Safe to come out yet?

A glimmer of hope on close of business Friday, October 17: the TED spread dropped below 4 pts, and global markets closed significantly up, including the FTSE, Dow Jones, Hang Seng, and the Nikkei.

Free and clear

The solution is now painfully obvious:  free and clear is the only way to be.  Especially in an economic free-fall.

Normally, reading economic reports is something I enjoy about as much as, oh, say, a prostate exam.  Particularly economic reports from conspiracy-theory sounding names like Shadow Government Statistics.

But my colleague Mike (aka "Dr. Nacho") gave me a copy of The Hyperinflation Special Report, compiled by John Williams.  It is a little smug, and certainly dire-sounding, but I have to agree with the paper.

Williams spends 23 pages building his arguments and positing his conclusions, but it's really common sense:  the government has run up it's "credit card" (the national debt), and there is no money to pay it back.  It can keep printing the money, but increased supply of money means the value of it (demand) falls.  This is inflation.  But when it happens on a very large scale, as it has in countries around the world, as recently as two years ago, you get hyperinflation. 

Williams bolsters his arguments with bolstered by some historical research.   It goes back to the definition of "money". Money (actually "wealth") used to be something of intrinsic value, like gold, diamonds, or even animals, food, or spices and incents.  As those things became to bulky to carry around, symbols of that wealth were created: gold or silver coins, usually.  Paper money was introduced as a symbol of a government's wealth, measured in gold (this was the gold standard).  In 1933, President Roosevelt abandoned the gold standard, in an attempt to shake the country out of the Great Depression.  In 1971, Nixon effectively admitted the government was bankrupt, and disallowed the redemption of dollars for gold.  The dollar has been floating on, well, confidence for the last 40 years.  Confidence that the U.S. government would make good on any debts, such as Treasury Bonds purchased by Americans, foreign investors, or other countries.

That confidence is quickly eroding.

The result could well be that, like a professional check kiter, everyone- citizens, foreign investors, banks- stops lending to the government.  Unable to get more loans, the Fed prints money to pay it's debt, but that money is devaluing rapidly.  The chaos and confusion of such rapid devaluation spurs more panic (as with the 11% market drop last week) and soon, you have hyperinflation.

Williams says it might take longer, maybe 2010.  But as government officials try to unravel the subprime/CDO/CDS mess, the scope of the problem may only grow larger.  A similar event occurred when a few minor accounting irregularities triggered an audit which led to the collapse of Enron and Arthur Andersen, and millions of dollars in pension funds and stock options disappeared in just a few short months.

To keep my money in the market, even in U.S. Treasury Bills is gambling.  Period.  The safest bet is to own real assets- house, cars, furniture- free and clear.  No debt.  Then a job is merely used for those monthly variable expenses- food, fuel, insurance, utilities, clothing, entertainment. 

Unfortunately, that's easier said than done.  But it's definitely the direction I'm heading.

Just the first bounce

On Monday, October 13, the Dow Jones gained 11%. "We've finally bottomed out, and the market is on the rebound," my Prudential retirement fund rep assured me.

Huh.

I am an optimist. Really, I am. But everything I have read and heard beyond the USA Today and CNN factoids indicates that the world financial system is still tumbling, and this market "rebound" may simply be the bounce of a ball that still has several flights of steps to fall.

Washington nationalized AIG. They have essentially nationalized several large banks (though Secretary Paulson refused to give the government the benefit of actual managerial input); European and Asian governments are earmarking well over $2 trillion for their bailout efforts. Iceland is bankrupt, and several lesser-developed EU countries (Turkey, Azerbaijan, and more) are right behind them. Why are we excited, again? Oh, right- the market rebound.

Why didn't Treasury bills creep up, and the LIBOR go down, too? The TED Spread keeps widening.

"About 10 things have to go right to escape with a mild global recession," said Simon Johnson, an economist at the Massachusetts Institute of Technology and former assistant director of research at the International Monetary Fund who runs the baselinescenario.com website, quoted in the San Francisco Chronicle. "We think the U.S. and the world are heading into pretty severe global recession. Whether it gets worse or not remains in question."

Oh, that's why. Guess I'll keep blogging. Dammit.

T-bills down, TED spread up, Silver & Gold Scarce

3-month T-bill yields were down to 0.11 percent, or basically, zero. After inflation eats 5%, that's a 4.8% negative yield to put your money into government bonds. Considering the state of the government these days, I'd almost rather put the money under my mattress.

The TED spread increased again, too.

A friend at work was trying to buy silver last week during business hours, so I overheard his struggles in trying to procure some. Another friend told me that prices for silver were 50-60% above "spot price." This guy says just 10%, but still. I didn't know what "spot price" meant, so I looked that up.

Seems that spot price is the price that silver (or gold) trades for on the open market; kind of like a stock price. So some sellers are selling precious metals for a large premium above the market price, presumably because demand is high from manufacturers, and the general public trying to hedge their money in precious metals. Strangely, gold was down 23% last week. Seems like they would track together.

Frankly, I'm not sure it will make a difference. I guess it has historically been safer to have gold and silver in severe economic hardship, but it's kinda hard to spend, y'know? I guess if you're just hording your money there, riding out the storm, then that would be OK.

But in this current situation, nobody knows anything, really. I moved our money into "safer" investments, but not before it lost 9% more on Friday.

I wonder how much my Bevo Buckle is worth?

Hitting home

There is so much big-picture economic news these days that it is sometimes hard to see how the current financial trouble affects us individually, except by watching our 401k value drop through the floor.

However, my wife and I are shopping for a home right now. We also have our home listed on the MLS and other sites, for sale by owner. Our current home is a unique design which will take longer to sell, anyway. Anything out of the ordinary always does. But we think that we can rent the home out for at least break-even money, if not a slight positive cash flow. Even if it rents at a slightly negative cash flow, with the rent paying all but a small portion of the monthly note, then we'll be happy. It would represent a return of 6% (the APR of our 30-year mortgage), which is better than just about anyplace else we could invest our money.

More confusing, though, is the house we are trying to buy. It's a "tainted property". Listed at $229,000, the owner is an attorney who is now in jail for mortgage fraud. The house is in pre-foreclosure, but it has a $500,000 IRS lien against it. We offered $222,000 to the lender, pending release of the tax lien, which the lender will negotiate.

It has been a little over a week since we submitted an offer. We were told it may take 2-3 weeks to learn whether the tax lien could be removed. The house had been shown many times, but no offers, mainly because people did not want to wait so long to find out if they could get the tax lien forgiven.

Now, in this tightening market, knowing that lenders are desperate, I am wondering if we should not withdraw our offer, and re-submit it for less, say $199,000. The intrinsic value of the house was a little inflated to begin with, even at $222,000 (the owner had it on the market for $249,000 before he went to jail). $222,00 is a reasonable price, considering it's good location, size, configuration, and age. However, I think the house is really worth about $200,000, once you remove the market "buzz" that has fueled Austin's home market for the past several years.

If I was an investor with cash, I absolutely would make such a low-ball offer. I see many homes starting to sit on the market longer and longer as credit and loan offers dry up for people with good-but-not-great credit scores and asset ratios. It started about a year ago, according to my credit broker, when sub-prime loans began to be scrutinized more and more buy mortgage-backed securities (MBS) buyers. Zero-down loans were rejected, and then any loan with less than 3% down, then anything less than 5% down, etc.

Now, I'm wondering if buyers who cannot afford at least 20% down, even with good credit, will have a tough time getting loans, and if they'll have to pay higher-than-expected interest rates, which could depress the market further, driving down home values.

For those who can afford to sit and wait, then pounce on deals with cash in hand, there will likely be incredible real estate deals to be had.

For those who need to buy or sell now, the news is not so good.

Bank of Curtis

Looks like I may own a bank soon!

Well, part of it, anyway. Like, whatever slice my taxpayer share gets me. Oh, I won't own the preferred, voting stock. No, just common stock. I would have preferred the stock injection plan that over 120 of America's top economists recommended. But it looks like I'll have to settle for some crappy version, which amounts to nothing more than a cash grant to the banks.

In other words, another bailout. Well, partial bailout. But lots of them. This on top of the

• $85 billion dollar bailout of AIG
• (plus $38 million more to AIG)
• $700 billion dollar general bailout package
• $900 billion dollar additional cash injection into various financial institutions announced this week
• Treasury's announcement of "commercial paper" buys (short-term loans for businesses).

I wonder if I'll get a free toaster with my account?

The wrong problem?

First, the problem was unemployment. Then, it was oil prices. Then, it was the sub-prime mortgage mess. Then, it was the credit markets. Now, it's the global banking system.

Could it be that the real problem is a simple crisis of confidence?

Chicago Graduate School of Business Professor of Finance Amir Sufi says that government officials missed the point. Every major recession in the past 100 years have been preceded by a drop in consumption, or consumer spending. There is no hard-and-fast reason for this, other than human psychology. Like a gaggle of birds on a wire, when one bird flies off, a few more follow, and then the whole flock peels off. It's herd mentality, but it is a perfectly reasonable reaction to envrionmental threats: better safe than sorry. Except when the "safe" move has the unintended consequence of collapsing the global economy.

John Mauldin makes a similar case, though with more of a supply-side view:

"[T]the key is consumer spending. Personal income fell 0.1% in April, with wages and salaries down a larger 0.4%. Real disposable income also fell 0.4%. This leaves it up just 0.4% annualized over the past three months, which is not supportive of significant increases in consumer spending. As we noted last weak, retail sales and discretionary spending is down."

Mauldin argues that hourly wages are the horse that pulls the cart of consumer spending, and changes in those wages predict economic malaise.

I don't know about that. But it makes sense to me that consumer confidence drives consumption, which in turn drives growth (or lack of it). After all, money's only value comes from an agreement between you and I that this 2-cent piece of paper is worth a dollar, or twenty dollars, or several million dollars (if the piece of paper is a stock certificate, for example).

So it makes sense to me that loss of confidence in that piece of paper's value could easily drive us to stop spending on frivolous things, and reserve our spending only on essential goods and services. That is the drop in consumption that leads to recession. At least, according to Sufi, and folks like Simon Johnson, former chief economist of the International Monetary Fund, is a professor at the MIT Sloan School of Management.

What can the government do to promote confidence in our paper money, so that more people will buy stuff?

Yeah, good question. But I am pretty sure that bailing out companies who then spend the money on resort spa junketts is not going to help.

Oh, and we just gave AIG $38 billion more.

The TED Spread

I was hoping the market would bounce back a little today. Instead, it fell off the trampoline.

NPR's excellent new Planet Money podcast interviewed veteran analyst and trader Vinny Catalano about his recent blog post, in which he explains that the key economic indices to watch are not the Dow Jones and NASDAQ, but rather the 3-month Treasury bills and the London Inter-bank Offering Rate, or LIBOR.

Another vital statistic of the credit market is the "TED spread". TED is an acronym of T-Bill and ED, the ticker symbol for the Eurodollar futures contract. The spread is the difference between the two. For example, if the T-Bill rate is 5.10% and ED trades at 5.50%, the TED spread is 40 basis points (bps). Basically, the higher the TED spread graph, the worse the credit crunch, and the crappier the economy. The TED spread fluctuates over time, but historically has remained within the range of 10 and 50 bps (0.1% and 0.5%), until 2007.

Today, the TED spread is almost 4%.

Catalano says three month T-bills are a good "panic gauge" for credit markets. He says that we want to see short-term T-bill interest rates rise, and the LIBOR fall. This would indicate that people are not fleeing from stocks to "safe havens" like T-bills. Ironically, there has been so much panicked flight out of stocks that T-bills have been paying negative yield- we're paying the government to take our money, and keep it out of the stock market. Scary.

Conversely, the LIBOR is the rate at which banks lend to each other. The LIBOR rate typically hovers around 2% in a healthy economy. Banks can make overnight loans to each other and collect between 1-2% interest, typically a zero-risk, guaranteed profit. Not anymore.

The Federal Reserve cut interest rates one-half percent today to the crazy-low rate of 1.5%. That was expected to help bring the LIBOR down, and encourage inter-bank lending, providing much needed grease to the gears of the international credit markets.

The LIBOR jumped to 4.58% (overnight rate was 5.38%). T-bills? Down, from 0.8% to 0.63%. My 401k is down 30%, year to date. The mattress is starting to look like a good investment.

Danielle, honey, Daddy's a little worried.

It only hurts when you laugh

This is just too funny.

The Day the Market Died

You never know.

And that's why I'm writing this. I've lived through the inflationary 1970s, with the long gas lines (back when gas was a scandalously high 60 cents per gallon); the malaise of the Jimmy Carter years; Reagan's double-digit unemployment; the savings and loan debacle of 1983; "Black Monday"- October 19, 1987, when the Dow dropped 22% in a single day; Y2k; the dot-com bubble; Enron's shame; 9/11; and what we thought was the sub-prime mortgage crisis.

None of those things were pleasant, but they all had a "rebound" effect. Now, I'm not so sure. This new thing- this Global Credit Crisis- feels much bigger, yet much more insidious. We're on the Titanic. Sure, there's icebergs out there, the water is treacherous, we know that. But we've got experienced, crusty sea captains navigating us safely through...

What was that awful crunching sound?

Oh, that's not an iceberg! It's just my 401k losing 20% 50% of it's value since last year. Whew.

I'm not an economic expert, but like many folks, I've been schooling up these past two weeks. There are great articles in The Economist, the Wall Street Journal, the New York Times, and many more. But the very best, clearest explanation of the current economic catastrophe has come from these two MP3 podcasts* of This American Life:

• The Giant Pool of Money
• Another Frightening Hour about the Economy.

Don't be fooled by the pithy titles; this is world-class reporting. And entertaining, too, for what that's worth. Listen to them in order, and keep in mind the dates they were posted.

*Note: you don't need an iPod to listen to them; you can listen to them on your computer, or download them and burn to CD, or transfer to any MP3 player you like.

After the news from Iceland today, the hairs on the back of my neck are standing up. I'm probably overreacting, but just in case, I thought I would document this period in our family's life, in case it brings any wisdom and perspective for my daughter Danielle, years from now. I'll explain what I understand about the crisis, but the podcasts do a probably do a better job of that.

A good friend of mine who is way smarter, and way, way more informed about this matter is hunkering down, financially. He's predicting the worst, as in hyper-inflationary Weimar Republic worst, or Chilean marshal law worst. I really hope he's wrong.

But you never know, y'know?