Econ 2009

[ewmayer]

Continuation of the now-rather-overlarge Global Financial Crisis thread. We begin by looking back: Bloomberg's obituary for 2008 begins thusly:

Journal of a Plague Year: Faith in Markets Cracks Under $30 Trillion Loss

It has been a year of record misery: the largest bankruptcy, bank failure and Ponzi scheme in U.S. history; $720 billion in writedowns and losses by financial institutions; $30.1 trillion in market valuation wiped out.

The biggest loss and the hardest thing to recover, though, may be something that can’t be precisely measured -- confidence in the markets and the firms that rely on them.

“The wholesale funding model lost its credibility,” said David Hendler, senior analyst at New York-based CreditSights Inc. “That started the semi-nationalization of funding in the financial markets. It’s a real chink in the armor of capitalism as supposedly the best process for allocating capital. The government is now deciding who gets access to capital.”

For Paul DeRosa, a principal of Mount Lucas Management Corp., a $1 billion hedge fund in Princeton, New Jersey, most unnerving was that the credit crisis revived something that, like the bubonic plague, was supposed to be a relic of the past.

“We had what was for all intents and purposes a systemic bank run for the first time in 70 years,” said DeRosa, whose fund is up 25 percent this year. “This ended our belief that financial panics were a thing of the past. That’s why this is a transcendent event.”

The price tag has been transcendent, too. Global stock markets lost about half of their value in 2008, or $30.1 trillion dollars. In the U.S., $7.2 trillion of shareholder value was wiped off the books, as the Standard & Poor’s 500 Index fell 39 percent through Dec. 30 and the Nasdaq Composite Index dropped 42 percent.

So, predictions for 2009? My attitude can be summed up roughly as, "If you thought 2008 was bad...". Hope I'm wrong, though.

[Uncwilly]

Originally Posted by ewmayer

So, predictions for 2009?

"Well, at least it ain't 1930."

[Fusion_power]

Before this is over, you may say "wish this was 1930".

On a different tack, I made a large payment on a loan for 130 acres of land. While I was at the local bank, I talked with the lady loan officer. I asked her what effects were they feeling from the market crisis and were they still lending money. Her reply was that yes they were still lending and they had never stopped lending, but that very few people were borrowing money. Now think about this for a minute. This is a well run local bank that has loaned money within this community for many years. They have access to money to lend, but nobody wants to borrow. If you are in the business of lending money, then the way you make money is from lending. This banks revenues are going to be hurt by the global market malfunction because of the simple effect that their source of profit has been curtailed.

Just some thoughts for the 1st day of a new year.

DarJones

[ewmayer]

Kathleen Pender, writer of the San Francisco Chronicle Net Worth column, has a nice description of the answer to the above question, containing a startling statistic which I have highlighted in bold:

Investors ask: Where did all that money go?

Charles Biderman, chief executive of TrimTabs Investment Research in Sausalito ... says that from the market`s bottom in 2003 until its peak in 2007, the market value of all publicly traded stocks worldwide grew from about $20 trillion to about $45 trillion.

During this period, only about $1.5 trillion in cash went into the market. Debt accounted for some of the remaining increase in market capitalization, but most of it existed only on paper.

"Market cap and money aren`t necessarily related," he says.

Suppose a company has 1 million shares of stock priced at $100 each, giving it a market value of $100 million. Over the next few days, someone buys $5 million worth of stock. Speculation drives the share price to $140, and suddenly the company has a market value of $140 million.

In this case, a $5 million investment has created a $40 million increase in market value.

Is the company really worth $140 million? Not if everyone tried to sell their stock at once. The first person might get $140, but everyone else would get less, probably much less.

"It`s not different than a Ponzi scheme, a legal one," Biderman says.

The same thing happens in real estate. Suppose the house next door sells for $700,000. Suddenly, every family on the block thinks their house is worth $700,000. [EWM: And even if they don`t, the city tax assessor`s office will surely set them straight.] But if everyone on the block put their house on the market, everyone could not get $700,000.

Multiply that by just about every asset class in the world, and you`ll get a sense of what happened last year.

My Comment: So the short answer is: "That money never really existed in the first place", but laissez-faire monetary policy, the institutionalized global financial-market Ponzi scheme which is Fractional Reserve Lending (which allows a given amount of capital to be lent out simultaneously many times over, "magically" creating the appearance - and at least until the pool of Greater Fools runs dry, the practical effects - of many shekels when there is really just one), an unprecedented amount of capital (both real and borrowed) flowing into equity markets from the combination of a tidal wave of middle-aged baby boomers and government-encouraged equity investments by way of retirement accounts, and a multidecadal collective delusion that equity markets and real estate could sustainably appreciate "above market" in perpetuity, made it all too easy to ignore the "where is all this money coming from?" question.

[R.D. Silverman]

Originally Posted by ewmayer

Kathleen Pender, writer of the San Francisco Chronicle Net Worth column, has a nice description of the answer to the above question, containing a startling statistic which I have highlighted in bold:

Investors ask: Where did all that money go?

My Comment: So the short answer is: "That money never really existed in the first place", but laissez-faire monetary policy, the institutionalized global financial-market Ponzi scheme which is Fractional Reserve Lending (which allows a given amount of capital to be lent out simultaneously many times over, "magically" creating the appearance - and at least until the pool of Greater Fools runs dry, the practical effects - of many shekels when there is really just one), an unprecedented amount of capital (both real and borrowed) flowing into equity markets from the combination of a tidal wave of middle-aged baby boomers and government-encouraged equity investments by way of retirement accounts, and a multidecadal collective delusion that equity markets and real estate could sustainably appreciate "above market" in perpetuity, made it all too easy to ignore the "where is all this money coming from?" question.

Do the arithmetic....

To go from $20T to $45T in 5 years is about 15% a year. The long-term
historical average for equities has been about 8%/year. 15%/yr is
indeed an extraordinary growth rate. At 8%/yr, the market value
should now be about (1.08)^5 * $20T... = $29T. Add another $1.5T
for the actual investment and we get a market value of $30.5T.

So we must ask why the market collapsed to a value significantly LOWER
than what the long-term average would yield? IMO, it is simple panic.

Comments?

[R.D. Silverman]

Originally Posted by R.D. Silverman

Do the arithmetic....

To go from $20T to $45T in 5 years is about 15% a year. The long-term
historical average for equities has been about 8%/year. 15%/yr is
indeed an extraordinary growth rate. At 8%/yr, the market value
should now be about (1.08)^5 * $20T... = $29T. Add another $1.5T
for the actual investment and we get a market value of $30.5T.

So we must ask why the market collapsed to a value significantly LOWER
than what the long-term average would yield? IMO, it is simple panic.

Comments?

We need some laws implementing structural changes in the way Wall Street
does business.

(1) Perhaps we should disallow buying ANY equity on margin......Just an idea.

(2) There should be no 'secondary' lending. If you are a financial
institution and want to lend money, go ahead. But now, YOU take the
risk. It should be illegal to sell the loan to another party.

(3) We BADLY need laws that restrict the way financial (and other)
companies compensate their employees.

(a) The way companies give out bonuses now strongly encourages
short-term risky behavior on the part of employees.

(b) Employees are not the owners of public companies. But they act as
if they are. Money handed out in bonuses most properly belongs to the
STOCKHOLDERS. These bonuses amount to legalized stealing
from the stockholders. I see a couple of possibilities.. One is that any
compensation scheme including one in which bonuses are given must
be approved at the annual stockholders meeting. Any bonus scheme
should also apply equally to all employees and not just the traders
and managers who take these absurd risks. Golden parachutes should
also require stockholder (and not just board approval).
A second possibility (and one that I like) is that Congress should pass a
law stating that total compensation (including salary, stock options,
stock grants, perks such as limo rides etc) should have a ceiling that
is at most (say) 20 times the corporate median compensation. I don't
but the horsesh*t argument that these ridiculous bonuses are needed
to attract 'talent' or to 'retain' employees.

Above all, bonuses need to be tied to overall CORPORATE performance.

(c) Senior Managers always argue that they deserve these bonuses because
they are responsible for seeing that the company does well and that they
should be compensated when it does do well.

Perhaps true.

However, it equally applies that if a company does poorly, that these
same managers must be held accountable. If layoffs are necessary, then
they should be the first ones out the door. And they should only be
entitled to the same layoff compensation as ALL OTHER employees.
They should also be the last ones hired back in case the company does
hire back any laid off employees.

An alternative to this scheme might be that layoffs must occur in order
of compensation; The highest paid employees get laid off first. Firstly,
because they are the ones who most probably can survive such a layoff
and secondlyy because it would minimize the number of employees laid off.

Public corporations are given certain advantages under our legal system.
Perhaps these advantages should also require that the social impact
of layoffs be minimized.

[Uncwilly]

Originally Posted by R.D. Silverman

(b) Employees are not the owners of public companies. But they act as
if they are. Money handed out in bonuses most properly belongs to the
STOCKHOLDERS. These bonuses amount to legalized stealing
from the stockholders.

Well, responsible stockholders should demand that the board not allow such compensation. Those that invest, should not do so blindly.

[R.D. Silverman]

Originally Posted by Uncwilly

Well, responsible stockholders should demand that the board not allow such compensation. Those that invest, should not do so blindly.

In principle yes. But who controls the agenda at annual meetings? Are
stockholders ever allowed to vote on compensation schemes? Not AFAIK.
Perhaps all we need is a law stating that such a vote MUST be taken
at annual meetings. Otherwise, I see no chance of it ever happening
in practice. Indeed, I know of no mechanism whereby the corporate
compensation/bonus scheme is even made available to the stockholders.
I have never seen an annual report that contains such information. And
you can be sure that if the law does not require it, then it will never be
included. Can a single (or even a group of) stockholder(s) even demand that
such information be made available and voted upon at the annual meeting?
Can the board prevent such a thing? I do not know the laws on this.

If I, as a stockholder stood up at a meeting and demanded that the
information be made available, could I even get a vote taken on such a
demand? Could I then ask for a vote on a proposal to limit compensation and
bonuses?

Comments?

[jasonp]

How often does it happen that a stockholder revolt derails anything at all proposed by company management? IIRC half the equity in public companies is owned by huge mutual funds that agree by default with everything the board proposes. Incidentally, this year was the first I remember when revolts by stockholders actually appeared in the news; they never won.

[ewmayer]

Originally Posted by R.D. Silverman

To go from $20T to $45T in 5 years is about 15% a year. The long-term
historical average for equities has been about 8%/year. 15%/yr is
indeed an extraordinary growth rate. At 8%/yr, the market value
should now be about (1.08)^5 * $20T... = $29T. Add another $1.5T
for the actual investment and we get a market value of $30.5T.

So we must ask why the market collapsed to a value significantly LOWER
than what the long-term average would yield? IMO, it is simple panic.

For the same reasons that frenzied buying can artificially inflate prices, panic selling can drive prices below fair valuations. It is arguable whether that is the case in equities currently, but note that the housing bubble still has a ways to go to revert to long-term historical means. I suspect for the next few years, equities will follow housing.

It is also debatable whether the 8% figure used by most investment planners is genuinely sustainable in the truly long term, i.e. whether there has genuinely been (on average) an 8% growth in the value of goods and services in the global economy for the past century. To some degree simple population growth (and ignoring the effects of concomitant depletion of finite resources, which one can only do up to a point) support such a figure in the emerging economies of the world, but 8% in the developed world, where population growth has flattened out? That seems far-fetched to me.

--------------------

Manufacturing index at 28-year low: Purchasing managers' report shows that December activity is contracting, remains recessionary.


Thousands of stores to disappear in '09: Experts say disastrous holiday sales will force many more merchants into bankruptcy - and ultimately into liquidation.


Secondhand stores shine in weak retail market: As thrifty customers turn to secondhand goods, resale stores are profiting from the recession.

On a Wednesday afternoon in late December, the average wait to sell clothing at Buffalo Exchange, a Manhattan consignment shop, was about 25 minutes. Beyond the front counter, where the consignors sought pocket cash and tax deductions, nearly a dozen shoppers squeezed themselves between overstuffed racks in the 450-square-foot space, seeking bargains amid used designer jeans and last season's cashmere sweaters.

"You should see this place on weekends," said the store's assistant manager. "The lines get to be at least 10 people deep."

The month-old shop, which already possesses the slight musty smell typical to thrift stores, is the first Manhattan location for Buffalo, a Tucson-based secondhand-clothes retail chain with 34 stores across the nation. The new store's crowds are indicative of both Buffalo Exchange's continuing success - the privately held company says it has $50 million in annual revenue and is concluding its third consecutive year of sales growth - and also of the resale market's overall performance. Secondhand shops are a bright spot in today's downtrodden retail industry.

My Comment: This is good both for consumers` balance sheets and for the environment. But I fear China Inc is not going to look favorably on the trend - Americans buying stuff they didn`t much need to start with and then quickly discarding it has been the basis for much of the Asian export economy of the past few decades.


Buffett's Berkshire Has `Nowhere to Hide' Amid Worst Drop in Three Decades: Billionaire Warren Buffett’s Berkshire Hathaway Inc. slumped 32 percent last year, the worst performance in more than three decades, as the U.S. recession forced down the value of the firm’s equity holdings and derivative bets.

My Comment: One wonders whether the opportunity to buy BRK-A at the current sub-$100K valuation [or even better, for 20% less during the late November meltdown] will prove to be a steal a few years down the road, or whether 2009 will prove to be another "year of the unprecedented", with back-to-back huge yearly declines in equity valuations.

[cheesehead]

Originally Posted by R.D. Silverman

We need some laws implementing structural changes in the way Wall Street
does business.

What's your opinion on reinstating the separation between commercial banking and investment banking (a la Glass-Steagall Act, with which I am only vaguely familiar)?