My Beef with Greenspan: A Picture is Worth a Thousand Words

Don't you get the feeling that Alan Greenspan, in his last 5 years at the helm of the Federal Reserve, was the financial equivalent of Indiana Jones at the beginning of Raiders of the Lost Ark, with the boulder barreling after him being the over-inflated, debt-riddled Economy that he created. Like Jones, he managed to escape just in time (via retirement in Greenie's case). Boy do I feel badly for Bernanke, who is left to clean up his mess.


I have yet to read his book, but I find it amazing that Easy Al continues to downplay his role in inflating the housing bubble. He credits "low worldwide long-term interest rates" for that. He fails to mention that he set in motion the mechanism that created low long-term interest rates in the first place.

It goes something like this:

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1. Fed drops Fed Funds Rate to 1% (practically paying banks to take its money after inflation is accounted for).

2. Foreign central banks drop their target rates to preserve the dollar's value vs. their currencies (so we can keep borrowing to buy their stuff, supporting their economies).

3. Ridiculously low interest rates spur massive increase in the global money supply (money is "created" via lending - e.g...
1. Fed "creates" $10 in Open Market Operations by lending to a bank to defend its 1% Fed Funds target (without the Fed constantly buying, the lending rate would go up as banks would require higher interest rates - at least high enough to cover inflation),

2. The bank lends $7 to someone (person B) who pays person C $7 for an item.

3. Person C deposits $7 in the bank.

4. The bank lends $4 to Person D... and so on and so forth.

Just in these four steps, the Fed's $10 turns into $21 (known as the multiplier effect).

4. U.S. spends a lot of this newly created money on imports (huge trade deficit), making foreign countries RICH!

5. RICH! foreign countries invest their surpluses (paid for by our huge debt splurge) in nice, safe T-Bills, Notes and Bonds, keeping interest rates nice and low so we can continue borrowing to buy foreign goods, making foreigners RICH!

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The long and short of it: create a bunch of money, and all of that money chases the same lending opportunities. If you want to lend, you have to offer a good rate (lest the coveted borrower take someone else's monopoly money). As such, massive monetary inflation will keep rates low.

Take away Greenie's step 1., above and you don't get low long-term interest rates, a housing bubble, and most importantly this mortgage mess that Uncle Ben is trying to clean up. Uncle Ben is also trying to do this housekeeping with the politicos on the Hill trying their best to foul things up with short-sighted policy measures in order to win votes for next year's elections.

Greenspan's legacy is pretty much summed up in the following chart (click for a larger image). M3 is the broadest measure of the money supply (which the Fed conveniently stopped reporting after it completely lost control of its growth).

The Fed has aided money creation at a 9% annual rate since about 1995 - massive monetary inflation as stated above - All of that money had to go somewhere, luckily it has been in assets so far (where next?)...

Can you say... slosh - TECH BUBBLE - slosh slosh - HOUSING / CREDIT BUBBLE - slosh slosh slosh - EXPLOSIVE INFLATION? Let's hope not.

Great Housing Article from Seeking Alpha's Markham Lee

I have a few complaints with the methodology (he admits to them)... but his conclusions are generally sound ... a house is not, nor has it ever been, quite the investment you think it is.

-eternitus

Adjusted Case Schiller Housing Data

posted on: September 07, 2007 | about stocks: SPY / IYR / ICF

After reading an article from a fellow Seeking Alpha contributor with Case-Schiller housing appreciation data for the 1990s and for the ‘00s thru May of this year, I began to wonder how the data would look if:

NEVER.... SELL... INTO.... A.... PANIC!!!! THAT IS SHAMEFUL!

Unless you really have to (as in a margin call)....


Waiting one day for the panic to subside is worth about 5.5% in this case, or the amount of money you could earn on a 12-month CD, or $550 on every $10,000 invested.

By the way, I'm on vacation this week. Are you jealous?

See you in a week (or on the other side).

-eternitus

OMG! The stock market can go DOWN!?!?!?! - A little advice from an investment pro

A good stock chart can tell a great story... as does the chart below depicting the S&P 500 over the last year.

Click on the chart for a larger image.

Apart from being a great reminder that the market is really just a bunch of scared, greedy people buying and selling... this chart is a prime example of why most small-time investors (as I presume you are) underperform the pros by a significant margin. We all want to buy after we've seen "YAY!" for a while (for fear of missing out) and sell immediately in times of trouble (usually a few days after a big drop, when we don't see a rebound).

Guess what? The guys who make the real money in the markets do the opposite. They buy when you soil your pants and give your shares away at bargain basement prices, and they sell to you when you want to jump on the bandwagon.

This is why I'm buying now, as I did in early March. Lot's of good stocks fall for no reason other than blind fear. The key is separating the wheat from the chaff.

Oh, and remember... there is a difference between price and value... every stock has one value, but many prices.

Cramer: "I've sold all of my real estate"

Thought of the Day...

The media did make a fuss about this May's abysmal pending home sales report (So I have to give them credit for that). However, they glossed over one key point. Read:

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The National Association of Realtors said its Pending Home Sales Index, based on contracts signed in May, fell 3.5 percent to 97.7 from a downwardly revised level of 101.2 in April. The May index is the lowest since 89.8 in September 2001. via the International Business Times -.

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Um... didn't something really bad happen in September 2001? I can't quite put my finger on it...

Oh yeah... that 9/11 thing...

I mean, it's really, really, really bad when the only month you can find worse is the one where our country was attacked, thousands of people died and billions of dollars of damage was caused.

- eternitus

What a great fourth of July Present

I was able to borrow an internet connection for this short post...

Just in case you're the one guy who thinks everything is on the up and up in the public markets... This was written before Blackstone's announcement that it was taking the Company private.

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The market looks to be positioning for volatile price action at Hilton Hotels Corp (HLT), where upwards of 32,000 lots moved today in options trading – 15 times the daily average volume for the hotel chain. While twice as many calls as puts moved today, concentrations of volume favored the July and August 35.0 straddles, and the July and August 40.0 calls.

The abrupt increase in volatility positioning indicates that the market is bracing for turbulence in Hilton shares with an uncertain, upside bias. Hilton shares gained 7 percent today to close at $36.10 in heavy trading – and with no market-moving news of note, we wonder if there' something to the chatter. Implied volatility on Hilton options soared 20 percent and currently sits at just above 38 percent – significantly above the 25 percent recorded historical volatility on Hilton shares.

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Insider trading in stocks is one thing. However, when you're knowingly trading with insider information in options, you're really ripping someone off.

That's because options involve an agreement between two parties. Let's examine...

Johnny Insider - He's the brother of an analyst at Blackstone Group. His sister - Lucy Lips, the analyst, lets the cat out of the bag that Blackstone agreed to buy Hilton at $47.50, more than $13.00 greater than the current price on the market on July 3. Johnny has $10,000 to spare, and is looking to use this information to his advantage. He has two choices - buy approximately 200 shares of Hilton, which would make him $2,600... or he could use the implied leverage of options, and make 20 times that much (you'll see how in a bit)...

Honest George - He's a market maker in options - market makers provide a valuable service... constantly offering to buy and sell shares at certain prices, giving all of us liquidity. He doesn't have any insider information, and believes that Hilton shares aren't going above $40.00 any time soon. He decides to sell the right to purchase 10,000 Hilton shares at $40.00 per share before the end of August for $1.00 per share.

He's selling a call option... As a recap, the buyer (Johnny) pays a "premium" $1.00 to the seller (George) for the right to purchase the shares at a specified price ($40.00).

Initially, Johnny pays George $10,000... which George believes to be fair compensation for the possibility that the shares will exceed $40.00, which would mean that he'd have to buy them at the higher market price and sell them to Johnny for a loss. Unfortunately, Johnny knows something George does not.

Tomorrow, Hilton's market price will skyrocket to $47.50 and Johnny will exercise his options. This means that George will have to pay $475,000 for 10,000 shares of Hilton and then sell them to Johnny for $400,000, taking a $65,000 loss (the $10,000 premium offsets some of the loss). Johnny can now sell his shares at the market price, netting a $65,000 gain(he doesn't get the premium back. As you see... the options strategy is far more profitable than simply buying shares...

Now you see how Johnny ripped George off.

George is a market maker, so it's his company's money he's losing. $65,000 doesn't seem like a big deal... but George makes tens of thousands of these transactions per day.... His trading strategy is supposed to be "market neutral"... meaning that he should make small amounts of money on each trade if the market goes either way. However, such a strategy only works when you know as much as everyone else does. George's exposure to loss may have reached into the millions before he got wise, costing the investors in his company (Average joes who invest in Goldman, Interactive Brokers Group, etc.) tons of money and putting his job in jeopardy.

I hope the SEC finds every one of the "Johnny's" out there. We all deserve a level field when we're trading in the markets.

- eternitus