgraded my view and now think it will go down as one of the worst regulatory changes brought about by accountants in American history. Yes, that's how strongly I feel that it has exacerbated the crisis. I'm not an accountant or a financial analyst but sometimes those outside the field probably have a more neutral view. Just to be clear, I am not arguing that it is the cause of the crisis! The cause is clearly mortgages given to people that couldn't afford them. I will also note that financial institutions benefitted 'on the way up' from this scheme. But it would have been better if they never benefitted on the way up no more than they suffer on the way down. What mark-to-market is doing is gravely exacerbating the situation. John Mauldin seems to share my view and comments about it in this week's lette...

It seemed like Ambac solved its short-term problems a few months ago but that was not to be. It seemed unlikely a few months ago but the suggestion by Moody's this week of a rating downgrade will cause serious problems for Ambac. The situation is very similar to what brought down the insurance giant AIG (however, AIG's problem was with its actual insurance issued in CDS form, whereas Ambac's problem is its side investment management busines). Namely, it looks like Ambac will be short if it had to post collateral , as required under its GIC contracts. Ambac will be short by $1 billion to $2.1 billion (based on present market values), depending on the company rating. Now that it has shelved its Connie Lee idea--I was never a big fan of this--it should have around $850 million. I think its easy to get $1 billion but $2.1 billion could be tough and would require approval from the insurance regulator. What is happening is that the market value of the assets are down (not surprsi...

The rally today was massive. The TSX was up around 7%. Here is a sector snapshot of the Dow indexes ( courtesy wsj.com ): I think the rally is bogus and unsustainable. Part of the rally is due to the elimination of short selling of financials. As you can see in the chart above, the big gainer was financials. The second best seems to have been energy. A lot of short sellers likely covered their positions in case the SEC extends the shorting ban to other industries. Overall, we finished the week largely flat in most countries but, needless to say, it was beyond a wild ride.

Russian market was halted again ... this time because it rose 30% in one day: Russian stocks rallied nearly 30% Friday, causing the markets' regulator to halt trading once again on the two main stock exchanges, after the government took a series of steps aimed at stemming the country's financial turmoil. I think emerging markets can still sell off in the next few months.

UPDATE: ProShares says that no new shares will be created but existing ones can be liquidated. One of the advantages of ETFs is supposed to be their inherent arbitrage which keeps their share prices close to the net asset value but that is going to be out of whack now that arbitrageurs can't create new shares of the ETF. Here is a consequence of the financials short-selling ban. The Ultrashort Financials ProShares (SKF) isn't trading: I have no position in it but just pointing out some results. I suspect that the derivatives market--such as those writing options--will also see less liquidity (since writers often hedge their derivatives position by taking long or short positions in the underlying stock.) This isn't a big deal (except for those bears who need to get their money out) but it's something that may happen to other stocks. I never would have thought this possible a few weeks ago but it is quite possible for the stock market to shut down. I'm not expecting...

The free market is becoming less free, that's for sure. It's quite ironic that the "free market" Republicans end up undertaking huge socialization programs. Congress and Senate are controlled by Democrats but the Treasury is run by the Republican president. Having said that, I think the Democrats would have done something similar, but perhaps with a greater cost to investors and less so to taxpayers. This post is about the proposed strategy for the US governmen to buy distressed mortgage assets. But first some key events that are unfolding. The SEC just banned short selling on 799 financial stocks . Financials will rally but it's not a market signal. It's close to a manipulation so it's questionable if the rally is temporary. I'm not sure what happens with inverse ETFs. Does this mean that no new ETF shares (of short funds) will be created? You are going to get some unpredictable results from the shorting ban. The US government is also creating a $50 b...

Found the following song lyrics set to Bob Dylan's The times they are a-changin' . I don't agree with the full lyrics but it's well done so I'm reproducing it here. If you are not familiar with the original song by Bob Dylan, check out the song on YouTube . (For those not familiar, Bob Dylan is an American rock & roll musician and is considered to be one of the most influential of all time. His most famous song is Like a rolling stone ( youtube link here ).) Posted by williambanzai7 in the comments on the NYT DealBook blog for the entry Henry Paulson's Frakenstein . I assume he/she is also the author of the modified lyrics. Reproduced without permission. “ The Markets They Are A-Changin’ ” (to the melody by Bob Dylan; posted by williambanzai7) Come gather round ‘bankers’ Wherever you roam And admit that the waters Around you have grown And accept it that soon You’ll be told to go home If your job to you Is worth savin’ Then you better start swimmin’ Or you...

It's a great time [to invest] -- Martin Whitman, on the current market meltdown Others may not quite share the enthusiasm but Martin Whitman, speaking at an investment forum in Toronto yesterday, thinks it's a good time to invest and reckons it's similar to 1974 : "We can't try to pick the bottom, but it seems to me that there are great values out there now, just like in 1974," the firm's co-chief investment officer said in an interview. The stock market crash of 1973-74, which affected all the major stock markets around the world, lasted 694 days before bottoming out. "Everything went down every day, and if you bought, you hit a lot of 10-baggers," recalled Mr. Whitman. "I hope that we do it with a lot of what we are doing now." One may recall that the 1973/1974 period was marked by a severe recession, with commodity prices going out of control. This time, however, we have a real estate bust, along with a potential credit contraction. ...

I remember when I was following Ambac early in the year, practically every day was wild. Well, now the whole market is wild. There is so much happening--many of which reek of desperation and I don't approve of--that you can literally read stories all night long. Here are some I find useful to know about... Moody's may downgrade Ambac and MBIA: Ratings don't matter to the monolines anymore since they aren't writing any business, with one exception. That exception is that rating downgrades generally require collateral posting for their investment business... I have been so busy with non-bond-insurer information that I don't even know what happened today. MBIA was up 40% today on no published news. Could be short covering but it's not clear. Some American pension funds stop lending shares: CALPERS, a large California pension fund, and others are supposedly refusing to loan shares of selected financial companies like Morgan Stanley and Goldman Sachs. Recall that s...

This is unbelievable. FSA, the British regulator, just banned short selling of all financials. I have been in favour of banning naked short selling but this is a dumb move. It goes against everything good about a free market and it is going to result in unpredictable outcomes. Possible problems include liquidity completely drying up for financials, difficulty for market makers (particularly derivative players such as option sellers) in hedging, and decline in trust by investors. In another note, the two exchanges in Russia still seem to be halted . The government is injecting liquidity into the market, as well as cutting oil taxes. This is another strategy that can easily backfire with rampant inflation in the future.

That's a question I have been wondering. The AIG takeover does seem quite murky. Steven Davidoff, writing for the Deal Professor (NYT's DealBook) raises important questions pertaining to the takeover . He also suggests some answers for why things may be what thye are. From my layperson perspective, it certainly looks like some shareholder rights were run over by the steamrolling government. However, this does not mean that AIG shareholders would end up with more money in alternate scenarios. It looks as if AIG did not raise $14.5 billion they would have filed for bankruptcy. Nevertheless, this deal raises all sorts of questions. I highly recommend reading the linked article when you feel like it. Newbies like us, who never worked in the industry, can learn a lot of the legal rights of shareholders. So even if AIG has nothing to do with you, the issues raised may help you in your future investments. I will warn, however, that laws are dependent on the jurisdiction so one shouldn...

I always felt that GM would be the one that would get kicked out of the Dow Jones Industrial Average first but I was wrong. The Wall Street Journal is reporting that AIG is being replaced by Kraft . AIG somehow manages to collapse 90% within a few months while GM miraculously survives some tough conditions in the auto industry. It's truly amazing in my eyes. I would have thought that diversified insurers would be stronger than investment banks or monoline insurers, but guess not--at least in the case of AIG. I lay most of the blame of AIG in the hands of management. This is a classic case of a few executives running the company into the ground. AIG would have faced losses and performed poorly regardless but management pushed it over the edge and actually managed to almost bankrupt it. The DJIA should be more stable with Kraft. I don't see great prospects for Kraft so the DJIA will probably lag in the future but it won't suffer losses or be as volatile. If I'm not mistak...

With the BCE deal seemingly on the ropes (stock is off another 8% today), it may be questionable to consider risk arbitrage but now may actually be a good time. I am looking at the Teck Caminco--a Canadian mining giant--takeover of Fording Canadian Coal Trust (FDG; TSX: FDG.UN). The stock is trading way below the cash portion of the offer but there are many question marks about financing . The latest suggestion by the Teck CEO that other coal users, such as steel producers, may finance the deal seems like grasping at straws. The risk with this deal is that Fording is trading at rich multiples given the commodities bull market over the last few years. The stock is up 100% in the last year so it's not clear to me what the downside is in a failed takeover (in contrast, something like BCE has a definable downside of about $30 per share.)

What are the chances of USA's debt rating being downgraded? The unthinkable may actually happen at some point within the next 10 years if USA goes down the current path. S&P says that USA's balance sheet has weakened: Pressure is building on the pristine triple-A rating of the United States following a federal bailout of American International Group Inc., the chairman of Standard & Poor's sovereign ratings committee said Wednesday. The $85-billion (U.S.) bailout of AIG on Tuesday by the U.S. Federal Reserve “has weakened the fiscal profile of the United States,” S&P's John Chambers told Reuters in an interview. “Lack of a pro-active stance could have resulted in further financial stress and put pressure on the U.S. triple-A rating,” Mr. Chambers said. “There's no God-given gift of a 'AAA' rating, and the U.S. has to earn it like everyone else.” ... Ten-year credit default swaps, or CDS, on Treasury debt widened three basis points to 26 basis poi...

Well, the SEC re-instituted its naked short-selling ban . The prior ban was a joke, not because I am against it, but because it limited it to select financial stocks. The new ban is for all stocks. Short selling is fine and helps markets but I am against naked short selling. Selling more shares than are available impacts firms that depend on capital markets for funding. Typically financial institutions, penny stocks, resource companies, and tech/biotech start-ups are hurt by naked short-selling. This ban should have been instituted many years, or decades, ago. Patrick Byrne of Overstock (OSTK) has been harping for years about how naked short selling was hurting his company. Who knows if naked short selling is the reason for Overstock's struggles but if it wasn't widespread, it wouldn't even be in a discussion. The cynic in me says that this change is going to have little impact. SEC doesn't have the resources to enforce it. But if someone is ever caught, they will pay a...