Saturday, January 31, 2009

How To Do A Bad Bank

On the eve of Treasury Secretary Timothy Geithner's announcement of the new plan to deal with the current economic crisis, I thought I'd post one person's thoughts on how to do a bad bank in a good way.

I have no confidence that the government will get things right tomorrow.

Scott Dauenhauer CFP, MSFP, AFI

Thursday, January 29, 2009

The Lehman Collapse: Good or Bad?

Way back on September 15th I wrote on this blog "The Lehman bankruptcy is a good thing. Yes, I said a good thing. Did you notice that Lehman went Bankrupt and didn't get bailed out? Finally a financial institution that the government didn't bail out.."

That seemed like an eternity ago and since I wrote those words I changed my mind and stated that had I known now what the regulators should have known then, I would have supported a Lehman bailout, or at least a more orderly bankruptcy.

The more I think about the Lehman bankruptcy, which is now credited with the start of the huge panic, stock market crash and credit market freeze up - the more I think that perhaps it was a good thing after all. Here is why:

Had Lehman been bailed out it would have only delayed the inevitable, which was the realization by everyone that the housing market was essentially a bust and this bust would make insolvent our entire global financial system. That delay, while it would have been nice, would have been just that, a delay (mind you, John McCain may feel different, had the financial crisis not occurred he might be sitting in the oval office right now). Perhaps we would just now being starting to deal with it or perhaps it would take a few more months, or years and who knows how many trillions more in mortgages would have been issued (in reality, not many, most of the sausage makers had gone belly up or been sold by the end of October).

My point, Lehman probably should have been rescued, it would have shown consistency and would not have led to the Reserve Funds breaking the buck and to a disastrous 4th quarter. But it would have happened eventually and like a band-aid, the quicker we deal with the pain of pulling it off, the quicker we can recover and get back on steadier footing.

I can pretty much guarantee that this is not what Timothy Geithner was thinking when he decided not to bailout Lehman, despite bailing out Bear Stearns and eventually AIG.

There you have it, letting Lehman go bankrupt was a miserable failure by our political leaders.....finally a failure that could ultimately benefit us in the long run.

I am finally starting to see signs of what needs to happen to move forward. Yesterday the Federal Reserve (article here) announced a foreclosure rescue that might actually help as it includes principal reductions in the modifications. It doesn't go far enough as it still requires the homeowner to be 60 days late (down from 90 days with Paulson's plan) and it appears that they will do everything possible NOT to write down the principal. As I said a few posts earlier, they will get it wrong a few more times before they finally get it right.

In addition, the "bad bank" entity idea that I introduced on this blog on December 3rd is gaining steam and appears to be the way we are going to deal with the crisis. If implemented correctly, it could go a long way to solving this crisis, but it will still take a minimum of three to five years to work this out and housing will never be the same again........until we all forget what happened and this happens again.

Scott Dauenhauer CFP, MSFP, AIF

Wednesday, January 21, 2009

'Air and Simple Gifts' John Williams at Obama Inauguration

Absolutely incredible. This was the most inspiring piece of music I've heard at an inauguration.

Monday, January 19, 2009

Do The Feds Read My Blog? "Aggregator Bank"

On December 3rd I shared an idea of how to cleanse the banking system in a post entitled "Will Anybody Actually Address The Problem?". The few sentences that explain the idea are as follows:

"The idea I came up with was to create a government pool that would accept the assets from the banks in exchange for some equity and future income rights, as well as some loan loss guarantees by both the bank and the government. This would effectively do what TARP was supposed to do, but without purchasing the assets outright. The pool would be run for the long run which would mean that "mark-to-market" rules would have no affect. This morning I was reading that this is in fact the approach that the Swiss took with UBS (or something like it)."

A few days ago Washington started talking about an idea that is very similar - thus far dubbed "The Aggregator Bank" or "The Bad Bank" I've linked to an article from Bloomberg about this potential plan.

This is positive news as it points to the potential that the government might actually do something that will work to solve our underlying problems that started nearly two years ago. While this is positive news, it isn't news yet and would require a lot of work to get done (the government has created this in pseudo form with the Fed (Maiden Lane) and other guarantees they've made). So, this is one step forward. Of course its not possible to take a step forward in government with out taking at least one or two backwards - congress wants to do two things (two steps backward) that would further hurt banks and homeowners. The first is to eliminate a rule the Treasury department modified last year that encourages good banks to swallow up bad banks without any government intervention and the second involves allowing bankruptcy courts the ability to "cramdown" a mortgage to a lender - or allowing a judge to modify loan terms without lender input. This would raise rates for everyone and is not needed. What is needed is for lenders to come to the reality that they need to write down a lot of bad loans with principal reductions not interest rate reductions and 40 year loans. Add in the governments encouragement for people to stop making their payments so that they could apply to have a loan modification and you have a situation where the government has floated an idea (bad bank) that could work and might be a step forward, but for that one idea has created three bad ones.

I predicted several months ago that the government would take two to three more stupid stabs at the current mortgage/foreclosure crisis and get it wrong before finally capitulating and getting it right - costing us two to three times what it would have cost had the problem been dealt with over a year ago.

Another idea I posted has been picked up by Obama, which makes this the second one - are the Feds reading my blog? Doubtful, had they done so we'd be almost out of this mess by now!

Scott Dauenhauer CFP, MSFP, AIF

Monday, January 12, 2009

2009: Its Going To Be Bumpy

Everywhere I go people are asking me what's going to happen with the stock market. My answer is the same as it has been for about a decade, I don't know. In the short term it is going to fluctuate, in the long term I believe it will rise. This answer for most seems ridiculous, however it is the only honest answer that can be given.

While I don't know where the market is headed in 2009 my gut tells me its not going to be a good year for stocks. I think you should prepare for the possibility that they could drop another 20%. It may not happen, in fact we could see stocks up 20 - 30% by year's end - I just don't know. What I do know is that the American and the global economies have some major problems to deal with and many of those problems are still not addressed.

For one thing, residential real estate is still going down in value. A home valued at $560,000 in Murrieta in February of 2007 is now valued at less than $200,000. A drop that is nearly unbelievable. Housing in many area's has turned out to be like tech stocks. The worst part is that the houses still are not clearing (selling) at these levels and 2009 - 2011 promises more will be dumped on the market, potentially depressing prices even more. My street alone is down over $5 million from purchase price (16 homes all bought in 2004). The banks are ignoring this problem. Don't believe what you read in the papers about banks working with borrowers - they are not. When they do they are only lowering interest rates and in some cases doing so only for the short term and then adding interest to the back of the loan. The banks for one reason or another don't seem to realize that they will lose less money by renegotiating the loans than allowing them to short sale or foreclose. The banks must turn into a mode of "losing less" or else the problem will continue to get worse. Without real estate being fixed, the economy cannot move forward.

The recession we have entered could be long and it will be very painful, there is just too much to clean up. This doesn't mean the stock market won't start recovering before the recession is over, it will, it always does, but that might not be until 2010 or later. My hopes are that it will be sooner, but letting hope overrule reality is a recipe for disaster.

Contrary to the negative tone of this post, I am long term optimistic. Innovation will drive this economy back to previous highs and beyond. We are the most innovative nation in history and we will continue to be.

I did not foresee much of what has occurred in the past few months, despite being very vocal about a housing bubble. The one thing that I missed was the egregious issuance of credit to those who never, ever had the ability to pay it back (well, I noticed it, but didn't realize the scale).

Some are asking if we should get out of the market, especially if it could fall further. My answer is that I believe that to be a bad idea. The only thing more difficult than figuring when to get out of a market, is when to get back in.

In conclusion, 2009 and 2010 may end up being terrible years for the economy, the stock market and housing or they could turn out to be ok, I don't know. What I do know is that the patient, long term investor will be rewarded for sticking it out during the tough times. Keep your head up, its not all bad news out there, we'll get through this like we get through everything else......and we'll be stronger for it.

Scott Dauenhauer CFP, MSFP, AIF

Friday, January 02, 2009

Swedroe:Lessons the Market Taught Us in 2008

Swedroe presents 16 lessons that we learned from 2008, a great read.

Scott Dauenhauer CFP, MSFP, AIF

Ben Stein: They Told Me That Madoff Never Lost Money

"I have never heard of an entity that could make money in all kinds of markets consistently, year in and year out. Yet we continue to believe that there will be one. It is, like much else in finance, a myth that will not die. I have never heard of a financial manager who promised to be able to defeat the markets anytime he chose and who, in fact, was able to do so. Even Mr. Buffett says repeatedly that he will have losing years and losing stretches of years. (Wow, is he right this year.)"

If its sounds to good to be true, it is. Lots of money was lost because people believed something they knew was not possible, but hoped for their sake it was. Interestingly enough, many of those who lost money never needed to take on such risk, they were wealthy and even investing their money in a low risk, low interest investment would have yielded them more money than they ever could have spent - they violated the first rule of investing - never put at risk anymore than you NEED in order to meet your goals. Some people must invest in stocks - it is there only hope, others don't need to take any risk.

Scott Dauenhauer CFP, MSFP, AIF

Hulbert: 2008 By The Numbers

Article Link

According to Hulbert, history suggests that stocks will be up in 2009.....or down. He says "Try as I might to find year-to-year patterns in the data, I came up empty: Whether or not the Dow gains or loses in a given year has little to do with whether it gained or lost in the previous year.

In other words, the stock market sometimes does bounce back after having a bad year. But on other occasions it continues to go down.

Consider 1908 -- the year after the Dow lost 37.7% -- when it gained 46.6%.
Not bad.

But before you get too excited, consider how the Dow did in 1932, the year following its 53.7% loss in 1931. In 1932, the Dow lost an additional 23.1%."

So there you have it, my prediction for 2009 - stocks will either be up......or down.

Please don't think I'm being flippant, this has been my prediction for at least the last eight years. Those who claim to know where the market is going are fools, if anything 2008 has proved this to be true. There is one true test of an economic forecaster - his/her balance sheet - if they can't produce one that shows they are multi-billionaire's they don't know what the market will do. If you knew what the market was going to do and had confidence in that prediction you would be enormously rich very quickly - I've come across zero economists (even the Doomsayers of the last 18 months) who have an enormous balance sheet - thus my conclusion is that the markets cannot be predicted with any accuracy.

Scott Dauenhauer CFP, MSFP, AIF