Options are the DNA on Wall Street

Ok, in one sentence, you have to read this article: click here.

Since the Bear Stearns collapse, there's been an ever increasing amount of talk about speculation and the impact that option traders and commodity, specifically, futures commodity, traders have on the markets. Well, this article certainly helps to support such arguments pointing-out that some investors made-out like bandits on the Bear collapse with a monstrous options bet not even the most bearish investors could have pulled-off without loosing a hell of a lot of sleep.

Apparently, some hedge fund companies placed million-dollar bets on put options with strike prices less than half of Bear Stearns' market share price at closing that day. If this doesn't smell like insider trading, then I don't know what does. The fact that this is the top headline today, the ones who were on the winning side of these trades are definitely sweating right now. You can be sure that regulators are going to be using a microscope in their investigation and if those gamblers (I mean traders) didn't lose any sleep before, then they're sure going to now!

Connection between writedowns and the economy

We've all heard about the big financial institutions, especially the investment banks, reporting enormous writedowns. According to Bill Gross, the manager of the largest bond fund, the total writedowns across the financial system could amount to as much as $1 trillion. When you consider that there is about $5 trillion in home mortgage loans, that's a significant number; the question is, what does it mean for the economy as a whole.

Well, if you've every studied fundamental accounting, then you'll be familiar with the concept of balance sheets and balancing inflows and outflows. When a company writesdown some assets, then that necessarily means that it has reduced one part of its balance sheet that directly affects its liquidity and ability to raise additional capital, no to mention its ability to pay its bills. In order to offset that lost liquidity, the company will sell assets or reduce lending. Reduced lending, of course, is the equivalent to the tightening of monetary policy Federal Reserve, which essentially works to slow down the growth of the economy by making borrowed funds that much more expensive (i.e. higher interest rates).

To make things worse, we're only at the beginning of the story. Firms are still announcing more writedowns and the consensus is that we're still going to see at least double of what we've seen thus far. When you think about this in terms of a domino affect, then this is still the first part of the domino chain; only after the financial institutions perform the compensatory actions that they'll need to after the writedowns, will the economy begin to feel the full effects of what we're seeing reported in the financial press. Bottom line: we've still got a great deal of pain ahead of us and it will simply take time for there to be a real recovery - no matter what the folks on CNBC would like us to believe when the market rallies.

Writing the GMAT? Prepare to be Palm-Printed!

Following the scandals that rocked the GMAT exam this year, it looks as though there will be a new step introduced to the MBA-application process: fingerprinting; well, palm-printing to be more precise. This article desicribes how the new technology will help affirm a test-takers identity and ensure that we are who we say we are when we sit down to write that all-important test. Looks like we're actually going to have to study now.

Employee Free Choice Act

This is scary. I'll admit to getting in on this story just today, but it really looks as though that I may not be alone. I first heard about this bill on CNBC this morning and subsequently went looking around the web to find an article that I could read on the subject. The fact that it took me more than a minute to find one is worrying. This is a very important subject and it's not getting nearly enough attention if you ask me.

At issue is the ability of a company's employees to certify a union without the need for a secret ballot that is currently required by law. Under the new legislation, a union could be certified without the company ever knowing about the registration drive until it was all over. This is a big, BIG, deal. If you run a company or invest in one, you want to watch this closely. What's worrying, however, is that one of the articles that I did find refers to this as an "obscure" bill; how can this possibly be obscure? It has the ability to transform the business landscape ...and no, that's not an exaggeration.

Further empowering unions will dramatically affect companies nationally. On CNBC this morning, they were interviewing the founders of Home Depot and they put it very bluntly. To paraphrase, they explained that this bill, if passed, would mean that a union could become certified and then install arbitrators that would set the wage rates for the company. Notice, that management did not enter into this equation. Could you imagine what this could mean for some companies? Could you imagine being a fledgling business, struggling to survive against your larger incumbent competitors, and learning that your employees just certified a union and that you would now be told what to pay your employees? This is exactly the issue at hand and it deserves far greater attention than what is currently getting.

Fortunately, it appears as though there are more than a couple of organizations ramping-up advertising campaigns to educate the public about the bill and its consequences. The fact is that this has already passed the house and only remains to pass the Senate before becoming law.

Actions Speak Louder Than Words. Sorry.

"Anybody can make loans. But banks are finding the problem right now is getting the money back." Can you say duhh? I mean, really; isn't that obvious? According to what we're seeing in the financial markets, it certainly does appear as though the banks have forgotten this fundamental principle. This article speaks to the efforts made by the Fed and Treasury to shore-up investor confidence in the financials, but when greater and greater exuberance among the banks is revealed, I don't think that any positive thinking can outweigh the market's pessimism.

Unfortunately for the government, actions speak louder than words and investors aren't going to jump back into the financials en mass before this industry demonstrates that it's learned something from this latest economic bubble and has very clear direction on how to surface once again. The government's efforts to combat speculation (or better phrased, manipulation) by short-traders and commodity futures traders and its support of Freddie and Fannie, are positive and likely necessary, but it's just not enough. These sorts of acts may keep us out of a modern depression, but they're sure not going to prevent a recession.

Almost comical, SEC's Chairman Cox's statements about how he intends to reveal unfounded rumors are just unrealistic. The markets already do a good job of uncovering untruths, but it simply takes time. Sometimes that required time is calculated in minutes and seconds, but in a global economy, this short window of time can represents billions of dollars traded worldwide. Again, such recognition by the government that rumours do possess the power to move markets is good and their intentions, too, are positive. That said, their ability to do anything about it is nil and beyond satisfying some concerns among unsophisticated investors, these sorts of statements will do nothing to help stabilize the markets or the economy. The unhappy truth is that it will take time. The economy didn't fall into this mess overnight and it won't recover that quickly either. Sorry.

Online Ad Slump?

With a headline like "Google ad slump spreads abroad", this article is certainly a little deceiving. Yes, it's true that the ad sales of Google, Yahoo! and Microsoft have all been falling, but that's relative to staggering growth rates that they've all enjoyed in this segment over the past few years. Google, of particular note, has seen growth rates approaching triple-digits, so a fall to only double-digit rates is certainly newsworthy, but let's not kid ourselves; there are many businesses that would love to see these sorts of growth rates!

I do appreciate what this slowdown means for the markets and I certainly don't question that the earnings misses reported by both Google and Microsoft last week needed to be followed by consequential declines in their stock prices and I'm sure that Yahoo! will see the same result from its report tomorrow. That said, with the majority of the economy slowing to a crawl or beginning to move backwards, the growth rates of almost 50% at Google and even double-digit rates persisting at both Microsoft and Yahoo!, this is the last segment with which investors should concern themselves.

I can't help but be reminded of a 'Lying with Statistics' lecture in undergrad. Headlines like this one only confuse the markets and inject further volatility. Similarly, seeing a headline that oil prices have "plunged" following several days of record-setting increases is just ridiculous. Newspapers and TV networks do need to sell ads and these headlines do grab your attention, but I would hope that readers and viewers would just wise-up a little - enough to send a message to these news directors and editors that we're not that easily manipulated. ...at least my hope is that we're not that easily manipulated.

Fund Managers Still Believe in Financials

For quite a while now, I've been looking for the bottom in the financials along with many others watching the market. This article about fund managers certainly seems to support my thinking, but also makes me glad that I haven't taken the plunge just yet. With the best fund managers seeing their portfolios hit by as much as 60% year-over-year, that represents a lot of explaining to investors.

Are these fund managers just fooling themselves? Are they just too stubborn to see what's going-on? Many believe that the financials have been unfairly pummeled by the markets. To some extent, I agree, but there's no denying that they deserve much of their stock price declines resulting from the CDOs and the continuing housing slump. That said, there I do also believe that investors have been so scared-off from this industry that the stocks have fallen harder than they should have. Of course, the question then becomes when will we see a bottom in the financial and when is the best time to get back in. Looking at the performance of the funds managed by the vest best of Wall Street, it would seem that even those in the know don't really know.

Fair Value, Insolvency and Stock Prices

Is anyone else somewhat baffled by the latest concern about the solvency of Freddie Mac and Fannie Mae and the resulting impact to its stock price? Where was all this concern back in the highs of the dot-com bubble? Those companies were most certainly insolvent - besides the cash infusions they were getting, they had zero revenues and their assets consisted, for the most part, of instantly obsolete computer hardware. So, then, why is it then that Fannie Mae's and Freddie Mac's solvency is now such headline-making news and, apparently, the basis for its volatile stock price?

It ultimately must come down to future expectations. Dot-com stock prices rose because the expected earnings of those companies continued to rise - regardless of whether those expectations are well founded. Consequently, then, it would seem as though the markets are now implying that neither Fannie or Freddie would be able to meet its debt obligations with the lower future expected revenues on the depreciating assets that it still holds. Of course, when you add-in the guarantee of the government, this adds a whole new dynamic to the mix. With that guarantee, the earnings of these two institutions become almost secondary as the government could always, then, step-in to satisfy any claims when they arose. The question remains, however, why the question over its solvency continues to be such a significant question mark.

Could it be that the markets have learned their lessons from the dot-com era and are now looking at the balance sheets of the companies in which they invest ...before they invest? It's possible, to some extent, but I think that it's actually more likely that this is just another example of the markets grabbing onto any kind of headline-making news to justify trades in either direction. Speculators, making profits on their short sales and derivative positions love volatility and Freddie and Fannie have been their best friends lately. A savvy investors should, on the other hand, question the headlines as to what actual news they reveal. Nothing had changed since the week prior to these solvency headlines to today; the only revelation was that the financial journalists decided that it was now news. Was it because they didn't have anything else to write about? Maybe more simply, questioning a company's solvency sells papers and sells TV ads. As an investor, of course, you need to question the value of that information.

Common Sense that's not so Common

If there is a silver lining to the current state of the financial markets it's that many of the events of the past few months will serve to fill a whole new generation of economic and financial textbooks - education future analysts and managers on what not to do. Last week, IndyMac became the second largest financial institution to be seized by the Federal Deposit Insurance Corporation (FDIC) after a run on the bank left it short on cash. Having seen its stock price fall from a peak of $50.11 in mid 2006 to a closing price of $0.28 on July 11, it certainly looked as though the markets could see what was coming, so why didn't the bank's managers?

IndyMac was, not surprisingly, [too] heavily involved in the so-called Alt-A mortgages and, of those mortgages, [too] heavily concentrated in California - the second worst hit real estate market in the U.S. Many now suggest that IndyMac could have avoided its collapse by altering its business practices when it began to see a peak in the real estate markets; of course, hindsight is 20-20 and we all seem wiser after the fact. That said, one of the first things that anyone learns when studying finance is diversification; how can the leaders of financial institutions like Bears Stearn and now IndyMac be so complacent in their responsibilities to diversify their businesses? 

Even if you don't know anything about investing, you've probably heard the saying 'not to put all your eggs in one basket'. I personally don't believe that IndyMac could have fairly spotted a market peak and adjusted its business accordingly. I do believe that the use of not-so-common common sense could have very well avoided its collapse. Every market goes through cycles and investing too heavily in just one such market exposes you to those cycles. Diversification is your safety net by compensating you for losses in one market with gains in another; it's so simple. Personally, the management of firms who don't exercise this common principle should be punished in some way - it should not be the federal government (and tax payers, by corollary) who should be held responsible in such circumstances.

What a roller coaster for Fannie and Freddie

Well, if you haven't heard about the roller coaster ride taken by Fannie Mae and Freddie Mac in the markets this week, then try this on for size. How about loosing 50% in its market cap in a matter of hours and then recovering to a loss of about 5% by the end of the same trading day. Then, of course, you must has what triggered all that volatility. The answer, unfortunately, doesn't exactly inspire a lot of confidence in the financial markets.

It comes down to your definition and interpretation of the government's guarantee of both Fannie and Freddie and, more simply, rumours and speculation. Rumours, probably more than anything, caused the massive swings. Rumours about both the institutions' abilities to raise capital as well as about what the government would do, exactly, to help protect investors. Secondly, there is now even more speculation about what any government support would mean for the U.S. government as a whole and how that could even more broadly affect America's financial markets and the continuing credit crisis.

With the Fed's credit window now opened to both Freddie and Fannie, many of the concerns have been calmed. As I write this post, actually, Freddie and Fannie are reallying - up almost double digits today. Nothing has changed, of course, from yesterday so your guess as to the cause of this rally is as good as anyone else's. That's the real problem; there's so much uncertainty that investors, and the markets as a whole, are too eager to grab on to any positive news and trade the hell out of it. If you've ever studied finance, then you'll remember reading about the efficiency of markets; the activity in Freddie and Fannie over the past month will no doubt go down in textbook history as an example of how inefficient the markets can be. 

Freddie, Fannie and Implicit Federal Guarantees

Freddie Mac and Fannie Mae have, between them, the worst of jobs in this particular market: making the mortgage loans that every other bank is running away from ...fast. Between these two companies, they guarantee about $12 trillion in loans. Yes, that's a 't'. What's curious about the current situation, however, is that although these two companies have the implicit guarantee of the federal government, the open market seems to have placed some question on whether that federal government would actually step-up when the time comes... as it may very well come.

Today, there's even a question of the companies' solvency. Solvency, as you know, represents a company's ability to repay all its creditors after liquidating all its assets. Consequently, there seems to be some question as to whether the assets of Freddie and Fannie actually outweigh the massive debts it now holds. Of course, with a guarantee from the Federal government, there would be no worry as the government could always, theoretically, print money to pay every one back. With the staggering sums at stake, however, some are questioning whether they will do so. How do we know that they're questioning this? Simple. Look at the premium that Freddie Mac just paid on its latest $3 billion debt issue - almost 3-quarters of a percent over the U.S. Treasury rate. That premium is a risk premium, of course.

One could, of course, take the opposite position on this and reap the rewards should the market have overreacted. The consequences of allowing Freddie and Fannie fail would overwhelm anything that could have happened from the failure of an investment bank such as Bears Strean, which the Fed has obviously stated could not fail. Similarly, then, Freddie and Fannie cannot fail. As such, the markets certainly appear to have seriously overreacted on their risk asssessment of these two companies. An investor prepared to take this leap of faith, however, could benefit from a staggering medium-term return should the Fed make its implicit guarantee explicit. So, where do you stand?

Alma Mater Networking Value

I just read an interesting article over at Bloomberg that discusses the value of our alma maters as a source of connections (i.e. networking). Not surprisingly, of course, the article starts-out by discussing the premium value placed on the Ivy League schools like Harvard and Wharton whose names are tossed-around Wall Street on a daily basis. There's no doubt that graduates of these schools have wealth of networking possibilities due, simply, to the immense size of the alumni populations from such schools. What's really interesting, however, is what the author found about schools in general - ivy league or otherwise.

Simply, we're happy to help those who share something in common with us. It speaks to human tendencies in general, I suppose. Birds of a feather, right? Well, those of us who graduated from schools with less well-known alumni networks may be happy to hear that the bonds between alumni may be even stronger for the very simple reason that there are fewer people out there to take advantage of those networks. It makes a lot of sense, when you think about it.

Harvard, for example, has such an enormous alumni network that there is no doubt that thousands are looking to benefit from that network on a daily basis. Conversely, graduates of smaller schools may encounter a fellow alumni rarely; consequently, these rare encounters are all the more special and may thus result in that much more value to each member looking to benefit from these networks in some way. Hurray!

Fannie Mae's Debt Issue & Credit Yield Spreads

Amid speculation that Fannie Mae doesn't have enough capital to weather the continuing credit crisis, it has gone ahead and issued $3 billion in new debt. What's interesting about this, however, is the yield (cost) at which it was issued. The new debt will yield 3.25% - a full 74 basis points above the equivalent U.S. Treasuries. Given that Fannie Mae, theoretically, has the backing of the U.S. government and, consequently, should benefit from essentially risk-free cost of capital, this suggests the investing community feels otherwise about its credit worthiness.

With all the talk about the ratings agencies and the validity of those ratings, I suppose it's not all that surprising to see investors making their own determinations about the credit risk associated with a particular issue. Moreover, when you think about it, shouldn't the market as a whole be better qualified to determine the risk associated with a particular security than a single ratings agency?

The capital markets serve as a pricing mechanism. The collective buying and selling of millions of investors every day works to determine the value that we, on average, associate to a particular security. Why, then, should we not use the power of the same distributed intelligence to ascertain the credit risk associated with a debt issue? To be fair, the markets already do this - using the ratings agencies as a sort of starting-point for their evaluation. My question, I suppose, is whether or not we actually need that starting-point.

Emerging Economies May Not Save Us

As the US economy, as well as the Canadian and much of the European economies, sinks deeper into recession, many are pointing (maybe partly with great hope) that the emerging markets will bail-out the rest of the world by driving overall demand. Unfortunately, that doesn't seem to be the case with emerging markets not only showing signs of weakness, but showing signs of even more drastic declines than what the developed economies are currently experiencing.

This graph is sourced from Charles Schwab's latest webcast and presents a diffusion index of developed (lower chart) and emerging (upper chart) economic forces. Essentially, a downward sloping line is a bad thing and an upward sloping line is a good thing. What I find most interesting about these charts is the leader-follower dynamic that appears to be taking place. While most analysts and market watchers have been pointing to China and India as possible saviors of the global economy with their fabulous growth rates, it now looks as though the declines in demand from the developed economies is beginning to take its tole on their markets. Moreover, it would appears as though the declines that they are now experiencing are more severe than what the developed economies have seen. 

Inflation appears to be the culprit here. While we've seen low single-digit rates, the developing markets (the blue, in the left-hand chart) are showing near-double-digit rates. More importantly, their pace of inflationary growth (the slope of the line) is noticeably more steep. This is primarily due to wage-pressures. While the US and other developed markets have not seen wages rise, this has not been the case in the developing economies. The rest of the world is facing much greater inflationary pressures than we are at home and this spells great trouble for them in the future. 

So what does this all mean for us at home? Well, put simply, we can't rely on any other economy to help bail us out. We are in a global economy, to be sure, but that economy is by no means uniform. The rest of the world, especially the developing parts of that world, are only beginning to enter their own recessions and everything points to their troubles being worse than anything we will see domestically. On the whole, of course, this suggests a very slow and long recovery. While the developed markets may be better prepared to recover sooner, we are no dependent on emerging markets just as they are dependent on developed markets. As they are likely to sink deeper than we are, their economic pains will most certainly ripple through the rest of the world.

The Interpretation of Polls

CNNMoney is reporting here that their latest opinion polls suggest 3 in four Americans believe that the economy is in recession. Besides the 'duh' factor that goes along with such a headline, I almost laughed when they continued to compare the 75% statistic with the 79% result that they got in a an April poll with the same questions. You guessed it, the article is positive wherein they suggest that the drop of 4% is a good sign of ...something.

Why is this laughable? Well, first off, this is an opinion poll and doesn't actually represent anything about the current state of the economy. Moreover, a drop of 4% in public opinion could be nothing more than an anomaly - especially a differential of only 4%! I do understand that the media is working its spin doctors to turn absolutely every bit of news into a positive headline, but this is getting to be a little ridiculous. Almost every business leader has not only been referring to the current recession as a given, but has gone on to suggest that we're in it for the long haul. 

Blame Everyone. Accept No Blame.

I find this almost funny at this point; comical, really. Moody's, who suggested that their triple-A ratings collateralized-debt obligations (CDOs) may have been incorrectly assigned due to a computer error is now ousting some employees along with an announcement that some may have violated internal policies to award unwarranted investment-grade ratings on constant-proportion debt obligations (CPDOs). Moody's has suffered a substantial hit to its credibility, to be sure, but do such tactics really work to reverse public opinion?

The media holds a very influential position in that it is often able to sway opinions in the general public. In this case, however, you're talking about a very specialized group with an intimate understanding of the companies involved and the business of credit ratings. Does media rhetoric really affect the opinions of investors who understand enough to question Moody's credibility in the first place?

Hang 'em High! GMAC & TopScore

I'm apparently behind the ball on this story, but I've now been sucked in; I'm really curious to see how this plays-out. For those of you who are not yet aware, there was apparently a site, TopScore, that was publishing current test questions from the Graduate Management Admissions Test (GMAT) and as many as 6,000 test takers, according to GMAC, may have used the site's service to get access to those questions. The question, of course, is what happens to those test takers now.

Like many of you, I'm sure, I worked really hard to prepare for the GMAT years ago and I'm a little disgusted by the thought that others could have cheated. A test like the GMAT is highly dependent on the distribution of test results; your percentile score may be more important than anything else. Consequently, if there was a group with an unfair advantage over the rest, then their scores would not only be higher than they would be otherwise, but those scores would directly, and negatively, impact the other (honest) test takers. With the futures of prospective MBAs so dependent on their results on the GMAT, I, for one, hope that the cheaters get what they deserve.

Depends on what you mean by 'inflation'

I was drawn to this article by its headline reporting that Warren Buffett, the billionaire investor and world's richest man, does not agree with Ben Bernanke's views on inflation and its medium to long-term impact on the U.S. economy. What I'll comment about, however, is the apparent distinction that the Fed makes between relative-price changes and what we would otherwise call inflation. Did you know that they made a distinction? I didn't!

Relative changes in prices are considered to be the result of the demand and supply forces that underly any market for a good or service. Inflation, more generally, is the resulting affect of a general change in price levels that causes our purchasing power to be reduced (assuming positive inflation, of course). What's interesting about this distinction, beyond the fact that such a distinction is even made, is that the Fed (and by the Fed, I'm really referring to Mr. Bernanke) believes that relative price changes are otherwise transitory and will not necessarily lead to inflation. The argument is one that I've written on before, simply that wages are sticky upward and that will mean subdued inflationary pressure. There is a problem with this argument though...

I do agree that wages are sticky and that will mean that inflationary pressures are somewhat tethered. That said, it would be difficult for anyone to argue that purchasing power has not been affected. Beyond the cost of fuel and the rising cost of food, consumer wealth is falling rapidly and this has a very real affect on consumption. As consumer wealth falls, they have less collateral and a generally lower willingness to spend. This, of course, must necessarily result reduced demand which will then result in slower sales, layoffs, even more bankruptcies, and ultimately even slower economic growth. So, my question, then, why does the Fed make such a distinction between relative-price changes and what we plebes call inflation if they both lead to the same thing?

Speculators & Scapegoats

If you're like most people, then you could use a little brief on how the futures markets function and, ultimately, the extent to which a futures market can actually affect current spot prices. I found this article quite good for that purpose.

The article makes the connection that most articles and media reporters do not: inventory. Inventories are the key to affecting any market's spot price. Put simply, or put otherwise, the spot price does not is not affected by volume fluctuations, but rather actual changes in demand and supply. To affect the spot price for a commodity, be that oil or wheat, there must be a change in the amount supplied or the amount demanded. If you look at futures traders as shoppers in a store, then the number of shoppers really should have no affect on the prices listed on the shelves. Instead, only those actually at the checkout are having an affect - the ones taking delivery of their orders. So how do inventories come into play?

Use your own logic; if you wanted to corner a market on a particular good, then what would you do? You would try to buy-up as much of the supply as possible and then be able to set your own price; right? Right! Essentially, you would be driving-up demand and causing a shrinking supply in that good. This is exactly the counter-argument against blaming speculators for the rising oil prices because the vast majority of participants in the futures markets never take delivery, but rather roll-over their contracts days before they expire; they are not taking deliver and are not hoarding those barrels of oil in secret warehouses until they can sell it at a higher price that they set themselves. The number of barrels available has actually increased.

So, then, how do you explain the very apparent bubble in the oil price? Well, we should start by considering not the U.S. market, but the global market as a whole. As much as American's (and Canadians, for that matter) don't want to hear it, the rest of the world (the Middle East excepted) pay far higher prices than we do. One could argue, then, that the North American market prices are simply adjusting to the global prices. The question I'm sure you will ask then, of course, is why now and why so dramatically. The argument there will likely involve a lot of pointing at China and India as their economies continue to grow at near-double-digits. Unfortunately, there's a counter-argument to that as well given that the growth of those economies is not high enough to fully justify the growth in the price of oil. So, then, we've come full circle without really answering any question.

Is speculation affecting the market price of oil? Yes, probably. Are the growing economies in China and India causing an oil price spike? Yes, probably. Can either be blamed exclusively for the rising cost of oil? No. In today's global economy there is never one reason for anything; it is the interaction of many forces that results in what we see reported at the end of a trading day. The headlines will try to point to one cause or another, but the wise investor will look at all the headlines over a period of time and apply a weight to each factor to form a more comprehensive picture of what may actually be occurring and then plan accordingly. We all want a silver bullet solution, but we all also, for the most part, recognize that that's rarely the right solution.

What an Ugly June that was!

It's July 1st and the headlines are pretty much dominated by news of how badly the second quarter closed. From the horrible IPO market performance, to the worst June recorded for the Dow Jones Industrial Average since 1930; that's right, we're talking about numbers we haven't seen since the great depression. From stocks to bonds, everyone is losing money. Well... not everyone.

Energy is the sole sector that's making money. Mining too, but the fact that that's spurred-on by coal mining predominantly, let's just call it energy. I suppose that that's not too surprising since everyone seems to agree that the rising energy costs, along with the weaker dollar, are responsible for the slowing economy. The question is, where do we go from here.

Banks want us to believe that we're approaching (or have hit) a bottom and that things will turn around soon. Brokers and traders are beginning to encourage people to get into the market to take advantage of the declines and prepare to reap the profits that will come from the market's climb. Personally, I believe that this is still quite premature. The credit crisis is widely seen as having caused the initial turmoil and from Buffett to Greenspan, the consensus is that we've yet to see the worst as far as the reported write-downs are concerned. Furthermore, the housing market has not yet recovered. Sure, the media is shining a bright spotlight on the nice markets in Florida and California that are seeing moderate recoveries, but this is likely more the result of foreigners entering the real estate market to take advantage of some deep discounts than it is a sign of a recover in the domestic market. The reality is that the U.S. is still slowing and that will have a domino affect on the rest of the world that is only beginning to show.

Unfortunately, the ugly June and Q2 is just the tip of the iceberg; this is a sign of what the near future holds and not a marker for the bottom that many would like us believe we've just hit. If you're looking for a silver lining, then consider this: wealth is not created or destroyed on the whole. If someone is loosing money, then someone else is making money. With so many loosing money, that should only mean that there are a whole lot more opportunities to cash-in. Happy hunting!

The Grass is Always Greener

This is a funny story about how the ban against futures trading in the market for onions, introduced in the late 50's, may finally be repealed to help stabilize the volatility in prices... yes, I said stabilize. All this, while the news is rife with talk about how futures traders (a.k.a. so-called speculators) are blamed for the persistently climbing oil prices. So where's the truth? Do traders help stabilize or do they increase volatility in the markets?

The price of onions, apparently, has soared as much as 400% between October 2006 and April 2007; that puts the rise in oil prices to shame. This happened, of course, with no futures market at all so analysts have no choice but to put the blame on the good ol' forces of supply and demand. All that volatility came on the back of swings in the weather; as the supply of onions dried-up, the prices soared. It's just that simple. So why, then, can it not be the same for the oil market?

As with a lot of things in life, it's more than likely that the truth lies somewhere in the middle. You must recall that a futures market was introduced primarily for the purpose of stabilizing the commodities markets by providing producers, farmers for example, with a way to hedge against changing weather conditions and ensure themselves of a more predictable revenue stream against which they could plan their businesses. Again, as with many things in life, there's a downside. Just as the futures markets can stabilize prices, they can also exacerbate fluctuations.

There are two fundamental forces: demand and supply. Weather affects only one side: supply. Similarly the arguments about how much oil is in the ground are all arguments about supply. The futures market makes it easier for people to speculate on the future price of good and this, simply, drives greater demand for that product. Without a futures market, the only people who are buying a commodity are those who can take delivery - just as you would at a grocery store. The futures market allows you to place an order for, let's say oil, with the option of canceling your order before it comes time to pick-up your order. That's what people have labeled speculation. It's nothing more than higher demand with a fancy name. So, then, what does this all mean?

The introduction of a futures market in the market for onions or, similarly, the legislation against speculation in the oil futures market will not really resolve anything in the long-term. In each case, market participants are responding to the current market conditions without much consideration for how the market outlook six-months or six-years from now. A futures market does stabilize the prices in a market during times of turbulent weather and may actually increase volatility in times of stable market climates. The futures market is a synthetic market introduced by laws and regulations; whenever you introduce such legislation you have to take the good with the bad. For any benefit that comes from a law, there's bound to be some negative externality that balances the scales. The grass is not actually that much greener on the other side of the fence. Sorry.

What do Analysts Actually Consider?

Many are pointing at Goldman Sachs this week and laughing a bit. A week ago, they suggested that the financials had hit (or were at least approaching) a bottom and that investors would be well to reinvest in the sector. A few days later, of course, they reversed their position and now recommend an underweight investment. My question has little to do with this particular recommendation or the financial sector, but rather how analysts could waiver between such extremes within such a short period of time. What is it that they look at?

It's certainly not the fundamentals! The fundamentals of a company do not change overnight and nor do they change within a week. Analysts are supposed to be the insiders who have a window into a sector, industry and a small group of companies - providing investors with greater clarity on a publicly traded company's viability as a going-concern. When I see such a respected firm reverse their position within such a short period of time, however, they come across as just another investor on the street that's watching the headlines on the ticker tape; they're just reacting to the latest news and speculation rather than actually investigating the underlying truths.

Competition & Deregulation Fight Stagflation Part 2

Sometimes it seems as though there's a counter-argument for every argument; isn't it great! I just finished writing how competition and deregulation was working to prevent inflationary pressures from spiraling out of control and then I read this article that made me rethink my position, again. I still believe that competition and deregulation are in-fact working to keep those pressures under control, but I neglected to consider the effects of rising fuel prices on the extent to which that competition can take place.

There's no doubt that communications technologies enable for a great deal of competition in the services sectors, but that's going to have a lot less of an impact on the manufacturing side of the economy. Ultimately, manufacturers have too get their goods into a market before they can sell them there and the rising cost of oil has made that far more expensive. The result is that domestically produced goods are just a little more attractive and the demand for those goods, as a consequence, is just a little higher. This higher demand for domestic manufacturing empowers laborers just a little more and makes wage-hikes just that much more likely. As I've written before, rising wages is the key influential factor driving inflation.

So where do the scales balance? Good question; it's anyone's guess really. I will say that the forces of competition and deregulation are not going away, but the oil price bubble may very well disappear. What happens then?

Oil Prices: Speculative Bubble or Not?

Yes, I know, it's not exactly an original headline, but the question does still persist. I'm certainly on the side of the argument that says it is a speculative bubble, but even I have my doubts about the extent to which the latest rise is due to speculation as opposed to real demand and supply factors. No one, for example, could argue that the supply of oil is not ultimately limited and that certainly has an effect on the price of oil. There is no doubt that the price of oil has to rise as the known sources of oil slows.

On the other side of the argument, my side, you balance the falling supply of oil with the rise in alternative fuel sources such as wind power that has received a lot of attention lately. Similarly, there's more talk about hybrids and plug-in hybrids among the automakers than ever before. As the cost of these alternatives fall, consumers will demand more of them and consequently require less oil (traditional fuel), which should drive-down the price of oil. As a result, you could argue that the force of dwindling supply is being countered by the rise in the availability of alternatives. The question then becomes, of course, which force is more powerful?

Actually, would anyone really question the suggestion that alternatives such as solar, wind and nuclear eventually outweigh the demand for oil? The cost of drilling and refining oil is only going to rise as the world's oil companies must search for less available reserves off-shore or in oil sands like those in Canada. By comparison, the improving technologies are only going to help drive-down the cost of the alternatives. The result almost certainly has to be that the demand for oil falls as the demand for the alternatives rises. The real question then becomes, of course, what is the timeline. Unfortunately, I don't have an answer for that, but I will say that I don't believe the current price of oil is sustainable and that a bet against oil will undoubtedly pay off in the long-term. I'm just not sure of my definition of 'long'.

Competition & Deregulation Fight Stagflation

I just finished reading an interesting article that has caused me to rethink my position on the state of the economy and where it may be going. I've written before on how the current slowdown resembles what we saw in the '70s and earl '80s, but after reading this article, I'm reconsidering the affects that global competition may have on the ability of the U.S. economy to ever see the sort of rocketing inflation that we say a few decades ago.

It comes down to wages. If wages don't begin to rise (accelerate, actually), then inflation will remain relatively under control. This is an important fact to remember when you consider that a global economy means that nearly every sector, industry and individual business competes with international vendors willing to cut prices and snatch-away customers. The article uses the airline industry as an example, but the same logic could be extended to almost any market. Whereas airline ticket prices rose by more than one-third in the early '80s, they've seen less than a 2% rise even with the unprecedented rise in the cost of fuel. The reason? Competition and deregulation.

There are more airlines, even with all the trouble in the sector, than ever before. Travelers have more choice than ever before. The result is that airlines are left sitting between a rock and a hard place. With the rising cost of inputs to their operations, the decision is no longer whether or not to raise prices, but rather whether or not to continue operations at all. They are no longer able to raise prices because their competition won't. One of any competitor airlines that had been fortunate enough to hedge the cost of fuel earlier will have a cost advantage and will simply assume all customers should its competitors increase their prices. In economic terms, it suggests an inelastic short-term supply curve. What's interesting about this argument is that nowhere have I mentioned wages, which is traditionally considered to be the primary driver of inflationary pressure.

There's competition for jobs too. Just like there are more airlines fighting over travelers, there are more people fighting over jobs. Workers are less able than ever before to request a wage increase. There are fewer labour unions and those that do still exist are less powerful. Moreover, the ability to outsource leaves employers not with the decision to increase wages or lose employees, but rather whether or not to keep employees or outsource operations oversees where costs could be a fraction of what they are locally. The consequence of all this is that rapidly rising inflation may really be a historical artifact.

We've Only Seen One-Third of Writedowns?

According to John Paulson, founder of the hedge fund company Paulson & Co., global writedowns stemming from the credit crisis may top $1.3 trillion, surpassing the International Monetary Fund's estimate of $945 billion. Who is Paulson, you ask? He's the guy who placed a bet on the speculative bubble in the sub-prime lending market, which has netted his fund a gain of a whopping 591% in the past year. This is the guy who saw the storm coming so you could say that he's got a fairly good insight into the breadth and depth of the sub-prime market.

$1.3 trillion in writedowns is three-times higher than the writedowns already reported. That's both a staggering total figure and worrying prediction for what the future holds for the global economy and financial markets. The U.S. economy has certainly taken the brunt of the immediate downturn, but as economic speculators are working diligently to maintain a positive attitude in the business press, the reality is that the downturn we've seen thus far is only the tip of the proverbial iceberg.

In a survey of hedge fund managers conducted at a meeting in Monaco last week, more than 80% said that the see the current credit crisis persisting for some time yet so Mr. Paulson is certainly in good company. Moreover, as much as 23% of those surveyed see the current situation worsening further before it gets better. What's interesting, is that it appears that these same hedge fund managers are watching the financial stocks like vultures circling; they waiting for the best time to buy the stocks that have been beaten-down by as much as half. If you're anything like me, then you will be watching the actions of these firms to insights into when, exactly, will be the right time to jump back into the banking waters where the opportunity appears to be astronomical.

If it's not one thing, it's inflation

I wouldn't exactly call it breaking news, but it was good to see consensus among the G8 that inflationary pressures were now the biggest threat to economic growth worldwide. The credit crisis certainly has worked to send many of the largest economies into a tailspin, the US most notably, but the persisting pressure of higher oil and commodity prices threatens to keep these same economies from any sort of near-future recovery.

Oil hit $139.12 per barrel on June 6, 2008; an all-time high. Commodity prices, like wheat, for example, have seen prices double in the past year. On a personal note, I can confirm that I've seen the price of whole wheat flour literally double in a matter of weeks at my local supermarket. While commodity prices represent a relatively small proportion of household spending (food, in general, may only see single digit-increases), the combination of these rising prices with declining home equity and accelerating unemployment figures paints a very black picture for the future.

It's a positive thing to note the G8's consensus, but worrying still is what actions will result from that consensus. To slow inflation, central banks will begin to raise interest rates. While many would tend to agree that this is long-overdue, the current state of the world economy as generally weak and slowing, will likely mean that in doing so, the higher cost of capital will only affirm the recessionary tendencies and result in a very, very slow recovery.

More Information Is Always Better

There's a lot of talk about the SEC and its persisting investigation of the ratings agencies. The good news is that, at least it appears at this point, investors will be winners now matter what the outcome.

I wrote earlier about the SEC's consideration of a plan to require the ratings agencies to make their research material available to others. This, of course, would allow others (hopefully individual investors as well) will be able to assess risk-and-reward profile for a given investment - just as the credit ratings agencies do. The advantage is that investors could become less reliant on the AAA-ratings and could review the actual data that goes into such a rating. With the agencies being blamed for having rated mortgage-backed securities as tripple-A (the highest investment-grade rating) that subsequently defaulted and resulted in hundreds of billions of dollars in losses and write-downs.

Now, there's news that the SEC will offer the ratings agencies a choice between two possible outcomes. The first, will be a disclosure of the underlying information as I described above; the second will introduce a new rating scale that would help identify mortgage-backed securities and distinguish them from corporate bonds. While certainly not providing as much information, this too would work to make investors more aware of where they were placing their money and that's never a bad thing. So, no matter what happens, at least its comforting to know that we, lowly investors, will ultimately win.

Ratings Agencies & Structured Securities

The SEC's investigation of the ratings industry continues and the latest target on their hit list is the rating of structured securities. The headlines suggest that the Commission may go so far as to ban the three top ratings agencies. Moody's, the S&P and Fitch from rating such securities at all. All three of these firms help to advise investment banks on the design of such securities, so how can they be trusted (by investors) to also provide impartial evaluation of their risk-and-return profiles?

What's more interesting, and possibly valuable, to investors, however, is the SEC's suggestion that the ratings agencies be required to make available all the data that goes into the ratings so that other firm (and possibly private investors?) be able to make their own determinations based on the very same information. In my previous studies about statistics we were often presented with research papers that claimed one result or another based on some analysis. What I often found quite interesting, however, was when such papers were later refuted by further analysis of the same data by other analysts.

As is often said, statistics can be massaged to say almost anything that you want. I can't help but think that ratings agencies are simply statistical analysts with an especially bring spotlight on their research reports. Data mining, the practice of scouring through numbers to find a particular trend or pattern, is a well known practice; try it for yourself. If you use enough data, I promise you that you can find any patter or trend that you want to find if you look hard enough and make the 'appropriate' assumptions. I think that the skill to analyze data yourself is invaluable and the news that more data may be made available to the public at some time the future will only help individual investors willing to put in the time and effort to make up their own minds about an investment.

Rise in Unemployment Tops 22-year High

Last week's unemployment figures unnerved the stock market, but we know - by now - that that unnerving didn't really last. It's hard to say what the market will react to at all, let alone to what it will react positively or negatively. The fact remains, however, that unemployment is rising faster than ever and this must have real economic impact regardless of what the stock market index figures say today or next week.

I was reading an article on the subject and it's sometimes worrying to see how an author or analyst will often look for data to confirm or undermine whatever the headlines say. For example, this latest jump in unemployment, which clearly spells negativity for the economy, was discounted by a researcher who found that similar occurrences in the past were followed by significant gains in the stock markets within the following 12-months. Should we, then, be excited by the news that more companies are cutting their workforces, more people are losing their jobs and consumer spending will ultimately be forced down?

Stock analysts lose 17% for Investors

Just because it's such a powerful sentence, let me start with a quote from the article that I just finished reading...

Investors who followed the advice of analysts who say when to buy and sell shares of brokerage firms and banks lost 17 percent in the past year, twice the decline of the Standard & Poor's 500 Index.

From the perspective of someone studying toward their CFA (Charterd Financial Analyst) designation, this isn't exactly the most rosy news. What's even more worrying is the sector within which these analysts' recommendations performed the worst - their own: financials. The question is why?

I can't help but wonder what techniques are being used to analyze these companies that analysts track ...if they do use a consistent technique at all, that is. In preparing for my own career as an analyst, it is precisely on this skill that I spend most of my time working: designing my own style and set of tools used to determine what makes a good investment and what does not. The MBA Association, www.MBAAssociation.Org, just launched their Intrinsic Stock Analysis Tool on which I collaborated and I think that this is a great starting point for anyone interested in the field or anyone interested in investing their own money and having the desire to truly understand the fundamentals behind a stock's price.

What I find interesting is that analysts measure their performance based on their 'Buy' recommendations alone; but what about their 'Hold' or 'Sell' recommendations. If you were to buy the stocks they suggested that you buy, you would be up by 17%, but if you were to do everything that they suggested you do, then you would be down by about the same amount. This implies that the money you would lose would be roughly double what you would gain on the up-side. That's a hell of a lot of volatility!

I find it a little frustrating to follow CNBC's latest stock market game with prize money of $1 million for the traders that generate the greatest returns within the few weeks over which the game runs. While it's great to see such games entice new people to the field of finance, it's worrying to see the style of investment that is encourage: trading, not investing. Everyone wants a quick buck, and it seems no one is willing to spend the time to analyze and develop sound investment decisions.

Ratings Agencies Screw-Up & Get Paid Anyway

With all the economic trouble that has resulted from the sub-prime debacle, a great deal of attention was paid to the ratings agencies that awarded high ratings to the debt instruments that later collapsed. In its investigation of the factors that led to this collapse, the New York Attorney General, Andrew Cuomo, also began an investigation into the credit ratings agencies themselves and a settlement in that investigation was just reached between the state and both Moody's and Standard & Poor's. That settlement, however, may leave some investors scratching their heads.

As usual, of course, no one admitted any wrongdoing. You may recall that I previously wrote that Moody's was quick to suggest that a computer bug had caused the ratings to be inflated in certain situations and it never assumed any of the blame otherwise. What is interesting about the settlement, however, is that it may mean greater revenues for these ratings agencies going-forward - yes, more money! The reason, however, actually makes sense.

It all comes down to incentives. Just as the top CEO's have a large part of their total compensation packages tied-up in stock options that align their interests with the performance of the company's earnings (that, of course, is a whole other story), the ratings agencies will be paid for initial analyses and assessments performed on new sub-prime issues. Currently, prior to the new rules, the ratings agencies were paid only if they were ultimately selected by the issuer as the final, official, ratings agency. This approach, of course, incentivized the agencies to give better ratings than they might have otherwise in order to win the business. Being able to earn some cash regardless of their ratings, therefore, should make them more willing to speak the truth ...of course, I'm not saying that they haven't been doing so in the past... you understand, right?

Marking-to-Market of Debt

I came across an interesting article that discusses the application of a new FASB rule (Statement 159) that permits the marking-to-market of debt. You will recall that marking-to-market is the practice of adjusting the balance sheet valuation of an item, previously only assets, to reflect that current market values rather than the book value or original purchase prices. Well, Statement 159, introduced last year, allows this same practice for liabilities. Considering the declining creditworthiness of the banks, you can imagine what's happened to the yields and prices of the bonds that they have on their books - it's resulted in billions of dollars in illusory revenues.

Why illusory? Good question. Just like marking-to-market of an asset, it represents the accounting adjustment of unrealized gains or losses - this does not represent actual cash flows. The investment banks, having recorded several billions of dollars in such marking-to-market gains, have been quick to offset their losses from the write-down of collateralized assets that have declined to pennies on the dollar. The write-downs, too, are unrealized losses so why then would anyone question this practice? Again, good question.

The difference is in the marketability of the assets or liabilities; put differently, it comes down to whether or not you could actually sell the assets (or buy the liabilities) at the new market price. In the case of the assets, there's no question. There is a market for the CDOs, CMOs and other three-letter depreciating assets that we've come to know over the past year; it's only a matter of price - if it's low enough, then someone will be happy to buy it. The reason is simple: they're marked-to-market based on an expectation (probability) of how much of that asset represents bad loans - the reality may be very different from what the current market dictates and the buyer of these assets could gain substantially from the even a small variance from what is currently predicted. Of course, they're assuming a great deal of risk for that potential.

In the case of marked-to-market liabilities, however, the story is very different. The debt held by investment banks such as Merrill Lynch, Lehman Brothers and other depository institutions such as Citigroup has declined in value as a result of their lower credit ratings, which has caused yields on their bonds to rise and, consequently, their prices to fall. To realize this declining liability value, however, these institutions would need to retire the debt - i.e. buy the debt back from the issuer. The question is, who wants to sell it? Moreover, to do so, these same institutions would need to raise funds, now at a far higher rate, in order to buy the debt, which would increase their actual cash flows going forward. Consequently, no bank will do this and this is why it appears as though an accounting regulation has been twisted in such a way to offer these institutions a paper-out that only leaves analysts and investors like you and me scratching their heads trying to decipher what their financial reports are actually telling them.

Inflation, excluding the inflation.

No one will be surprised by the fact that I, along with tens of millions of others, believe that inflation is being underreported by the government; I've written on it countless times in this blog alone, and if we've ever talked economics, then I'm sure the subject came-up. It's probably why this article really caught my attention and I'd recommend it to all of you who would like to know more on the subject.

The long and short of it is a comparison of the US economy with that of a couple dozen other countries - including many of America's trading partners. What's surprising is that US inflation rates have been a relatively consistent 3% to 4% lower than that represented by this benchmark group. Of course, economists would argue that this differential can be explained away as a result of greater productivity in the US, but do we actually believe that the US economy is more productive than India or China, for example? 

Many of you know that there are two commonly-quoted inflation rates: the headline rate and the core rate, or what the author of this reference article calls the inflation, excluding inflation. Guess which one is the official rate? What you quickly notice after glancing at a graph such as the one below is that the difference between the official 'core' rate and the more realistic headline rate is growing - the greater the separation between the two, the more unrealistic are the figures being reported by the government, and more importantly for us investors, the less reliable are the valuations used to compute a stock or bond price!

Anyone who's taken a class in finance understands the importance of the inflation rate in the calculation of the price of any asset; it's absolutely critical as a starting-point including the risk-free rate to determine a real rate of return on investment. Without an accurate measure of inflation, we have no real idea of what our real return is - i.e. what the purchasing power is of our investment upon maturity.

The thing that I like most about this article is that the author doesn't present any of this as a conspiracy theory, but rather as an alarming warning to investors - cautioning us all about keeping this discrepancy in the back of our minds when making our valuation calculations and investment decisions. Now go... read it.

Entrepreneurship: Making The Most of Any Situation

In reading an article about the latest spate of foreclosures hitting the state of New York, I came across a very interesting business - foreclosure bus tours. I realize that this isn't likely a new business, but it's new to me so I thought I'd mention it. What I find fantastic about this concept is the entrepreneurial spirit that seems to rise-up from any situation - no matter how bad it may appear to be.

The tours, that charge $75 per seat, take prospective buyers around the latest foreclosure filings. It's simply ingenious; they're fulfilling a growing need or interest and making money on it. Beyond just providing the transportation, they're also facilitating the buying process by bringing along mortgage brokers, home inspectors and even contractors to help those buyers make qualified decisions.

I can visualize the business model already. I can imagine that the bus company has brokers, independent home inspectors and contracts lining-up to come along on these rides as the resident experts on-board; moreover, I would hope, that they're paying a pretty penny for an exclusivity option. 

It really is that simple. Spot the need and figure out how to satisfy it.

Is the downgrade of the financials warranted?

In short, no. The downgrade of the investment banks just doesn't make sense. Why? Simple. With access to the Federal Reserve's credit facilities, the same facilities made available to the commercial banks, these investment banks have access to plentiful, and cheap, capital whenever they need. A credit rating downgrade, by definition, presumes that the ability of the entity being downgraded to satisfy its debt obligations has somehow worsened. The fact that these banks now have access to more, not less, capital directly contradicts this action by the ratings agencies.

So, then, why did they do it? Good question - I'm not sure I know the answer. The consensus, however, seems to be that the ratings agencies are late to the game and are now reacting to popular fears that have all but disappeared since the first fall-out from the collateralized debt obligation defaults and, more recently, swap defaults and associated insurance scandals. Furthermore, the spotlight that was placed on ratings agencies following the aforementioned collapse when they did has placed the integrity of their models and practices into question. It could very well be that they are now simply trying to follow the herd rather than lead.

Back to the Future: Stagflation

The economy growing had been growing at 5%+ prior to the continuing rise in commodity prices; the country is engaged in a wildly unpopular war, which helps to worsen the growing budget deficit and ever-expanding foreign borrowing; the Middle East is in turmoil; the American dollar is in a free-fall with no bottom in sight due to a lax monetary policy; commodity prices are surging - oil having quintupled in the past half-decade alone. That's right, it's the early 1970s all over again!

The similarities between the current state of the economy and that of three-decades ago are eerie indeed; Dick Cheney is even in the white house - just as he was then under President Ford as his chief of staff and, as then, is often blamed for America's pursuit of so-called stability in the Middle East to help assure the flow of oil. Of course, with no oil actually emerging from Iraq, that's a whole other story. Thirty years ago we were in a very similar situation - it was called stagflation: slowing growth, rising unemployment and inflation. We recovered then at significant cost, which led to slow growth, high interest rates and high inflation for the better part of the following fifteen years. The question now is how will we get out of the current state of economic woes?

Fortunately, there is a growing consensus about what the solution is to get the global economy out of its current doldrums: technological advancement. Although it is an admittedly simplistic analogy, imagine if the cost of the war in Iraq had instead been invested in sustainable technologies - whether in food, energy, water or even climate change. 

Assuring the flow of energy to America need not be as expensive as it has been. The cost of the war in Iraq is estimated at nearly one-half trillion dollars; yes, trillion! The cost of a nuclear power plant is less than $10 billion per reactor - not even counting the fact that the investment wouldn't be flowing across the border and would instead create jobs both during the construction and the following operation and maintenance. Of course this is just one example, but you get the idea.

The sheer numbers involved open the doors to tremendous opportunities for technological advancement. America is currently spending on its war in Iraq the sorts of dollar sums that could quite literally solve problems and answer questions that have caused impediments to scientific progress or, at least, slowed its progress. Science and technology can improve yields per acre - resolving any concern over food shortages. Science and technology can clean not only the drinking water, but also clean-up our lakes and rivers and prevent future pollution. Imagine how much better the world would be, let alone America. Imagine further how admired America would be as a leader in technological advancement.

Timing Losses & Financial Institutional Strength

Let me tell you a story to prove a point. Assume that you loaned me $1,000 2-years ago (thanks, by the way) and I had not paid you any interest or principal ever since. Assume further that we met today to negotiate a settlement and I offered to pay you $200 as a one-time payment to satisfy the entire amount of the loan. The question: how much money did you lose and when did you lose it?

Those of you who are financial inclined are likely already doing some discounted cash flow calculations, but let's keep things simple; let's ignore the time-value of money. Many of you, then, are likely shouting a loss of $800 today, and I'm sure that many more of you would be tempted to agree, but to see why this is the wrong answer, we need to differentiate between paper-losses (accounting) and actual losses (cash flows).

From an accounting perspective, you, the lender, had created an account to represent the account loan and the expected future repayment. What is important to acknowledge, however, is that the $1,000 that you lent to me flowed out from your bank account 2-years ago - not today. Put differently, you have had $1,000 less funds for 2-years; my offer to repay you only $200 of the full amount does not represent a loss, but rather a positive cash flow today. Actually, it's as simple as:

-$1,000 :: cash flow out to me in the form of a loan

$0 :: cash flows from my repayment of principal and interest

+$200 :: cash flow from my repayment and settlement of the loan today

Now, I'm sure you're asking yourself why this revelation is important. Well, let's consider the banks that are scrambling for credit and new sources of financing in light of the so-called credit crisis spurred by the billions of dollars in write-downs. Ask yourself when those related losses actually occurred. Also, ask yourself whether the settlement of these debts at $0.20 on the dollar leaves more or less cash on the balance sheets of these banks. Notice, that I asked about whether this left more or less cash - I didn't ask about net assets. This is the difference between accounting losses and actual (cash flow) losses.

The interesting conclusion that many of you are now likely making is that the settlement of these bad debts is actually leaving these banks in a stronger, rather than weaker, financial position. So why are they scrambling to borrow from the Federal Reserves auction facilities? Good question. They certainly don't need the cash - their cash positions haven't changed! Only their accounting positions have changed. It is true that this does affect their ability to lend as it leaves them with fewer assets and collateral, but fears over bank failures is certainly unfounded. Now, as an investor watching the markets and seeing the tumbling stock prices of many, if not all, financial institutions, ask yourself if the broader market has misinterpreted the events over the past few months. Lastly, ask yourself the market's overreaction leaves you with an opportunity to profit from the rebound that is unquestionably going to happen - given enough time for the banks to restart their lending engines.

MBA Interest Surges In Slowing Economy

What are more and more people thinking about as the economy continues to slow? You guessed it, school. The MBA is, of course, at the top of the list for many professionals who are looking to take advantage of the declining opportunities in the marketplace to prepare themselves with a business education - readying themselves for when the rebound come-around.

The MBA Tour, a worldwide tour that brings together between 20 and 25 business schools in one place, at one time, has grown in popularity; attendance was up 30% last year and Peter Von Loesecke, the founder of the Tour and MBA graduate from Cornell's Johnson School, believes that it will continue to grow even more rapidly as the economy worsens. It makes a lot of sense.

A graduate business education, like any other post-grad degree, requires that you take time away from your career and suffer the opportunity cost of that lost income in addition to the, sometimes, staggering tuition costs and related expenses. Clearly, then, the best time at which to take that on is when the opportunity costs are minimized. Whether they realize it yet or not, prospective MBAs are behaving like trained business people already; once they graduate, they'll understand the economics behind their prior motivations.

The Companies MBAs Love

It's not much of a surprise really; you could probably guess many of the companies that made the list, but there's a great little article, here, that outlines the top-25 companies for whom new MBA graduates would love to work. What I would not have guessed, however, was that Google made the top spot - it's the #1 most desirable employer according to Universum, a research firm that publishes the list for Fortune.com.

Of course, I would have listed Google on the list as well, but maybe not as #1 - ranking McKinsey, or another big consulting firm, instead. Maybe this is a sign of things to come - a greater focus on business innovation rather that resume-prestige? On the other hand, maybe it's just a normal reaction to desiring the most talked-about names - Google certainly does qualify for that.

Disconnect Between Wall Street & Main Street

I don't know about the rest of you, but I find it funny when I see two headlines, one after the other, that contradict themselves in evaluating the state of the economy. One will say something like "The stock market rallied today after news of..." and the other will read "Consumer confidence reaches all-time low." How can both be true?

Here's something to ask yourself: if unemployment is rising, people are losing their jobs. If housing prices are falling, home equity is likewise falling. Consumer debt, as everyone knows, is rising like at no other time in history. All these things point to far lower incomes, so where is the money coming from to support the stock market rallies? Wouldn't it make sense that the declining wealth of the masses would result in a withdrawal from the financial markets to help prop-up their other expenses - like food and shelter?

There's no doubt that the world, as a whole, is not suffering the same economic declines that the US has seen of late, but many indicators point to this only being a delayed. These economic woes are not exclusive to the US; in today's global marketplace, no one economy, especially one the size of the US market, stands alone in either a rally or decline. We grow and shrink together - like it or not. It could be, then, that investors in markets that have not yet seen declines in their own markets are pouring more of their money into the US as a bet on its ultimate recovery. There dollar is certainly undervalued compared to its historical average so that could be one reason, but it all just doesn't seem very clear. Any thoughts?

Bonuses & the U-Shaped Recovery - What to Expect

On the bright side, the job losses on wall street are far less than they were following the dot-com bubble burst earlier this decade. While financial institutions shed about 17% of their forces, those same institutions have only cut about 3% during this latest downturn. Unfortunately, there's a downside to this story.

The downside is that many, if not all, are expecting many more cuts to come. You may have heard people referring to a U-shaped recovery; well, were only still on the left-side, the downward side, of that 'U'. It will essentially be a very slow downward slide that will see an increasing number of jobs lost before we hit the trough of this business cycle. Worst yet, it will be an equally slow climb back up. So, who among us are the most at-risk?

You guessed it; the higher your salary and/or bonus, the more likely you are to get a pink slip. It's no secrete that wages are the #1 expense for financial institutions and they're losing money like a leaky rowboat. To hedge those losses, their first act is to cut their expenses proportionally and the story seems to be that there are many more write-downs to come - more paper losses at these firms necessarily mean more job losses for those working there.

The best thing to do is to stay focused on your long-term career goals. Your career is not your job; it's the union of your experience and education. Losing your job does not represent a loss of your career; it provides you with the opportunity to explore areas that you haven't had the time to review in the past. Use every opportunity to enhance your experience and education and your career will continue to excel.

B-School Students Anticipating Hurt After Graduation

With the up-coming graduation season, the pressure is mounting on graduates from business schools around the country (and the world, for that matter) to find the high-paying jobs that will help pay for those hefty school loans. Unfortunately, the economic turmoil of the past few months paints a hazy picture and after reading this article, it looks as though graduates are going to get an introduction to what they can expect as part of their graduation ceremonies.

I remember when I was graduating from business school and it's hard not to have lofty expectations. You've just spent a small fortune on an education that you sought purely for its ability to help boost your earnings expectations; all that, after leaving the workforce and suffering the opportunity cost of that lost income. A MBA is an expensive education, like most post-grad degrees, actually, and it's difficult to blame graduates for desiring the six-figure salaries that they've been trained to seek. The reality, however, may be a shocker and in listening to keynote speakers at their graduation ceremonies, graduates will have a window on what they can actually expect to face when they return to the real world.

The economy is hurting. Wall Street is laying-off thousands. Foreign markets are mounting pressure on almost every domestic sector. While getting a speaker who will motivate and inspire graduates may leave them with a warm and fuzzy feeling, it's unlikely to set proper expectations. Having graduated during the last economic slowdown, I personally feel that getting a realistic picture is far more valuable. These are highly educated and ambitious people; they don't need people to motivate them - they need people who will share their honest insights and it sounds as though that is exactly what they will get.

Of course it's an Oil Price Bubble!

It's almost funny how the discussion over whether oil prices are spurred by speculation or market demand forces; of course it's a speculative bubble. Those arguing against this view are quick to point to China's growing economy and similar demands from India; there's no doubt that that is the case, but it's ridiculous to think that anything changed so drastically in either of those markets within the past year to justify the rising prices we see around the world.

Need some proof, no problem. How about the total notional value of over-the-counter commodities derivatives that have risen from $1.02 trillion in 2004 to a value of approximately $8.4 trillion by the end of 2007. Yes, there no doubt that some fundamental demand must be credited for part of this rise, but numbers are simply so staggering that suggesting a speculative bubble is not the primary culprit is simply irresponsible. So, assuming that it is a speculative bubble, why is that important? Good question!

The prices are now so high that they are actually affecting demand - rather than vice versa. Drivers are driving less; airlines are cutting flights and jobs as well as authorizing new fees for customers to cover the cost of rising fuel prices. Similarly, other commodities are rising (most notably wheat prices, which have doubled in the past few months) under pressure from increased transportation costs. All these rising costs mean one thing: a slowing economy. Given that many, including the likes of Mr. Warren Buffett, have publicly stated that we are already in a recession, this does not paint a rosy picture for our economic near-future.

Yes, inflation is also a big deal. With all these rising pressures the concerns over inflation have been rising as well. The only thing that has kept those inflation rates from jumping along with commodity prices has been the Fed's ability to retain the trust of its citizenry who appear to continue to believe it has things under control; this belief has led to stable wage prices. Basically, people don't believe that it's in their interest to demand higher wages because of the rising unemployment rates. That said, this won't last. As prices continue to rise, people will eventually have to demand more money in order to pay for that expensive gasoline and bread and, when they do, the Fed will lose control. Fed Chairman Ben Bernanke has received a lot of kudos for his efforts thus far, but if inflation isn't brought under control many believe that he will be faced with an economy similar to that faced by his predecessor Volker.

When inflation grew to double-digit-levels in the late 70s and early 80s, Fed Chairman Volker was forced to move interest rates even higher; this, of course, led to one of the deepest recessions since the great depression. Many now believe that we may be heading into a similar situation if the Fed doesn't begin to raise rates sooner rather than later. The Fed is enjoying low inflation expectations, but those expectations are beginning to show signs of upward movement and the Fed really does need to take this seriously. 

Trusting the markets to manage themselves is wise, in theory, but the market won't keep itself out of a recession. The business cycle is a natural phenomenon and the only way to flatten that cycle is via fiscal and monetary policy. If the Fed doesn't do its job, the speculative bubble will lead to one of the worst economic slowdowns ever. Ask anyone who was invested in the markets during the bubble-burst of 2000 and you're likely to hear about their lessons learned. Well, this is another bubble; it's time to apply those lessons-learned and react proactively rather than reactively.