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- THE FRIDAY LETTER -
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for friends and subscribers)
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| http://www.gilder.com/ | Issue 356.0/September
19, 2008
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HEADLINES:
- The Week / Kessler: Lehman =
Pan Am
- Friday Feature / Rutledge: Fed
Reveals Heart of the Problem
- Friday Blogger Bonus / Wesbury &
Stein: Don’t Worry
- Readings /
The
Week /
Lehman = Pan Am
ANDY KESSLER, Forbes.com (9/15/08): Not to sound harsh, but Lehman Brothers reminds me of Pan Am
Airlines. No one (well, beyond their employees) is going to miss them.
There are plenty of others to take their place.
In
the '70s and '80s, a deregulated airline industry grew beyond its means, was
stuck with bad assets, prices dropped and consolidation became inevitable. Pan
Am was an early innovator, flying seaplanes into previously unreachable
Caribbean Islands. They eventually flew everywhere, competed with everyone,
stretched their balance sheet so it was as inedible as the mystery meat they
served on flights and then one day went ... Poof!
Analogies
only go so far, but Wall Street got caught in the same wringer. Deregulated
since 1975, balance sheets grew and grew as money got thrown at the profitable
business of trading stocks and bonds, investment banking and money management.
In the cheap-money period of 2002 to 2007, Wall Street’s thirst for capital saw
no limits.
Inevitably,
too many players and a bit of technology in the form of electronic trading
squeezed the profitability of Wall Streets bread-and-butter businesses.
Wall
Street will always be in the compensation game. Half of revenues are set aside
for employee salaries and bonuses. But at the end of the day, Wall Street is
like every other business: It has to generate a return on capital. With profits
fading in baseline businesses, firms discovered the trick of using their huge
capital to borrow short term cheaply and lend long in the form of subprime
mortgages.
Traditional
banks can get away with this because they borrow short term from their
depositors, who are usually loyal and lazy, happy to keep their money in the
bank, under-earning, in exchange for perks like free checking and ubiquitous
ATM machines.
Investment
banks have no such luxury of stupid people to borrow from. Instead, they borrow
from one another and from institutional investors: all short-term paper. When
the subprime "easy money" loans turned toxic, the short-term
facilities fled for safer ground. Hence the flushing sound you are hearing all
over Wall Street.
So
now Wall Street consolidates. Should you care? Not even for an instant. I spent
20+ years on Wall Street, competing against scores and scores of firms, always
wondering what they all really did. E.F. Hutton. Shearson, Drexel. Heck, I even
worked for PaineWebber in my early days (daze?) on the Street. All gone. And
nobody misses them.
The
true money-makers all find jobs elsewhere. The worker bees in the middle tier
see disruption, but are eventually absorbed into the reconstructed Wall Street.
The bottom tier goes to work at Foot
Locker.
So
no crocodile tears for Lehman or Bear Stearns or anyone else. It's just a name
on the door. Wall Street will soon (hurry up, dammit!) rid themselves of the
mad-cow-infested subprime loans and won't dabble in mortgages ever again or in
five years, whichever comes first.
And
finally, Wall Street will go back to basics, helping allocate capital to growth
industries around the world and charging un-modest fees for services rendered,
keeping half for themselves. And someone else will take Pan Am's ... I mean
Lehman's ... slots.
More from Andy Kessler:
http://www.andykessler.com/andy_kessler/2008/09/forbescom---lehman-pan-am.html
|
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Friday Feature / Fed Meeting Reveals the
Heart of the Problem
DR. JOHN RUTLEDGE blog (9/16/08):
The
Fed’s announcement after yesterday’s FOMC meeting reveals that they are
completely out of touch with reality. Their actions since March have
significantly worsened the financial crisis. They still don’t get it.
As
I have been screaming for a year, the U.S. crisis is a capital market event,
not a GDP or CPI event. Investors lost confidence that they were able to
understand the cash flows they would receive as security owners. They simply
refused to own bonds, which shut down the mortgage market. The capital market
has been frozen like a fly in amber, with prices no longer a reflection of the
value of the underlying cash flow streams.
The
job of policy makers in this case is to fix the capital market problem and end
the blackout before it infects the GDP economy. That means providing clarity
and visibility over after-tax returns and it means providing adequate liquidity
until markets open again.
They
botched the job.
Congress
and the administration were distracted by the stimulus package they hastily
slapped together last spring. Sending checks to mailboxes is straight out of
the textbook–the wrong textbook. It is designed to deal with a spending
problem, not a capital market blackout. Spending has never been the problem.
Now Congress is talking about doing another round of the same stuff. Great
short-term politics. Terrible economics.
The
Fed’s job is to provide liquidity. Instead, they diverted their energies to
propping up troubled banks and investment banks by extending massive loans to
institutions that were never eligible before. At the same time, they adopted
procedures to sterilize the resulting reserve increases by selling
T-bills in the open market to suck the additional reserves back out of the
market. The net result was simply to shift bank reserves from healthy banks who
were making loans to their customers to the sick ones. Total reserves did not
go up at all. The monetary base has not grown in the past year. The Fed’s
balance sheet has imploded.
The
upshot of all this is the Fed has provided no liquidity whatsoever and
we have had one crisis after another.
The
FOMC statement today, in writing about the balanced risks of growth
and inflation shows they do not have a clue what is wrong with the system. The
Fed does not print oil and should not chase growth-induced commodity price
swings up and down with monetary policy. We don’t have an inflation–housing
prices–the largest asset class for every American family–are still falling.
It is time for the Fed to wake up and stabilize the capital markets.
And
will somebody please tell the candidates and members of Congress that this is
not a good time to talk about increasing tax rates on capital gains, on
dividends, or on income.
Respond to
John’s blog:
http://rutledgecapital.com/rutledgeblog/
__________________________________________
Friday Blogger Bonus / Don’t Worry
Brian
Wesbury & Bob Stein, Forbes.com (9/15/08): There is not enough room on page
one of the nation's newspapers for all of this week's news. Any of the major
business stories--the Lehman bankruptcy, a sale of Merrill Lynch, AIG capital
needs, plummeting oil prices or new Fed lending facilities--could be
above-the-fold headline news.
The
U.S. is moving through its deepest set of financial market difficulties since
the banking and savings and loan crises of the 1980s and 1990s.
The
key thing to remember here is that the emphasis belongs on the word financial.
The economy is not the problem; lousy lending standards and the excessive use
of leverage are the problem. Gales of punitive destruction are knocking down
one investment bank after another, while gales of creative destruction continue
to move the economy forward. In fact, real gross domestic product (GDP) has
grown 2.2% in the past year and accelerated to a 3.3% growth rate in the second
quarter.
As
in the 1980s and 1990s, the roots of our current financial market problems reach
back to a period of absurdly low interest rates. In the 1970s, when the Fed
held interest rates too low for too long, banks made similar mistakes with
their balance sheets--borrowing at short-term rates to make longer-term loans
in inflation-sensitive assets.
In
this decade, by cutting interest rates to 1%, the Fed caused investment banks
to overuse leverage-based strategies. Borrowing short and lending long turned
so lucrative that many financial market players could not help themselves. Wall
Street based its business model on leveraging up the most leveraged asset on
Main Street--housing.
When
the Fed pushes interest rates below their "natural" level, mal-investment
always occurs. And in the current case, the mal-investment was a double whammy.
Not only did Main Street gorge on real estate, but Wall Street ate it up too.
This double set of leverage has blown up because the housing market became
overbuilt and housing prices stopped rising.
Mark-to-market
accounting exaggerated this process by allowing firms to mark up assets above
true fundamental value when the market was strong but is now forcing firms to
mark down assets, to below true fundamental economic value.
The
good news is that this financial hurricane is unlikely to change the economic climate.
The bad loans made earlier this decade did not create a widespread economic
boom, and the realization of how bad some of these loans are will not create an
economic bust…
Read
on:
http://www.forbes.com/opinions/2008/09/15/banks-economy-fed-oped-cx_bw_bs_0915wesburystein.html
__________________________________________
Readings /
Players Remake Financial World
http://online.wsj.com/article/SB122177811990254369.html
Nvidia
to Slash 6.5% of Workforce
http://www.forbes.com/technology/2008/09/18/nvidia-chips-layoff-tech-enter-cx_bc_0918nvidia.html
The
Best Stocks to Buy Now
http://online.wsj.com/article/SB122176122427553155.html
Thinking
Through the Turmoil
http://www.forbes.com/wallstreet/2008/09/18/investing-wall-street-biz-wall-cx_mm_0918roundtable.html
3D Solar Cells Made Out of Carbon Nanotubes
http://blogs.spectrum.ieee.org/tech_talk/2008/09/threedimensional_solar_cells_m.html
Is
Apple’s Success Luck or Skill
http://news.cnet.com/8301-13506_3-10045516-17.html?part=rss
__________________________________________
Friday Letter Editor: Mary Collins George / mcollins@gilder.com
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