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.