Good Articles

http://blogs.wsj.com/economics/2008/10/29/many-homeowners-think-theyre-immune-to-price-declines/

http://online.wsj.com/article/SB122533157015082889.html

Investing Attitude

The general attitude among many asset managers right now is:

There are opportunities right now, but let's hold off, because there may be more among the future.

Mohammed El-Arian:

The focus on investing now is that you want to focus on the opportunities that have tremendous mean reversion potential, since some asset classes may not mean revert for quite a long time. The system has quite literally broken down. The burden of proof is higher than simply looking at a company's P/E ratio and saying 'this looks low historically, let's buy it.'

He predicts there will be some more institutional failures within the next couple months.

Countervailing Factors to a Deep Recession

Barron's wrote an article (due to be published tomorrow) proclaiming that the recession everybody is anticipating won't be as bad as many in the media think.

Here is the article.

Update this post after reading/thinking about it.

• The main gist of the article is that decreased oil prices will lead to a spur in consumer spending. The question to ask is: Of the average consumer, what percentage of their consumption is devoted to gas/electric bills/goods whose prices fluctuate heavily due to energy costs? How much MORE money would the average consumer spend on goods, ceterus paribus, given its fall since July from ~$147/barrel to new lows of below $70/barrel?
• The author posits that oil at $80/barrel would induce $170 billion in energy savings over 6 months if it held at that level. Assuming half is spent in Q4 2008 and the other half in Q1 2009, the boost to annual spending would be 3.5% in each period. However the author notes that much of this boost would be counteracted by decreased home values and possible decreased stock prices. Overall, GDP will increase slightly according to the author.
  
• Here are his official reasons for hope:

1. Starting in the current quarter, consumer spending (70% of GDP) is likely to post gains, bolstered by lower energy prices.
2. Inventory-to-sales ratios are low. Retailers won't be stuck with a glut of unsold inventory (which would further drag down growth) and may even choose to rebuild inventory next year if the economy grows sufficiently.
3. Capital spending was subdued during the recent expansion, leaving no need to work off excess industrial capacity.
   
4. Net exports will increase growth very slightly.

Here is another article in Barron's with the 'con' point of view.

Parting Words From A Hedge Fund Manager

This made me laugh.

Here is the full letter.

Whether his views are right or wrong, he is at least honest. Then again, he can afford to be. There is definitely something to be said for actually enjoying life rather than trying to egotistically inflate one's self-image through money, women, achievements, etc. If those occur coincidentally with the enjoyment, so be it. But when they become the purpose in and of themselves... a hollowness sets in. At least, that has been my experience.

Research This

http://www.youtube.com/watch?v=-NSk_ZeAH_I


Interesting speech by Noam Chomsky.

Research:

- What is the history of R&D funding in the US? Is most of the private sector's progress driven by public sector research, as Chomsky posits? I know that productivity is the key driver of economic growth, and productivity is in turn largely driven by scientific research and advancement. Thus, this is a crucial issue to consider when deciding on how big a role the state should play in the economy.

- Another thought I had while watching the speech. What is the relationship between a nation's increased economic wealth and its level of ethics/values/morality? Is morality an economic luxury?

- Learn about Chomsky's propaganda model. Read the manufacture of consent.

The Fallacy of 'Wages Haven't Risen'

If you read the newspaper at all or listen to political speeches, one pseudo-statistic is quoted with such high frequency that you may need to wear ear muffs before your brain starts to bleed. It goes something like this:

"Over the past 8 years, the average American worker has not had any wage increases. Combined with the soaring cost of health care, most people now feel that they are worse off than they were 8 years ago."

Now hold on a second. Let's assume that most health care is employer provided. Employer provided health care is a sort of economic appendix; it arose in the Great Depression when FDR put wage caps on what companies could pay their employees. To get around these wage caps, companies paid their employees in non-direct ways, such as healthcare/dental care, retirement packages, paid vacations and so on. Thus, if you want to really find out what a given worker 'makes' in his job, the rational way to do so would be to look at not just his wage, but also the benefits he receives.

According to NCHC.org,

"By several measures, health care spending continues to rise at the fastest rate in our history.

In 2007, total national health expenditures were expected to rise 6.9 percent — two times the rate of inflation.¹ Total spending was $2.3 TRILLION in 2007, or $7600 per person. Total health care spending represented 16 percent of the gross domestic product (GDP).

U.S. health care spending is expected to increase at similar levels for the next decade reaching $4.2 TRILLION in 2016, or 20 percent of GDP.

In 2007, employer health insurance premiums increased by 6.1 percent - two times the rate of inflation. The annual premium for an employer health plan covering a family of four averaged nearly $12,100. The annual premium for single coverage averaged over $4,400.^"

My hypothesis (I haven't done any econometric analysis or read any rigorous papers on the topic) is that wages HAVE risen; the rise just hasn't been reflected in dollars per hour. Wages have risen in the sense that employers are now paying more and more for their workers to access a higher quality of health care. I'd like to see if I'm right about this, and if so, what the magnitude of the effect is.

Mr. Market's Gone Schizo

Benjamin Graham must be chuckling in his grave. Believers in semi-strong and strong efficient markets must be rationalizing away. We have witnessed some of the largest inter and intra-day pricing movements in history, violent waves on the surface of the economic ocean, yet as is often the case with short term price movements, the prices (perceptions of the fundamentals set on the margin by fearful/greedy investors) and the fundamentals (the actual reality of the economy) are completely out of proportion. Problems can emerge when the perception of reality affects reality itself, when irrational price change behavior starts to influence economic decision making, but that is a different topic for a different post.

The core issue of this financial crisis is housing prices. The structure of assets that many financial institutions have on their books can be thought of as a huge bet that housing prices in the US would continue to rise or, if they fell, the fall would be shallow at worst. This has obviously not been the case. Witness the Case-Shiller index data on housing prices:

http://www2.standardandpoors.com/portal/site/sp/en/us/page.topic/indices_csmahp/0,0,0,0,0,0,0,0,0,1,1,0,0,0,0,0.html

The most recent data available is for July 2008; using a CPI-esque methodology to measure home prices, the index assigns a value of 100.0 to prices on January 2000. Prior to January 2000, prices slowly rose through the years through a combination of inflation and perhaps a bit of real appreciation as the US economy (and hence the assets within the economy) gained in value. However, it would take a retardedly high amount of economic growth coupled with inflation to justify the extreme price movements we witnessed over the last half decade. Consider...

From January 2000 to July 2006, the ENTIRE NATION's houses more than doubled in value on an aggregate basis. The index went from 100.0 on January 2000 to 206.52 in July 2006. That's a bubble if I've ever seen one! Now consider that many of our financial institutions own assets whose value depends largely on housing prices keeping or continuing to rise in value. NOW consider that they levered up these assets to really high amounts. Bear Stearns had a leverage ratio of 33:1. When house prices were increasing and mortgages could be repackaged and sold abroad easily, this meant massive profits for investment bankers and massive amounts of resources in our economy diverted to more housing production. Witness the huge amounts of empty condominiums and "for sale" signs in many of our metropolises Enough about that though, let's look at where we are today and where we may be going.

As of July 2008, the Case-Shiller index has a value of 166.23. Let's be quite generous and assume that the fair market value of these houses on an aggregate basis is 115.0, despite the massive amounts of new home construction (find out how much new construction) which may have sent home prices below 100.0 And let's also assume that housing prices won't overshoot on the downside (as so often happens when a bubble turns into a crash). What does this mean?

Housing prices still need to fall by about 30% from their current levels just to reach fair market value with very generous assumptions. This means that the toxic mortgage assets banks hold on their books will only become more toxic as housing prices continue to fall. Combined with the insane level of leverage banks used to purchase these assets... it's no wonder that Paulson and Bernanke are asking for huge sums of money to recapitalize our financial institutions. Because while bailing these institutions out is deplorable and has huge opportunity costs (think of all the children who could be given health insurance with $700 billion), having our banking system fail would be even worse. Businesses would not be able to expand (or in some credit-hungry industries, operate at all...), people would not be able to take out loans, economic activity as we know it would slow tremendously and a repeat of the 1930s could very easily set in. The natural human reactions of fear, xenophobia, and political upheaval would rear their heads and it would be an ugly situation.

The national media has a rather limited attention span, and I haven't seen too many people who really grasp the 'big picture' of what's really going on in the financial press, the way that home prices have driven this entire crisis. It's euphoria one day and panic the next. If any of the few people who might stumble across this could point me to someone who really 'gets it', please let me know.

Given:

• Consumer confidence is so highly driven by house prices (when peoples' home values go up, they 'feel richer' and spend more)
  
• House prices are downward sticky (people are extremely reluctant to sell their home for less than they bought it)
• The large amount of debt the average American consumer has already accumulated through reckless spending combined with the consequent tightening of credit (insert data here about average consumer's debt)
  
• The fall that still needs to occur in housing prices
• The large decline in consumer spending, which constitutes 70% of our GDP, that will occur as a result of the above
  

We may be in for a long and nasty recession. The problem could be compounded if President Obama (yes, he will be president) over-regulates the economy and raises taxes too much. I think a tax increase is needed and obviously more regulation is needed in the financial sector, especially with regards to accounting transparency, but the temptation exists to go too far in the direction of higher taxes and more regulation, which would only add fuel to the recessionary fire.

On the bright side, this means if you have a lot of cash, there exists a tremendous potential for profit by buying cheap companies which will only become cheaper and undervalued as our economy deteriorates.