Billionaire Adolph Merckle - who committed suicide yesterday - sure didn’t seem to know the first thing about diversification and risk management:
His fortunes worsened dramatically last year after he was caught on the wrong side of trades in Volkswagen shares, whose price spiked when Porsche revealed it controlled more of VW than had been thought. Merckle had borrowed VW shares to sell them short in expectation of their price falling, while other trades also went against him.
Predictions are probably the best Rorschach tests for bloggers and investors. Everyone is in the prediction business, because every act of investment (including sitting on cash in the sidelines) is an implicit prediction about the future.
Writing down my predictions for the year has proven itself to be a great tool for me to become explicitly aware of my cognitive biases. Because if there’s one thing I’ve learnt in investing, its this - It’s not what you don’t know that kills you, but instead its what you know that’s wrong. (Can’t seem to find the original source for this quote).
So here’s the top 10 predictions on my mind as of today:
Stock market - The Obamarama stock market rally will be mostly over by Obama’s first quarter as President. By late 2009, it will be obvious that all of the government bailout and spending efforts are like holding an umbrella in a hurricane. The nation will finally resign to the reality of a longer term depression. This realization alongwith a few shocking municipal bankruptcies will cause the stock market to finally bottom in early 2010.
Bond bubble - The treasury bond bubble will continue to inflate, pushing yields to even lower levels than today. Bond bears will get clobbered in 2009 by being too early and too aggressive. The only thing that can burst the treasury bond bubble is a “growth scare”, which will not occur until 2010.
Obama - Barack Obama will not have the courage to give the economy the bitter pill it needs to quickly get rid of the mal-investments and excessive leverage that led to the current crisis. Nor will Obama have the courage to suggest that the government needs to be a referee in the market, rather than the dominant player it has become thanks to Paulson and Bernanke. The high of “Yes we can” will slowly morph into a hangover of “Yes we could have.”
Suburbia - 2008 will be seen in 2009 to have been the last year of the techno-triumphalist era. By the end of 2009, it will be apparent that technology (software, finance, green technology) alone cannot indefinitely sustain the now defunct credit-driven consumerist suburban SUV lifestyle. Austerity will be the new black.
Real estate - Real estate will overcorrect on the way down, and “fortress areas” like Cupertino in the Bay Area will also experience severe price reductions as IPO/options wealth, jumbo mortgage financing and the hope for a quick recovery dries up. It will be finally realized that encouraging excessive home ownership tends to hurt the economy by making it harder for workers to relocate to where the jobs are.
Alternative energy - Alternative energy and OPEC countries will ironically find themselves on the same side, hoping for higher oil prices so that their respective industries and economies become viable. Oil prices will continue to disappoint them by being stagnant, and this will be a silver lining for the middle-class consumers.
Pakistan - The world will again be fashionably outraged for a few days in the Fall of 2009, when it becomes clear that new attacks were being planned against Indian targets even while Pakistan was condemning the recent 26/11 Mumbai attacks. India and Pakistan will again lurch towards war after the next terror attack. The US will once again force India to back down by essentially telling India: “not tonight dear, I have a headache”.
Microsoft - Microsoft will realize (if it has not already) that there is no point going after has-been giants like Yahoo, and will instead (correctly) acquire Facebook and/or Twitter at bargain prices. For the first time in its history Google misses out on the obvious due to the “not built here” syndrome.
Google - Google revenue will surprise to the upside, but it will be at the cost of cutting down on other expenses, including payroll/bonuses, bandwidth bills for Youtube and possibly even Gmail and other Google apps.
Never intended as investment advice. Read my disclaimer.
Today we face the ironic situation of the US government abandoning free market principles to save the free market.
Whether or not the Government will succeed remains to be seen. But in the mean time, there are some fascinating unintended consequences going on (fascinating in a morbid sort of way).
It seems like every generation learns the hard way that central planning does not work, and indeed often worsens the situation that it claims to cure.
So here are just a few examples of how the current US government actions often worsen the situation that they are trying to solve:
1. Lowering interest rates reduces credit to companies
People who invest their money in CDs and money markets are (sometimes unknowingly) lending this money to companies who need the money and are willing to pay interest for short-term loans.
By driving interest rates so low, the Federal Reserve risks a perverse side effect - many money markets will have an expense ratio that’s higher than their interest rate! This means that many money market investors will have a negative return on investment. If this causes investors to withdraw from the money market (and invest into, say treasuries), it lessens the amount of money available for companies to borrow. This is already happening, as evidenced by the huge demand for treasuries (even at near-zero interest rates).
If the government wants more money to be available for lending to companies, it needs to increase interest that people earn on savings. This will provide incentives for people to save, which causes more money to flow into money markets and CDs, and hence increases the pool of money to be lent to companies! Right now the very opposite is happening.
2. Lower interest rates reduces lending to individual borrowers
If you are a bank, here is an easy way for you to get almost free money with virtually no risk:
Borrow nearly unlimited amounts of short-term money from the Fed (at the 0.5% “discount rate”)
Buy longer term treasuries with this money (earn >2%)
Hold to maturity if necessary
Repeat
Note that the above does not include having to lend to flaky retail borrowers! So this rate cut actually has an unintended consequence of making retail borrowers even less attractive to banks!
3. Helping defaulting homeowners encourages more to default
If the government provides relief to homeowners who are behind on their payments, it creates incentives for even more homeowners to fall behind, so that they too can get lower interest rates and hopefully even principal reductions!
Surely not what is intended.
4. Guaranteeing deposits causes money to leave good banks
By providing strong guarantees to money deposited in unhealthy banks, it creates an incentive for people to withdraw their funds from otherwise healthy (but not government-backed) institutions into bad banks that are guaranteed by the government!
5. Lesson learned by bankers - take even bigger risks next time
This is probably the worst of the unintended consequences. An entire generation (and probably more) of bankers and traders have now learned - that if you take risks, make sure you take huge ones. So that if you fail, you are more likely to be bailed out in the long run. The moral hazard being created by this bailout is just staggering.
The financial, mortgage, insurance and auto bailouts almost guarantee that the next bubble will be even bigger and even more disastrous when it bursts.
Ever wonder who would invest in 0% interest treasury securities ?
While regular folks like you and me can invest in treasury securities, we aren’t driving the market. Treasuries are where institutions play. When it comes to big money market funds, and cash/income components of various mutual funds or other investments, these institutions are usually buying up treasuries. Especially with money market funds, since safety is paramount, these securities are the go-to place to find safety. That being said, this is where billions of dollars are traded. Yield, or rate of return isn’t as much of a concern as protection of principal, so the 0% rate is of little concern.
In addition to institutional investors, foreign banks are the other major player. In fact, the government reports that about half of the over $5 trillion in publicly traded debt is owned by foreign nations — namely China. Even with the economic turmoil here and abroad, U.S. debt is still viewed as one of the safest investments around the globe. So, when yields are down, it doesn’t matter when you’re looking for absolute safety on a global scale.
And finally, you have many pension funds investing heavily in safe investments like treasury securities. Just like money market mutual funds that seek safety, you have plenty of pension funds worth billions that need to be able to keep up with paying current retirees, and to allocate investments in this economic climate to protect what assets they do have.
A friend asked me at a party the other day - “What can those of us who are not economic news junkies like you learn from this crisis ?”
There is only one answer to this question - “No matter how you create your wealth - you need to have a well thought-out strategy to help you 1) identify the dangers to your wealth, and 2) to select the steps you will take to protect your wealth. Without this strategy, you will become easy prey for the bigger animals in the economic food chain.”
And for those of us who are lucky enough to be economic news junkies in this environment, every day brings rewards and new lessons that can be learned.
Consider - today for the first time in history - US 3 month treasury bill rates went negative:
If you invested $1 million in three-month bills at todays negative discount rate of 0.01 percent, for a price of 100.002556, at maturity you would receive the par value for a loss of $25.56.
The following could be written about any real estate market over the last decade, but is especially stunning coming out of Dubai:
For the past decade at least, real-estate speculation has been the national sport. The price of houses and apartments, many not yet built, rose by 43 percent in the first quarter of this year alone. Mortgage money was easy to get and speculators commonly flipped properties for substantial profits in a matter of weeks, sometimes even days, before the first monthly payments came due. Everybody wanted in on the game. “Employees didn’t focus on their work anymore,” complains the chairman of a regional transport company. “They all wanted to go buying property for 10 percent down, if that.” As of June, Dubai had 42 million square feet of office space under construction, more than any other city in the world, even Shanghai.
What was a flat desert 20 years ago is today an urban canyon. Such is the frenzy that the Hard Rock Café, built among vacant lots in 1997, is now surrounded by skyscrapers and plans to tear it down for another high-rise are being debated as if the Hard Rock were a heritage site.
A common misconception amongst novice home buyers is - “its a great time to buy - the rates are so low!”
In fact, as Calculated Risk explains, a rational buyer should be doing exactly the opposite:
A rational buyer wouldn’t pay more just because the interest rate is lower - although they might have to pay more because the demand is greater. But the current buyer wouldn’t pay much more, because the rational buyer would realize interest rates will probably not be artificially low when they try to sell, and their future buyer would have a higher interest rate and a lower price.
When I talk about the current financial crisis with friends and family, I often sense that many do not fully comprehend the scale of the crisis nor of the bailout so far.
So I created this graph based on data from Jim Bianco of Bianco Research (via Barry Ritholtz)
(Click to zoom)
Here is the raw data:
Jim Bianco of Bianco Research crunched the inflation adjusted numbers. The bailout has cost more than all of these big budget government expenditures – combined:
Lawrence Summers, Obama’s soon-to-be top economic advisor, strikes a pragmatic tone on the crisis. Rather than toe the party line on greed and corruption in Wall Street, he points out that financial crises are not new and are actually rooted in human nature rather than on financial innovation.
He seems to be quite candid in this interview - but it remains to be seen what happens after he enters the Washington jungle.
David Merkel is the first of the “guru bloggers” that I follow and respect to call it a depression:
I’m going out on a limb here, and I’m going to suggest that we have already entered a depression. The concept of a depression is even less objective than that of a recession, but some suggest that a decline in real GDP of 10% or more is the criterion, which we have not attained yet.
I don’t think a 10% decline in GDP is the right threshold. Depressions are different because of their widespread nature, often coming through financial systems that are in danger.
As it is now, many things are happening that are depression-like. Here we go:
Record high levels of total debt to GDP
Many go hat in hand to the government.
The spreads of the bond market are at record levels since the last depression, and maybe comparable.
There is policy paralysis and confusion. No one knows what to do or leave alone, they act blindly or cower in fear.
Ultrasafe investments have record low yields.
Banks don’t trust each other.
GDP is shrinking, and unemployment is increasing at a rapid rate.
Financial businesses are failing and shrinking at high rates.
The government comes in to “help” the markets, and ends up replacing the markets.
The security of banks and other financial entities is open to question.
Econbrowser: Federal Reserve balance sheet The bottom line is that Bernanke has made a gamble with something approaching 2 trillion. If the gamble wins, taxpayers owe nothing. If the gamble loses, taxpayers are committed to borrow a sum equal to any losses and start making interest payments on it.
Credit Crunch: the board game | Credit Crunch | The Economist The aim is to be the last solvent player. In order to achieve this, players try to eliminate the competition. Risk cards encourage players to pick on each other.
Players who cannot pay their fines may borrow from each other at any rate they care to settle on—for instance, 100% interest within three turns. They should negotiate with the other players to get the best rate possible. Players who cannot borrow must either go into Chapter 11 or be taken over.
Manhattan office vacancy rate hits two-year high The overall vacancy rate rose to 10.9 percent in the fourth quarter, the highest level in two years and more than three percentage points greater than a year ago, according to the report released by FirstService Williams.
Four really, really bad scenarios - Politico.com Print View A pessimist by nature, Rickards believes that many economic forecasters are wrong, and the recession will get far worse than predicted.
He sees an epic disaster scenario in which the U.S. gross domestic product declines by a staggering 35 percent over the next six to seven years. Crippling deflation could take hold. Unemployment, he says, could approach 15 percent.
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inflate, pushing yields to even lower levels than today. ![202px-Barack_and_michelle_[1]](http://mungee.org/wp-content/uploads/2008/12/202px-barack-and-michelle-1.jpg)
machine
year of the 
experience severe price reductions as IPO/options wealth, jumbo mortgage financing and the hope for a quick recovery dries up. It will be finally realized that encouraging excessive home ownership tends to hurt the economy by making it ![202px-Hubbert_world_2004[1]](http://mungee.org/wp-content/uploads/2008/12/202px-hubbert-world-20041.png)
attacks were being planned against Indian targets even while Pakistan was condemning the recent 26/11 Mumbai attacks. India and Pakistan will again lurch towards war after the next terror attack. The US will once again force India to back down by essentially telling India: “not tonight dear, I have a headache”.
there is no point going after has-been giants like Yahoo, and will instead (correctly) acquire 
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e money with virtually no risk:
hy banks, it creates an incentive for people to withdraw their funds from otherwise healthy (but not government-backed) institutions into bad banks that are guaranteed by the government!![2865329444_23e699b3b4_m[1]](http://mungee.org/wp-content/uploads/2008/12/2865329444-23e699b3b4-m1.jpg)
