Will The Dollar Collapse?

A friend of mine who lives in Zurich sent me this article and asked about my opinion of this gloomy scenario:

http://www.swissinfo.ch/eng/business/Dollar_faces_collapse.html?cid=30012940

Here is my response:

I don’t think the dollar will collapse or stop becoming the reserve currency.

It isn’t unprecedented for a first world country to have such a high level of debt during time of war, or when preventing a depression / severe recession. The U.S. is doing both.

Under these conditions, there has never been a default as long as:

1. the currency is not backed by gold,

2) a lot of the debt is held outside the country.

Also, a bubble occurs when most people think there is no problem. Right now, everyone worries that the U.S. has a debt problem – including the government. That is a bullish sign. So, I think that the debt will be eased off. Eventually the dollar will strengthen.

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Keep Investing Simple, Simple, Simple

I've been reading three interesting books on the demise of the Wall Street firms of Bear Stearns and Lehman Brothers.

I'll review the books more specifically in separate posts, but I'm motivated to point out that the biggest folly of these firms was to over-complicate investing and trading.

For example, one of the final straws for Bear was having to bail out its own sub-prime hedge funds. These hedge funds blew out because they loaded up (with leverage) on complex, illiquid products derived from mortgages. They used the products as collateral to borrow money from banks so they could keep buying.

Even with this use of leverage and sophisticated products, they were making 9 and 10% returns at the time I was making 12, 15, and 22% returns using my Stock Trading Riches system.

I was doing better than them, and I was using plain old liquid stocks and no leverage. They are using crazy securities invented by "rocket scientists"and using 40 to 1 leverage!

It goes to show that you should never underestimate simplicity.

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Interesting Article on Citigroup CEO Vikram Pandit

New York Magazine has an article on Vikram Pandit, and mentions a bit about Citigroup and the financial crisis.

This quote from page 5 of the article (mentioning Citigroup’s Sandy Weill and Clinton’s Treasury Secretary Robert Rubin) is a good example of the marriage of politics and finance that got us into this mess:

Rubin and Weill had been friends since the late nineties, when Rubin served in the Clinton administration. It was Rubin who helped push through the Gramm-Leach-Bliley Act that effectively allowed the merger of Travelers and Citicorp. A year later, Weill made Rubin a board member at the company he helped create, paying him a salary of $17 million a year.

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David Einhorn Thinks The U.S. Debt Will Be Our Problem - Not Grand Kids

It's become a cliche that our government debt will be a legacy that future generations have to repay.

However, David Einhorn, of Greenlight Capital, made a speech saying that our future generations can rest easy.  The explosion in government spending during the last few years means that WE will end up paying for it.

In his insightful speech, Einhorn lays out how last year's "stimulus" wasn't really a stimulus because, rather than being a one-shot boost to the economy, it permanently increased government base-line spending and created / preserved government jobs.

The speech details how official government statistics are manipulated and understate inflation. 

The Fed has us on a cycle -  going from one bubble to bailout to next bubble.

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Goldman Sachs Cartoon

A friend sent me this cartoon from Casey Research (http://www.caseyresearch.com/images/1272369060-GS-2GSD.jpg).

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$100 Million Payday for Energy Trader?

Andrew J. Hall is the head of a small trading company called Philbro. He made a lot of money for Citigroup and now his contract calls for a nine figure bonus.

The problems are:

1. Will the government allow it? They probably will because it is well-documented in his contract.

2. If they pay the bonus, Citigroup may experience a public backlash.

3. If they don't pay the bonus, other companies will be happy to hire him.

I think this situation shows the complications and problems that arise when government gets too involved in business.

Citibank is at a big disadvantage with the government having a veto power over their bonuses. Other companies are already trying to lure away Citigroup's superstars.

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Recession Postponing Divorces

A lot of divorcing couples are having to find creative ways to live together until the economy improves.

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Good Article on Banks and TARP (Bailout) Money

Zackstocks has a good explanation about the latest idea of converting TARP loans to common equity.

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Finally, an understandable explanation of derivative markets

Heidi is the proprietor of a bar in Detroit. In order to increase sales, she decides to allow her loyal customers - most of whom are unemployed alcoholics - to drink now but pay later. She keeps track of the drinks consumed on a ledger (thereby granting the customers loans).

Word gets around about Heidi's drink now pay later marketing strategy and as a result, increasing numbers of customers flood into Heidi's bar and soon she has the largest sale volume for any bar in Detroit. By providing her customers' freedom from immediate payment demands, Heidi gets no resistance when she substantially increases her prices for wine and beer, the most consumed beverages. Her sales volume increases massively.

A young and dynamic vice-president at the local bank recognizes these customer debts as valuable future assets and increases Heidi's borrowing limit. He sees no reason for undue concern since he has the debts of the alcoholics as collateral.

At the bank's corporate headquarters, expert traders transform these customer loans into DRINKBONDS, ALKIBONDS and PUKEBONDS. These securities are then traded on security markets worldwide.

Naive investors don't really understand the securities being sold to them as AAA secured bonds are really the debts of unemployed alcoholics. Nevertheless, their prices continuously climb, and the securities become the top-selling items for some of the nation's leading brokerage houses who collect enormous fees on their sales, pay extravagant bonuses to their sales force, and who in turn purchase exotic sports cars and multimillion dollar condominiums.

One day, although the bond prices are still climbing, a risk manager at the bank (subsequently fired due to his negativity), decides that the time has come to demand payment on the debts incurred by the drinkers at Heidi's bar.

Heidi demands payment from her alcoholic patrons, but being unemployed they cannot pay back their drinking debts. Therefore, Heidi cannot fulfill her loan obligations and claims bankruptcy. DRINKBOND and ALKIBOND drop in price by 90 %. PUKEBOND performs better, stabilizing in price after dropping by 80 %. The decreased bond asset value destroys the banks liquidity and prevents it from issuing new loans.

The suppliers of Heidi's bar, having granted her generous payment extensions and having invested in the securities are faced with writing off her debt and losing over 80% on her bonds. Her wine supplier claims bankruptcy, her beer supplier is taken over by a competitor, who immediately closes the local plant and lays off 50 workers.

The bank and brokerage houses are saved by the Government following dramatic round-the-clock negotiations by leaders from both political parties. The funds required for this bailout are obtained by a tax levied on employed middle-class non-drinkers.

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Nassim Nicholas Taleb, Financial Risk, and Black Swans

The February 2 issue of Forbes featured an article on Nassim Nicholas Taleb, the "Oracle of Doom" who wrote the best selling books "Fooled by Randomness" and "The Black Swan: The Impact of the Highly Improbable".

For years, he has been warning that the world is like the titanic - "sailing at night in iceberg-strewn waters, just a few feet from diaster."

Taleb, an options trader, complains that the financial crisis was caused because Wall Street "is in the business of hiding risk, and greatly underestimates the probability of outsize moves."

The name of the book, "Black Swan", comes from the fact that Europeans had only ever seen white swans - until black swans were found in Australia.

Besides Wall Street, Taleb also blames economists who were "overconfident" that their risk control models falsely showed that banks were profitable and in control.

He is a big believer in "fat tails" - or the idea that events predicted with low probability under the standard bell curve, actually occur more frequently.

As an investor, for both his personal account and his hedge fund, Taleb puts most of his money in Treasurys, and uses the rest to bet on volatility with options. He sells options that pay off with moderate volatility, and buys options that pay off with high volatility.

This strategy "has delivered a string of mediocre results interrupted occasionally with spectacular years" like 2008. He told Forbes that he personally took home "in the low eight figures" last year.

Taleb has been criticized for giving general warnings of doom, but no details about what to do. In response, he offers these suggestions for reforming the system:

1. Complex derivatives (like swaps) should be banned because they are tools for hiding risk.

2. There should be a two-tier financial system. Banks that might need to be bailed out someday should be treated like utilities, and only allowed to invest in simple stuff. Hedge funds that invest with private money could so more sophisticated investing, but with the knowledge that they will never be bailed out.

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Don't Be Too Pessimistic About the Financial Crisis

"The most dangerous words in investing are: 'This time it's different.'"

- the late John Templeton

Usually, investors are warned against excessive optimism during bull markets, but Forbes publisher Rich Karlgaard recently had a column where he cautioned against excess pessimism in bear markets.

He went on to write about 1975. At that time, even Berkshire Hathaway stock had been cut in half. New York City was almost bankrupt, and the mood was extremely pessimistic.

As we all know, New York City and Warren Buffett recovered just fine.

Then, as a further mood lifter, Karlgaard mentioned a long list of successful companies that were started during hard economic times:

1. General Electric - one year before the Panic of 1893

2. Disney - the recession of 1923-24

3. Hewlett-Packard - 1939

4. Hyatt - the recession of 1957-58

5. Intel - 1968 (year of assassinations and political upheaval)

6. FedEx - launched during the Arab oil embargo of 1973

7. Microsoft - 1975

8. Apple and Genentech - 1976

9. Wikipedia - 2001

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Seychelles: Tropical Paradise Files Bankruptcy

The Seychelles Islands, the Indian Ocean archipelago off the African coast, filed for bankruptcy.

Long the playground of the rich and famous, the Seychelles' private and public debt total $800 million - the size of its whole economy. With a population of just 87,000 people, the Islands might now be the most indebted country on earth.

The country got into trouble due to decreased fishing and tourism revenue. Last year, the islands defaulted on a $230 million euro-dominated bond arranged through Lehman Brothers (before its collapse).

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Bank Bailout Not Working

If they actually did think that the bailout was meant to help, I hope they now realize it is a waste of money.  I think the government will have to bite the bullet and acquire Citigroup (and maybe BofA), restructure and break it up, wipe out the shareholders, and make the bond holders whole.  Then, sell the restructured companies back to the public. From yesterday's Washington Post: Shares of Citigroup stock peaked in 2006 at $55.70, which gave the company a market capitalization (price of stock times number of outstanding shares), or value, of $277.2 billion. Today, Citigroup's market cap is $5 billion. But keep in mind that the federal government has already plowed $45 billion into Citigroup, which means the company is worth far less than the actual amount of cash it has received. Astounding. The bank has become a black hole. Cash goes in and never comes out. Citigroup and Bank of America are deemed by most analysts as being the sickest of the big banks -- the ones whose balance sheets are most poisoned by toxic assets.

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Are We Heading For A Depression?

Yesterday, I came across a very interesting blog called MikeKane2008. It was started in January of last year, and ended in December.

The author, Mike Kane, is basically one of those who feels we are on the verge of a serious depression. Like James Sloman, he feels that the global derivative bubble reached around $1 quadrillion at its peak. This is $1,000 trillion - which means (according to Sloman) that the bailouts are "like trying to put out a fire with a teaspoon of water."

It's interesting because he also thinks like I do - that bailing out the banks is a waste of time and money. Something must be done about the debt that is at the bottom of this mess.

Mike's solution, however, is radical. He quotes from the Bible, Deuteronomy 15: 1-11

At the end of every seventh year, cancel all debts. This is the procedure: Everyone who has lent money to a neighbor writes it off. You must not press your neighbor or his brother for payment: All-Debts-Are-Canceled—God say so...

Mike thinks the only solution to prevent a chaotic collapse is for ALL debt in the world to be forgiven, to give the global economy a fresh start.

My solution was requiring as many mortgages in danger of failure to be refinanced into longer terms - as much as 50, 60, or even 100 years - to make payments affordable.

Chances are, most of these long term mortgages will end up being paid off sometime in the next 20 years anyway.

As far as depressions go, I'm still cautiously optimistic that we will avoid one, but I am not as confident as I was maybe a few weeks ago. For now, I just want to hunker down, hold on to my job, and stick with my Stock Trading Riches system, because it wins through defense and feeds off down markets.

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Wayne Allen Root's Economic Stimulus Plan

Robert Ringer included a guest post from Wayne Allen Root, last year's Libertarian vice presidential candidate.

The post highlights what Root would do about the economy:

1. One year income tax vacation for all Americans.

2. Phasing out capital gains taxes over a 5 year holding period.

3. No taxes on capital gains, interest, and dividends for Americans over 55.

4. A business tax cut.

5. No taxes on the sale of one's principal residence.

6. $7500 tax credit for employers who hire a worker.

7. After the tax vacation, institute a reverse flat tax.

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Simple, Elegant Solution to the Mortgage Crisis?

So far, throwing billions of dollars at major banks like Citigroup does not seem to be working.

This is because mortgages are continuing to default, causing the bank's mortgage backed derivatives to deteriorate further.

I wonder if we can't solve this problem elegantly, without spending any more money.

Why can't the government stop foreclosures by requiring the banks to rework mortgages with variable terms?

A variable-rate mortgage is where the rates change, depending on the interest rate.

Instead, why can't the banks work with individual homeowners and simply change the terms until they reduce the monthly payment to something the homeowner can afford?

For example, change the term from 30 years to 40, 50, 60. Heck, even go out to 100 year mortgages in some cases, if needed.

You could argue that the homeowner would not live long enough to pay off a 100 year mortgage, but the point is this would be a mathematical abstraction to keep the homeowner in the house, and stabilize the mortgages underlying the derivatives.

Chances are, these long term mortgages, like all mortgages, will end up getting paid off within 20 years when the owners refinance or move.

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How To Understand The Stimulus Bill

Shortly after class, an economics student approaches his economics professor and says, "I don't understand this stimulus bill. Can you explain it to me?"        the professor replied, "I don't have any time to explain it at my office, but if you come over to my house on Saturday and help me with my weekend project, I'll be glad to explain it to you." The student agreed.        at the agreed-upon time, the student showed up at the professor's house. The professor stated that the weekend project involved his backyard pool.        They both went out back to the pool, and the professor handed the student a bucket. Demonstrating with his own bucket, the professor said, "First, go over to the deep end, and fill your bucket with as much water as you can." The student did as he was instructed.        The professor then continued, "Follow me over to the shallow end, and then dump all the water from your bucket into it." The student was naturally confused, but did as he was told.        The professor then explained they were going to do this many more times, and began walking back to the deep end of the pool.        The confused student asked, "Excuse me, but why are we doing this?"        The professor matter-of-factly stated that he was trying to make the shallow end much deeper.        The student didn't think the economics professor was serious, but figured that he would find out the real story soon enough.        However, after the 6th trip between the shallow end and the deep end, the student began to become worried that his economics professor had gone mad. The student finally replied, "All we're doing is wasting valuable time and effort on unproductive pursuits. Even worse, when this process is all over, everything will be at the same level it was before, so all you'll really have accomplished is the destruction of what could have been truly productive action!"        The professor put down his bucket and replied with a smile, "Congratulations. You now understand the stimulus bill."

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Citigroup Not Purchasing New Corporate Jet...

…after criticism from the Obama administration said that such jets aren't "the best use of money at this point"…

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John Thain is getting Subpeonaed in NY about the billions in bonuses Merril Lynch paid out before Bank of america got its latest bailout...

http://www.charlotteobserver.com/597/story/499083.html

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How To Understand A Trillion Dollars Deficit

I like this Time article, especially the example with seconds. It really shows the magnitude difference between a million, billion, and trillion: 1 million seconds = 11.5 days 1 billion seconds = 32 years 1 trillion seconds = 32,000 years

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