| Bag Lady Musings |
Spring 2008 |
In this issue:
Who's Left Holding the Bag (and it ain't Prada!)
"I'm mad as hell and I'm not going to take this anymore."
For those of you who may not be familiar with this famous line from the seventies allow me to introduce my all time favourite movie — Network.
One of the greatest of dramatists, Paddy Chayefsky, wrote this scathing satire almost 30 years ago about the abuses of network television. As we sit here observing the aftermath of the subprime fiasco, shaking our heads over the negligence of the rating agencies, the complicity of the banks and rolling our eyes over hedge funds using such high leverage — I too, like Howard Beale, the veteran network anchorman of Network, "am mad as hell."
And just as Chayefsky urged viewers to repeat the now famous mantra in order to reclaim their humanity from a medium that threatened to take it away, I too would like to be able to wash my hands of all those lending institutions. Alas we cannot so easily do away with those who got us into this mess. But it will be you and me, the consumer, the taxpayer and those companies' shareholders who will be left holding the bag ! We are on the hook for trillions of dollars in questionable investments our banks made when the good times were rolling.
In Berkshire Hathaway's 2007 Annual Report, the CEO of Wells Fargo aptly dissected the recent behaviour of many lenders, "It's interesting that the industry has invented new ways to lose money when the old ways seemed to work just fine."
If you find yourself confused by this entire financial crisis don't worry you're not alone. Part of its simple enough, people who bought houses they couldn't afford with help from the banks and "nothing down" mortgages, are now falling behind on their payments. However, the overwhelming majority of homeowners are doing just fine. So how is it that the impact of this subprime morass has been felt globally, frozen credit markets, sent stock markets gyrating, caused the collapse of Bear Stearns (a survivor of the Great Depression and the fifth largest securities firm on Wall Street), left the economy on the brink of recession and forced the Federal Reserve in the U.S. to take its boldest action since the 1930s?
A top executive at Lehman Brothers was quoted recently saying, "We're exposing parts of the capital markets that most of us have never heard of." One of the fastest-growing and most lucrative businesses on Wall Street in the past decade has been in derivatives. Credit rating agencies slapped high-quality ratings on many of these products despite having only a loose familiarity with the quality of the assets behind these instruments. Even CEOs of a few of our Canadian banks have been quoted saying they didn't really understand the risk behind what they were buying and selling.
In a recent New York Times interview, Bill Gross, manager of the world's biggest bond fund and custodian of nearly a trillion dollars in assets commented that, "The investment community has morphed into something beyond banks and something beyond regulation. We call it the 'shadow banking system.'" It's the private trading of complex instruments and a dizzying array of innovative products that experts now acknowledge are hard to understand and even harder to value.
Mr. Binder, a former US Federal Reserve Vice Chairman, who holds a doctorate in economics from MIT, when asked about these complex derivatives said, "If you presented me with one and asked me to put a market value on it, I'd only be guessing."
Don't feel sheepish if you are still confused!
In the late 90s, Wall Street made it easier for buyers to get loans and transformed the mortgage business from a local one centered on banks to a global one in which investors almost everywhere could pool money to lend.
The new competition brought down mortgage fees and spurred some useful innovation. As is often the case with innovations though, there was soon too much of a good thing. Investors around the world flush with cash either from Asia 's boom or rising oil prices demanded good returns. Wall Street answered with subprime mortgages.
Because these loans go to people stretching to afford a house, they come with high interest rates — even if initially disguised by low rates. Then these mortgages were sliced and diced again into pieces bundled into investments known as collaterized debt obligations — CDOs ( a term that appeared in the New York Times only three times before 2005 but almost every week since last summer). Once bundled, these different types of mortgages could be sold to different group of investors, who in turn attempted to get even better returns through leverage.
Are you beginning to see how this got so messy? Bear Stearns, for instance, had borrowed thirty dollars for every dollar of its own. (Back in the 60s the normal bank leverage was considered to be 6-8x equity.) If you made a $100 million bet with only $1 million down and $99 million in debt the value of the investment would not have to go up significantly for investors to be able to double their money. However, if that $100 million investment were to lose just $1 million of its value, the investor who put up only $1 million would lose everything.
Homeowners were encouraged to do the very same by putting little down on new homes. The American home seemed like such a sure bet that a huge portion of the global financial system ended up owning a piece of it, which explains why the mortgage mess had such ripple effects (Switzerland's biggest bank, UBS, with $3.1 trillion in assets made an astonishingly large bet on risky mortgage securities — at one point that bet amounted to $80 billion, which up to now has forced them to write down about $37 billion).
Also many banks sold complex insurance policies on the mortgage debt that left them on the hook when homeowners who had taken out a "wishful thinking" mortgage could no longer get out of it by flipping their house for profit.
As Warren Buffet said in his 2007 Annual Report "... just about all Americans came to believe that house prices would forever rise. That conviction made a borrower's income and cash equity seem unimportant to lenders who shoveled out money confident that house price appreciation would cure all problems."
And shouldn't investors have known better? Historically the price of American homes has risen at a rate similar to the annual rate of inflation. Yale economist, Robert Shiller, has pointed out since 1890, discounting the housing boom after WWII, that rate has been about 3.3%.
But alas investors often fall prey to the pervasive failing known as "extrapolation bias" which is the all-too-human tendency to assume that the current trend will continue forever. Remember when Internet stocks were increasing in value? Many people expected that they could count on continued increases. So what did they do? They put most of their money in technology stocks and got walloped!
Today the US is experiencing widespread pain because of this erroneous belief. As housing prices fall a huge amount of financial folly is being exposed. "You only learn who has been swimming naked when the tide goes out," said Warren Buffet, "and what we are witnessing at some of our largest financial institutions is an ugly sight."
I'm not sure if I have helped you understand what has been going on or just brought you to the same level of frustration as Peter Finch in Network. What I do know for certain is that the financial industry will find it hard to make the same amount of money that they have over the past few years from those exotic financial instruments and we will have to be prepared to pay more for our banking and for our loans. Along with the rising prices of food, gas and utility perhaps we will all be "mad as hell."
Necessities Not Accessories — An Investment Strategy
Not something The Bag Lady® likes to hear but unfortunately it's one of those notions that make sense in light of the present economic environs. As put forth by Dennis Gartman, author of the much respected Gartman Letter, "In a period of economic weakness, accessories are cast off while necessities are embraced. Consumers... as their job prospects weaken, as unemployment rises, as they begin to save more and spend less... will abjure Tiffany's and Coach, and Harley Davidson, and Whole Foods and will embrace Wall Mart and Johnson and Johnson... they will abjure Moet Chandon; they will embrace Budweiser."
Bah, Handbags? It's Time for a Worthier Obsession.
First it's necessities not accessories and now it's ditch the "IT" bag and get ready to flaunt your heels!!??
Bag fatigue? Can it be that the bag has been usurped by the phenomenon of the "It Shoe"? Think not in terms of a nifty pair of pumps to carry you from A to B but more of an obsession with weird and wonderful shoes — sci–fi fantasy footwear.
Gara Geddes, executive fashion and jewellery editor at Harper's Bazaar proclaims, "I think everybody has bag overload."
A handbag is never going to make the wearer appear taller and slimmer. "All you need to do is slip on a pair of spiked-heeled shoes and you instantly find yourself in tune with your inner sex-goddess," says Sandra Deeble, in her book A Passion for Stilettos.
This season's collection of shoes has burst forth in a riot of exotica — they include python and suede sandals that look like insects, with their curvaceous cut-outs and wing-shaped details; designs topped with jeweled spiders or leather dragonflies; richly colored satin shoes on metal candlestick-shaped heels; and lurid snakeskin knee-high gladiator sandals.
As for how to make such hardwear wearable? — Ah to devote any thought to practicality would be to miss the point. It is said, after all, that style guru Diana Vreeland's soles never touched the pavement. These are the ultimate cab shoes!!
Contact Us
For more information, please contact:
Sandra Pierce
Senior Vice President
Investment Advisor
The Fox Pierce Segal Group*
E: spierce@blackmont.com | T: 416 512-3696 | F: 416 221-1958
W: www.foxpiercesegal.com
If you would like to unsubscribe from this newsletter, please click here.
The Fox Pierce Segal Group*, Blackmont Capital Inc., 4100 Yonge Street, Suite 500, North York, Ontario M2P 2B5
Toll Free: 1 (800) 591-0137 • Fax: (416) 221-1958 • Website: www.foxpiercesegal.com
*The Fox Pierce Segal Group is part of Blackmont Capital Inc. • Blackmont Capital Inc. — Member CIPF & IDA
|
