Friday, January 25, 2008

Tax Rebate Blues

Today the government announced that people will be getting tax rebates. Unfortunately (fortunately?) my wife and I make too much to get one. It's kind of funny because we don't make that much more than the limit and we live in one of the most expensive cities in the world (NYC). A couple making a combined $190k in Peoria, IL is probably a LOT "wealthier" than a couple making that much in New York City. I think there should be some kind of a cost of living adjustment depending on where you live for rebates like this, as well as for things like the limits on Roth IRAs.

I know you're all getting out your "world's tiniest violins" and saying "cry me a river." I hear ya. I realize we're lucky to make as much as we do. Although, I worked 15 hours today so I wouldn't say its all luck. Would you?

Wednesday, January 23, 2008

Diamond Ring Rebate

Did you buy a diamond ring or other diamond jewelry somewhere in the 1994-2006 timeframe? (I did- got engaged during this period). Well, you may be eligible to receive a rebate from DeBeers, which recently settled a class-action lawsuit.

Just wanted to pass that along. I know a few bloggers and readers of this blog may have gotten married during that period. You might only get 50 cents, or you might get $200 from what I've been hearing. It's at least worth going to the website and filing your claim.

Fed Rate Cut

So we just got an intra-meeting 75 basis point cut. I guess the Fed's job is to prop up the stock market now. I'm not a huge economics expert, nor do I really care one way or the other what the Fed does with rates at the moment. However, it looks pretty obvious that the move was done due to declines in global stock markets and a desire to prevent such declines in the US.

Monday, January 21, 2008

Best Place to Park Cash

By the way, I've been looking around for a while now, and currently I think my best option for investing short-term cash is the ING Direct Electric Orange checking account. If you'll recall, when I first got the opportunity to open one of these accounts I declined , but later, I decided to go for it.I'm getting a 4.9% APY since my balance is at least $100,000 and I haven't seen any rates out there that beat it. I did recently sign up for an Emigrant Direct account because I know their rates have been higher than ING Direct's saving account rates at different times in the past. However, since I have so much cash right now (relatively speaking, for me), the rate ING offers me is better than my alternatives so I haven't put anything into Emigrant yet. When I do eventually buy a house, I won't qualify for the higher rate at ING Direct and I will have to evaluate which of the two make more sense for me at that time.

Anyone see anything that beats 4.9%? I've seen some CDs yielding a bit higher at some smaller online banks, but I'm not too interested in opening up a bunch of different accounts just to chase a tiny bit of yield.

401(k) In the Red

I have to admit, it's a strange experience to log in and see my 401(k) balance squarely in the red. My total portfolio has lost 9.6% of its value sofar this year, with my small-cap funds (13% of my current balance) down about 14%, my index fund (60% of my current balance) down 9.5%, my international funds down about 7% and my fixed income fund (3% of my current balance) up .3%.

Everything is down except for my fixed income fund. If you recall from my 2006 year in review, I historically haven't even had any fixed income allocation in my retirement account. However, I added some in '06, my reasoning being that "I decided to put a small amount of my retirement money in a fixed income fund purely for the sake of diversification so that in the years when equities are in the red (and I know these years are coming!), I will be able to look at my portfolio and see that at least one of my investments is up. The fixed income fund underperformed my stock investments this year, returning 5%."

I guess that time has come! These days, I almost wish I'd put even more into the fixed income fund back then :)

In a way, I am thoroughly entertained by everything going on in the market right now. It was easy to see we were in the midst of a housing bubble, and it was even easier to see that we were in the midst of a credit bubble. I've written about both over the past few years. For people in my age group, these are the second and third bubbles we've had the fortune of observing (the first being tech stocks in the late 1990s). I guess the moral of the story is that if it seems too good to be true (housing prices increasing 20+% every year, tech stocks increasing 50%+ per year, credit being incredibly easy to obtain), stay away from it. If you time it right in the short term you might do well, but you have to get out at the right time. I don't think anyone out there can time markets successfully on a consistent basis, so you're better off not even trying.

By the way, a brief update on Moody's: the stock is sitting right near a 52 week low just under $34 a share. I don't want to jinx it, but I have been picking some up in my trading account. Remember its extremely risky to put money into individual stocks. I'm only investing an amount I could comfortably lose without losing any sleep. MCO reports earnings in the early part of next month and I anticipate some reaction (positive or negative) to the reported earnings as well as the outlook. If you take a step back from the current environment you'll see a company generating good free cash flow and high margins. As long as it survives the current significant threats, I think the company will continue to show great returns and hopefully the market will reward this.

Wednesday, January 16, 2008

Finding Bargains in Your Shopping Cart

I buy a ton of stuff off of I've been using the site for about 10 years now and bought everything from books (my first purchase was "The Intelligent Investor" by Ben Graham) to socks, to toys and many things in between. I have an credit card and it gives me extra reward points when I shop on the site.

Anyway, I started noticing something about a year ago. When I added items to my shopping cart but didn't check out, I would come back a few days later and and click on my shopping cart to find a few alerts reading something like:

The price of the book "The Intelligent Investor" has decreased from $13.95 to $9.99 since you added it to your cart.

Basically Amazon keeps a record of the prices of things in your shopping cart and lets you know when they go up and down.

I've found this pretty fascinating from a few different standpoints, the primary one being finding bargains on items that I would like to have, but don't need right away at the prices they're currently listed for. To take advantage of this feature, I add basically anything I might want to my shopping cart, and sign in every now and then to see if anything has been updated. Sometimes the price reductions are so good that they'll convince me to buy the item right away before they get raised again.

It's also interesting to see how much prices actually fluctuate. Over the course of a month, my purely unscientific survey has shown the average item's selling price changes at least twice.

I started noticing this about a year ago, but it might have been happening for a lot longer... not sure if this is something everybody knows about.

One thing I also wonder about is whether or not Amazon lowers prices specifically to get a customer to buy something. For example, maybe they have some software program that checks what items someone has had in their cart for a while, and this triggers them to lower the price a certain amount on certain items as an inducement to make the purchase. I'm sure if they tracked customer responsiveness to price changes like this over time, they could figure out some pretty effective incentives that would drive sales increases.

I'm also curious if Amazon offers different prices to different customers at certain times, though I doubt they can practice much, if any, price discrimination.

Anyway, I guess the takeaway is to play around with this yourself, especially if you use Amazon and haven't already discovered this on your own. Add some items that you might want to buy at lower prices and then just wait for Amazon to make you an offer you would accept. For example, I have a 42 inch LCD tv in my cart right now. If Amazon tells me the price has decreased a few hundred dollars below where it is now, I might consider buying it.

This is basically the same approach I take to investing in individual stocks. I have a list of the companies I want to own, but I wait for the market to offer them to me for the right price before I'm willing to buy. Please note that I stole this approach from Warren Buffett, but he stole it from Ben Graham anyway, so I don't think he will be too angry. (For more reading on this, you might want to learn about who Mr. Market is).

Sunday, January 13, 2008

Moody's Thoughts on the Causes of the Subprime/Credit Crisis

I recently happened upon a paper written by Moody's as part of its "Global Financial Risk Perspectives" series entitled "Archaeology of the Crisis" where the rating agency attempted to "dig a little deeper" to discover the causes of the current credit crisis. It is sort of complex and not aimed at the general investing audience, but I found it to be a pretty interesting read nonetheless. While I know that past results don't predict future performance, I do think you can learn a lot from studying market bubbles/blowups and hopefully avoid finding yourself invested in one in the future.

Moody's basic thought is that the roots of the crisis are deep and entrenched, meaning you can't just pin it on a few little things. It presents a list of seven observations that I'll discuss a little below:

1) Incentive structures in the financial markets are flawed. My read on this was that people working for banks are paid (and paid very well) based on current performance without taking the long-term impact of their decisions into account. Put more simply, people are looking to make a quick buck. Moody's goes into how this applies to traders at investment banks but I'd also note that this applies to people like mortgage originators and real estate brokers. Their commissions are paid when people buy houses. Whether or not the person defaults on a mortgage and loses his/her home down the road does not matter to the broker, so at the height of the real estate bubble, they were just stuffing anyone they could into homes they couldn't afford. The basic short-term nature of incentive structures in the financial markets inevidably introduces more risk into the system.

2) Regulators and policymakers, looking to maximize growth, don't limit banks enough to prevent financial crises. What Moody's seems to be saying here is that bank regulators such as the Federal Reserve could prevent crises by requiring banks to keep much more cash on hand to deal with problems, but then banks wouldn't be able to earn any money. Since policymakers have implicitly agreed that letting banks grow and make money is a good thing, they accept the risk of the occasional crisis.

3) "The mystifying interaction between credit risk and the economic cycle." That's how Moody's third point reads, but I will admit I had a hard time understanding their argument here until I read the next sentence "Another problem is the difficulty of measuring risk over time." I think the crux of this argument is that the people who measure risk (rating agencies, risk management departments at banks etc...) have trouble doing so because their measurements are impacted by the cyclicality of the economy and it is hard to separate structural risk from cyclical risk, because their measurements are based on the current state of the world around them, which may or may not be in the midst of an unrecognized bubble. This is a pretty arcane topic and I might not be reading it right, but let me try giving an example...

In the late 1990s before the equity market bubble burst, people were saying that risk premiums were lower, so stocks were less risky than they have been historically, and their sky-high valuations were therefore justified. These people were having trouble looking at risk from a long run perspective and were just using the results of the current market cycle which led them to believe that the world had somehow changed. It turns out the world hadn't changed, the markets were just coming to the peak of a huge uptick in the cycle. I think the London Business School paper "Global Evidence on the Equity Risk Premium" does a better job of explaining this than I could:

"Over the last decade of the twentieth century, US equity investors more than trebled their initial stake. In real terms, they achieved a total return (capital gain plus reinvested dividends) of 14.2 percent per annum. During the last five years of the 1990s, US equities achieved high returns in every year, varying from a low of twenty-one percent in 1996 to a high of thirty-six percent in 1995. Many investors became convinced that high corporate growth rates could be extrapolated into the indefinite future. With steady growth rates, equity risk appeared lower. Simultaneously, there appeared to be a decline in the premium sought by investors to compensate for exposure to equity market risk. This drove stock prices onward and upward. Surveys suggested that, in consequence, many investors expected long-run stock market returns to continue at double-digit percentage rates of return.

Then the technology bubble burst... With markets having fallen, investors started to project lower returns into the future."

4) Difficulty in tracing risk. The crux of the argument here is that all of the structures that developed in the past 10 years or so (mortgage security pools and wrappers, pools of pools, risk transfer structures etc...) were complex and opaque. The investors who purchased the risky investments like mortgage loan pools had less information than the people who created them, so it was hard for them to truly measure what kind of risks they were taking. For example, if I borrowed $200k to buy a house, the mortgage originator might sell that mortgage to an investment bank who would combine it with other mortgages into a pool, then sell off chunks of that pool to a hedge fund under various degrees of risk assumption. The hedge fund manager would never get a chance to look at my financial records, yet he owns an investment that is partially dependent on my ability to make my mortgage payments on time. The shady mortgage broker might have lied about my income on the application as a result of the incentive structures discussed in point 1 above, but the hedge fund manager would have no way of knowing that. In addition, the bank who created the security might have made some assumptions or variations to the way the loan pool was created that were buried in some 100 page prospectus that the fund manager might not have been able to discover. The way the whole process worked made it difficult to state exactly what the risks were in the security the ultimate investor owned.

5) Confusion over the definition of "liquidity." The paper gets even more arcane here, so I don't blame you if you get sick of this entry and click out to somewhere else, but to me, Moody's seems to be sort of going on the defensive here. It mentions that there is a misconception that "highly rated securities are necessarily liquid." The agency's argument is that when it gives securities a high rating based on the issuer's balance sheet, it does not necessarily mean that there will always be an orderly market for buying and selling the security, ie while the credit risk of the security might be low, the market risk might still be very high. This seems to be what happened to many of the mortgage-backed securities. As everyone decided that mortgages were toxic, it became difficult to find any buyers for the securities, so even though the majority of mortgages underlying the securities might still have been performing as expected, the securities would only sell at extremely low valuations in the market.

6) No satisfactory valuation paradigm in the credit markets. As we all know, there is often a disconnect between market prices and underlying economic values. Moody's is saying here that the models people were using to value the credit securities that came out in the past 10 years or so were inadequate, and additionally that no adequate models exist.

7) "Spurious precision" in a complex system. Basically what Moody's is saying here is that financial reporting is discrete and precise. Banks have to put a value on their liabilites and assets as of certain dates (usually quarter end for their 10-Qs and 10-Ks) yet the values of some assets and liabilites cannot be precisely estimated, as pointed out in point 6. This leads to huge writedowns and further panic in the financial system.

I am sure our current market conditions and the ultimate fallout (the extent of which we don't know yet) will be well studied in the future but I think the above points do get at some of the main causes of the current crisis in the financial markets.

Wednesday, January 9, 2008

2008 Market Decline

So, I take some time off from posting for the new year and the market tanks.

First of all, Happy New Year to all of my readers. I hope you were able to take some time off around the holidays. I found it hard to pry myself away from work, but I managed to do so and really enjoyed the downtime.

The Dow closed at 13,500 on December 26th and has since fallen about 1,000 points. Hopefully there's more to come (allthough the market rallied today). People are as pessimistic as ever on the future of the housing market, gold is nearing $900 an ounce, oil touched $100 a barrel for one brief trade (but based on the rumors I've heard it was the minimum contract amount and the trade was just done by a person looking for bragging rights).

Looks like it's going to be an interesting year.