• European Short Sale Ban Continues

     

     

    Watch the WSJ Video Here

     

    In an effort to reduce market volatility, Greece banned short selling.  France, Italy, and Spain soon followed suit.  Belgium too.  Now the bans that were due to expire have been extended. 

     

    And yet, stock market volatility continues. 

     

    “Short-sellers sell borrowed shares with plans to buy them back later at a lower price, a practice politicians and some investors blame for roiling markets” reported Bloomberg 9/29/2011. 

     

    However, rather than reduce market volatility, some believe that short-sale bans are having an opposite effect:

     

    “The ban has only succeeded in drying up liquidity, increasing volatility and those stocks subject to it will be worse performers,” said Simon Maughan, head of sales and distribution at MF Global Ltd. in London. “That is what this ban has achieved.”

     

    Discussion Questions:

     

    1.     How and why would an investor sell a stock short?

     

    2.     Why do some investors believe that short sale restrictions do more harm than good?

     

     

  • The Problem of the Chinese Yuan

    Chinese goods are cheaper than American goods because Chinese currency is too cheap.  That’s the story told by legislators, and they’re sticking to it. 

    According to Bloomberg, new legislation with bi-partisan support has been proposed to penalize China for keeping the Yuan artificially low:

    The legislation would let U.S. companies seek duties on imports from China to compensate for the effect of a weak yuan, which lawmakers said gives Chinese companies an unfair advantage against U.S. manufacturers.

    Not everyone agrees, however.  The Club for Growth believes that the proposal is “disastrous” and starting an “ugly trade war…would benefit no one.”

    Supporters of this bill believe that cheap imports from China are harming our nation's manufacturers, but they fail to realize that China ships intermediary goods and raw materials to the United States, not just final consumer products. These cheap goods are used by our nation's businesses to produce final products that can be sold at competitive prices. And even if supporters of this bill had a valid argument, the better course of action to spur our nation's economy is not to punish another country through higher taxes on ourselves, but by lowering taxes on corporate income, capital gains, and dividends. This would ignite economic growth, expand our access into foreign markets, and make American companies more competitive and innovative. Likewise, cheap imports are not a drag on the economy. They give consumers more choice and the extra resources to save and invest.

    (Great Wall of China, photo N. Richie)

    Discussion Questions:

    1.     Go to www.oanda.com.  What is the current exchange rate between China and the U.S.? 

    2.     How does a strong currency affect an economy?  How does a weak currency affect an economy?

  • Mutual Fund Loyalty

    What keeps financial advisers coming back to the same mutual fund provider?  Survey says…mutual fund performance and some softer qualities.   A survey by Cogent Research LLC of 1,643 advisers revealed that mutual fund performance over 2 to 5 years was the primary reason for adviser loyalty.  However, some softer qualities such as the provider’s investment philosophy and the quality and depth of the research emerged as winning characteristics. 

     

    According to this Investment News article (available by free subscription):

     

    The two biggest gainers in overall adviser commitment were T. Rowe Price Group Inc. and Legg Mason Inc. In contrast, The Hartford Financial Services Group Inc., Dodge & Cox and Eaton Vance Investment Managers all lost ground. The top scorer, Dimensional Fund Advisors LP, also scored highest in last year's survey.

     

    Discussion Questions:

    1.     According to this related article, why did money flow out of mutual funds last month?

     

    2.     What are exchange-traded funds, and how do they differ from traditional mutual funds?

     

  • Cash Flow to Shareholders

    Cash flow to and from the firm can take many forms.  Firms generate cash flow from their assets through their day-to-day operations (called operating cash flows), by selling their fixed assets, or by reducing their net working capital.  On the other side of their balance sheets, firms can spend the cash they generate by (a) repaying debt or by (b) repurchasing shares of their own stock.

     

    Warren Buffett has chosen to do just that--repurchase shares of Berkshire Hathaway stock.  Closing at $108,449 per share today, Berkshire stock is cheap, according to Buffett.  And he's "putting his money where his mouth is," according to Bloomberg.

     

    Berkshire Hathaway's press release on 26 September:

    In the opinion of our Board and management, the underlying businesses of Berkshire are worth considerably more than this amount [book value], though any such estimate is necessarily imprecise. If we are correct in our opinion, repurchases will enhance the per-share intrinsic value of Berkshire shares, benefiting shareholders who retain their interest.

    Discussion Questions: 

    1.     What is the current book value per share of Berkshire Hathaway stock?  What happened to the stock price for Berkshire Hathaway after the press release announcing the repurchase?

     

    2.     What methods will the firm use to complete the repurchase transactions? 

     

    3.     What alternative ways does Berkshire have for spending the excess cash?  Why are these options less attractive than a share repurchase?

  • Banks Take On More Derivatives

    “Even as federal regulators ratchet up scrutiny of the derivatives market, Wall Street is diving deeper into the $600 trillion industry,” reported the N.Y. Times.

    Despite all the bad press about derivatives, banks have increased their credit exposure to derivatives by $11 billion to $364 billion according to a recent report by the Office of the Controller of the Currency (OCC).  The number of banks reporting derivatives activity was 1,071 which is 24 more than last quarter.  According to the report,

    Derivatives activity in the U.S. banking system continues to be dominated by a small group of large financial institutions.  Five large commercial banks represent 96% of the total banking industry notional amounts and 86% of industry net current credit exposure.

    Discussion Questions:

    1.     What is a credit default swap?  What risks are associated with this market?

    2.     What is the Dodd-Frank Act implementing to reduce the risks associated with derivatives?

  • Can More Lending Cure Our Economy?

     

    Will the Fed’s attempts to reduce long-term rates encourage new loans?  According to this CNNMoney article, probably not. 

     

    "Low rates can only do so much," said Greg McBride, senior financial analyst with Bankrate.com. "Operation Twist will not prompt banks to make loans they're not comfortable making. It won't prompt people to buy houses if they're worried about a job loss, and it won't help homeowners refinance mortgages if they're already unable to qualify."

     

    Some believe that lower long term rates will reduce bankers’ incentives to lend.  Banks make money by lending money long term and borrowing short term.  If long-term rates fall and short term rates rise, then bank profits get squeezed.  Is that enough to cause bankers to sit on the sidelines and stop lending?  I don’t think so. Bankers are innovative.  They’ll find a way to survive this interest rate environment. 

     

    The bigger issue is that borrowers can’t qualify for the loans or don’t want more debt.  This is not something that can be fixed by the Federal Reserve’s Operation Twist.

  • Searching the Old Ledgers

    “The merchant when bankrupt searches his old ledgers.” 

    ~ Arabic proverb

     

     

     

    The Dallas County District Attorney is suing Bank of America and Mortgage Electronic Registration Systems Inc (MERS) for failing to properly record the sale of mortgages with the county and avoiding the filing fees that should have been paid since the company was created in 1997.  The county is seeking $10,000 per violation and liability could exceed $1 billion, according to this Bloomberg article by Fisk and Sterngold on Sep 23, 2011. 

     

    One particularly interesting tidbit:

     

    MERS is owned by financial institutions including Citigroup Inc., JPMorgan Chase & Co., Wells Fargo & Co. and Stewart Title Guaranty Co., and industry trade groups including the Mortgage Bankers Association and the American Land Title Association. It’s also partly owned by Fannie Mae and Freddie Mac, the housing finance agencies now controlled by the U.S. government after being bailed out in the 2008 financial crisis.

     

    This may be a boon for counties around the country—a new source of revenue in troubled times.  If Dallas wins, others may follow suit. 

     

    Discussion Questions:

     

    1.     What has happened to Bank of America’s stock recently?

     

    2.     What is Bank of America’s credit rating?  How has that been affected by recent events?

     

     

  • Technically, Oil Prices Fell Too Far

     

    Crude oil prices dropped 7.4 percent this week, but rebounded when investors felt that the prices had fallen too far.  According to Bloomberg’s Rachel Graham and Ben Sharples on Sep 23:

     

    Crude dropped below its lower Bollinger Band for the first time in more than six weeks, according to data compiled by Bloomberg. This indicator is at $80.84 a barrel today. Bollinger Bands plot support and resistance levels based on volatility and are used by investors to determine entry points for buying or selling contracts.

     

    On his website, John Bollinger describes Bollinger Bands:

     

    Bollinger Bands consist of a set of three curves drawn in relation to securities prices. The middle band is a measure of the intermediate-term trend, usually a simple moving average, that serves as the base for the upper band and lower band. The interval between the upper and lower bands and the middle band is determined by volatility, typically the standard deviation of the same data that were used for the average.

     

    Back to oil.  If oil prices are driven by factors such as Bollinger Bands, then investors can find ways to profit from the changes in the market.  If, however, oil prices are driven by fundamental factors such as supply and demand for oil, then price charts won’t provide enough information. 

     

    I think OPEC is choosing the latter (i.e. supply and demand).  Graham and Sharples reported, “The Organization of Petroleum Exporting Countries will decide whether to cut supply after monitoring the global economy over the next two months and the pace of Libya’s production recovery, an OPEC official with knowledge of the matter said yesterday.”

     

    Discussion Questions:

     

    1.     What is technical analysis? If investors can earn abnormal returns using Bollinger Bands, then what does this say about the Efficient Market Hypothesis? 

     

    2.     What is fundamental analysis? If investors can earn abnormal returns by forecasting supply and demand, what would that say about the Efficient Market Hypothesis?

     

  • Twist and Shout

    Watch the Bloomberg Video here

     

    The Fed announced today that it plans to sell $400 billion in short-term Treasury securities and reinvest the proceeds in Treasury securities with maturities of 6-30 years.  Additionally, the Fed plans to reinvest in agency mortgage-backed securities (MBS).  The Fed plans to hold the Fed Funds rate at “exceptionally low” levels of 0-0.25 percent because of the downside risks that still plague our economy.

    According to the Bloomberg interview pictured above, this “operation twist” is the Fed’s attempt to drive long-term rates down and help the mortgage market.  Unfortunately, this comes with higher interest rate risk for the Fed as they hold longer-term bonds.   

    Discussion Questions:

    1.     Why is this strategy called “operation twist?”

    2.     According to the Fed, what is the likely effect of this plan on short-term interest rates?

    3.     What are the likely effects on interest rates for other types of bonds such as corporate bonds?

  • Return of the Greek Drachma

    European flag courtesy of www.europa.eu

    In a recent Financial Times commentary, Nouriel Roubini of the Stern School at NYU said that Greece should default and exit the Euro.  Greece is currently stuck.  The country cannot repay its debts, and the future is looking bleak. 

     

    According to Roubini,

    "A return to a national currency and a sharp depreciation would quickly restore growth and competitiveness, as it did in Argentina and many other emerging markets that abandoned their currency pegs,”

     

    The problem Greece is facing is an inability to compete and that is preventing the Greek economy from growing enough to repay its debts.  Roubini is suggesting that having the ability to devalue its currency will fix the problem.

     

    Discussion Questions:

    1.     In the Financial Times commentary, what are the other possible solutions suggested by Roubini?

     

    2.     What is the problem with each of the solutions identified by Professor Roubini?

     

    3.     According to the CNBC article, what are the costs if Greece or Germany choose to exit the euro?

     

  • Merger Fever

    B.F. Goodrich was a former Civil War surgeon who started a rubber company in Akron, Ohio in the late 1800s.  The company grew to be one of the biggest tire manufacturers in the world, and later sold the tire brand to Michelin.  Along the way, Goodrich diversified into manufacturing of airplane components.  According to their website, Goodrich is a “leading global supplier of systems and services to the Aerospace and Defense industry. If there's an aircraft in the sky - we're on it.”

    United Technologies is the conglomerate that owns Pratt & Whitney and Otis Elevators.  In a NY Times article, United Technologies said it is considering buying Goodrich. 

    Though the shareholders of acquirers usually see their shares declining at the time of a merger announcement, this hasn’t been the case lately.  United Tech has made a practice of growing by way of merger or acquisition. 

    United Technologies’ top executives have made no secret that they consider acquisitions a key growth strategy. “You’re going to see us put our balance sheet to work, you’re going to see us put more cash to work on the M.&A. side,“ Gregory J. Hayes, the company’s chief financial officer, said in July, according to Reuters.  (Read the NY Times article here).

    United Tech has successfully acquired some companies, but not all.  In 2009, it bought GE’s fire alarm and security systems unit.  In 2008 it attempted to buy Diebold, the auto battery manufacturer, but withdrew because of the financial crisis.  Though Goodrich no longer has a relationship with B.F. Goodrich Tires, Goodrich itself is a worthy target for this acquisition by United Technologies.  With $587 million in net income, it is enough to attract an acquirer.

     

    Discussion Questions:

    1. Why might United Technologies be interested in buying Goodrich?
    2. What is the typical pattern of stock price behavior for the target firm and for the acquirer firm in the days (or weeks) surrounding the new stock purchase?
  • Diamond in the Rough

    “Diamonds” photo by Mario Sarto licensed under Gnu Free Documentation License (GFDL)

     

    What’s the problem with investing in Diamonds? For one thing, they are hard to value (without the help of a diamond appraiser).  And they are illiquid (that is, they cannot be converted to cash quickly without a pawn shop). 

    If you expect diamond prices to rise but aren’t sure how to invest in the glassy substance, you can now invest in the diamond fund established by Harry Winston Diamond Corporation (NYSE: HWD), the diamond mining and retail firm.  The fund is being set up as a limited partnership with Diamond Asset Advisors with up to $250 million in assets and “offering institutional investors direct exposure to the wholesale market price of polished diamonds.” (thestreet.com May 19) 

    According to CNBC,

    "I think that over the long term there will be a strong appreciation of diamond prices based on increasing luxury demand from India, China and the Pacific Rim," said industry expert Rapaport, adding that a weak dollar would also increase diamonds' appeal as a safe haven for investors.

    Broader demand and a consequent improvement in liquidity should support diamond prices over the longer term, making such funds attractive, although the horizon is cloudy in the near term, some market watchers said.

    Investing in diamonds is not without its pitfalls. Others have tried and failed over the years.  Still, if you want to invest in diamonds and aren’t knowledgeable enough to invest directly in the precious gem, perhaps a diamond fund is something to consider.

     

    Discussion Questions:

    1.    According to the CNBC article, the fund is being launched as a “private placement.”  What is a private placement and who can invest in it?

    2.    How have previous diamond funds fared in the past?

    3.    Why might investors choose to invest in this diamond fund? Why might they choose not to?

     

  • Bad News for French Banks

     

    photo by N. Richie

     

    Moody’s cut the credit rating of Societe Generale (SocGen) and Credit Agricole and is still reviewing BNP Paribas.  In its press release on 14 Sep 2011, Moody’s expressed concern about the banks’ “exposures to the Greek economy.”  The long-term debt rating for Societe Generale was reduced from Aa3 to Aa2 and for Credit Agricole from Aa2 to Aa1, a one notch downgrade for both banks.  Moody’s also indicated that the banks faced potential problems in the banks’ “funding and liquidity profile.”

    According to Market Watch, 15 September 2011,

    The ability of European banks to access funding, especially in dollars, has come under increasing scrutiny in the last few weeks as U.S. money-market funds have reduced their exposure to European banks and shortened the time period over which they will lend money.

    All three of the French lenders are among the European banks that are most dependent on money-market funds for funding of that type. 

    Watch this Bloomberg interview with Frederic Oudea, CEO of Societe Generale

    Discussion Questions:

    1.     According to the Market Watch article, what other evidence exists that European banks are facing a potential funding crisis?

    2.     What impact will these downgrades have on French banks?

     

  • Europe's Financial Crisis

    Photo of euro banknotes copyright by European Central Bank and used by permission of ECB

    Jean-Claude Trichet, the President of the European Central Bank (ECB), the European counterpart to our Federal Reserve, is pushing European governments for “decisive action to halt the debt crisis.”  According to this Bloomberg article,

    Eighteen months of crisis-fighting and 256 billion euros ($355 billion) in aid for Greece, Ireland and Portugal have failed to stabilize markets. The turmoil has spread to Italy and Spain, sending tremors through Europe’s banking system and leading to speculation that a currency meant to be permanent might break up.

    The ECB has been busy lending money to European banks facing a liquidity crunch.  Additionally, German Chancellor Angela Merkel and French President Nicolas Sarkozy  have promised to help Greece remain in the euro.  These two actions have helped give financial markets some hope.

  • The Rogue Trader Strikes Again

    photo of UBS sign by twicepix licensed under Creative Commons

     

    Every few years, the same story grabs headlines.  In 1994, Nick Leeson held the infamous title of “Rogue Trader” when he lost the equivalent of $1.4 billion and single-handedly brought down Barings Bank.  In 2008, the title was passed to Jerome Kerviel, the 31-year old who lost $7.2 billion for Societe Generale.  Today the title goes to Kweku Adoboli, the trader for UBS who lost $2 billion for the troubled bank.  In an internal memo republished by the NY Times, UBS seeks to reassure employees:

    Dear colleagues,

    We regret to inform you that yesterday we uncovered a case of unauthorized trading by a trader in the Investment Bank. We have reported it to the markets in line with regulatory disclosure obligations. The matter is still being investigated, but we currently estimate the loss on the trades to be around 2 billion US dollars. It is possible that this could lead UBS to report a loss for the third quarter of 2011. No client positions were affected.

    We understand that you have already had to contend with unfavorable, volatile markets for some time now. While the news is distressing, it will not change the fundamental strength of our firm.

    We urge you to stay focused on your clients, who are counting on you to guide them through these uncertain times.

    We want to reassure you that we, together with the rest of the management, are working closely with the Investment Bank’s management and risk and controlling to get to the bottom of the matter as quickly as possible, and will spare no effort to establish exactly what has happened. We will keep you updated on the progress of our investigation.

    Yours,

    The Group Executive Board

    Discussion Questions:

    1.     How did some of these actions go undetected and generate such large losses at these banks?

    2.     What risk management practices would prevent such behavior in the future?

  • Ponzi: A Name Which Will Live in Infamy

     

    Charles Ponzi went to prison in 1920 after pleading guilty to fraud.  He tricked investors by claiming that he could earn tremendous returns using postal coupons, but instead he used money from new investors to pay existing investors until he was finally exposed.  Today, a Ponzi scheme is a fraud with little or no actual investment.  Investors are kept in the dark and are satisfied to think they are earning a high return while the cash inflows from new investors are used to satisfy any cash outflows to other investors. 

    Eventually, all Ponzi schemes fail. 

    Some fail within a year.  Others, like Madoff, last for decades.  According to the AP video above, Ponzi schemes fail for one of three reasons: 

    ·       The promoters vanish with the funds

    ·       The scheme collapses under its own weight

    ·       The scheme gets exposed

    Governor Rick Perry of Texas recently accused the government of running a Ponzi scheme of Social Security: (Read the Bloomberg article here)

    “It is a Ponzi scheme to tell our kids that are 25 or 30 years old today, you’re paying into a program that’s going to be there,” Perry said during a Sept. 7 debate of the Republican presidential candidates

    Those who disagree with Governor Perry claim that there is a difference between tricking innocent investors and a government social insurance program.  Governor Herbert of Utah (Rep) even called Perry’s comment a “dumb thing.”  On the other hand, others claim that Perry is drawing attention to a growing national problem.

    Charles Ponzi died at the age of 66, a poor man.  In the Bloomberg article by Lynch, Mitchell Zuckoff, author of Ponzi’s Scheme: The True Story of a Financial Legend, said that Ponzi “could have used Social Security.”

    Discussion Questions:

    1.     According to the SEC, what is a Ponzi scheme and how can investors protect themselves from fraud?

    2.     What is the difference between a Ponzi scheme and a pyramid scheme?

     

  • Insider Trading Scheme Uncovered

    photo of FBI Evidence Response Team vehicle courtesy of http://www.fbi.gov/news/photos

    Stolen information passed to conspirators through telephone booths and throwaway cell phones.  Evidence being destroyed as the authorities close in.  It sounds like the stuff of movies, but unfortunately this was real life.  Read the Bloomberg article here.

    Matthew Kluger, a former attorney in Washington and Garrett Bauer, a former trader in New York, were arrested by the FBI today for insider trading and face a civil suit from the SEC for their “longstanding serial insider trading ring that made at least $32 million in illegal profits” (SEC Complaint for Violation of The Federal Securities Laws, Case No. 11-cv-01936-KSH).

    What exactly is insider trading?  Does it always involve the cloak-and-dagger activity described here?  Not necessarily.  In fact, it is not always illegal.

    "Insider trading" is a term that most investors have heard and usually associate with illegal conduct. But the term actually includes both legal and illegal conduct. The legal version is when corporate insiders—officers, directors, and employees—buy and sell stock in their own companies. When corporate insiders trade in their own securities, they must report their trades to the SEC.

    Illegal insider trading refers generally to buying or selling a security, in breach of a fiduciary duty or other relationship of trust and confidence, while in possession of material, nonpublic information about the security. Insider trading violations may also include "tipping" such information, securities trading by the person "tipped," and securities trading by those who misappropriate such information.

    Obviously Kluger and Bauer were engaging in the illegal kind, and they are about to learn that crime doesn’t pay.

    Discussion Questions:

    1.     How did Kluger and Bauer make money by insider trading?

    2.     According to the SEC definition found here, what are some other examples of insider trading?

     

  • The Market for Oil

     

     

    Can an investor make money in oil? If markets are efficient, then the only returns that can be earned are those that are available to everyone. It’s the “abnormal returns” that are not available.  Theoretically, if markets are efficient, then investors can earn the same return as everyone else—not an “abnormal” return, only the appropriate return that is commensurate with the risk.

     

    The CNBC report above listed some reasons that oil has increased in value.  Some of the reasons are fundamental and deal with the supply and demand for oil.  For instance, one third of oil production in the Gulf of Mexico is still shut down due to Hurricane Lee and a decline in oil inventories are leading to higher oil prices. Other reasons are technical, and deal with price and volume trends.  One technical factor that seems to be affecting oil is momentum, that market phenomenon where gains are followed by more gains leading to an upward trend in the market.

     

     

    Discussion Questions:

     

    1.     What is the efficient market hypothesis?

     

    2.     If markets are not efficient in the semi-strong form, what kind of analysis would lead to abnormal returns in the oil market?  What if markets are not efficient in the weak form?

     

  • Save the Banks or Sue the Banks?

    Photo of U.S. Treasury Building by Florian Hirzinger licensed under Creative Commons

    So if the government sues the banks and the banks fail, will the government bail them out again? Just wondering.

    The Federal Housing Finance Agency has sued the 17 banks that it claims are responsible for the big losses at Fannie Mae and Freddie Mac.  According to the Bloomberg article, one of the defendants is Ally Financial, formerly GMAC, which is still "majority-owned by the U.S. Treasury." 

    It’s a ridiculous situation, for sure. Then again the FHFA is doing what it’s supposed to do: preserve and conserve the assets of Fannie and Freddie. It’s not the agency’s fault that Congress passed the Troubled Asset Relief Program and gave the Treasury Department new powers to keep Ally and its ilk alive.

    Congress could have let those companies die, as they deserved to. It didn’t, though. So now the inevitable claims are working their way through the courts. The government’s roles as both a referee and a player in the financial markets remain as conflated as ever.

     

  • Portfolio Insurance

    Earthquakes.  Hurricanes. Floods, Tornadoes.  Having just come through a series of natural disasters, everyone recognizes the value of a good insurance policy. We buy insurance, not because we expect bad news.  We buy insurance to protect us from the big losses, and we know that protection comes with a price.

     

    According to this recent article by Steven Sears in Barron’s, investors might want to consider insuring their stock investments by hedging. The hedge he recommends is to buy (i.e. “go long”) call options on VIX, which is an index of stock market volatility. 

     

    “Rather than worrying so much about the hobgoblins of global finance, or sitting around palavering about political solutions, you might protect your investments with a hedge and insure your stock portfolio just like you would your car, or your house or your health.

     

    Discussion Questions:

     

    1.    What is the VIX index and how would an investor profit if he/she buys a call on the VIX?

     

    2.    According to the Barron’s article, what season is supposed to be the most volatile?

     

    3.    Rather than VIX call options, what other derivative contract will serve as portfolio insurance for a stock portfolio?

     

  • The Fall of FNMA and FHLMC: Who's To Blame?

    Photo of Fannie Mae at 3900 Wisconsin Avenue, NW in Washington, D.C. 2008

    by NCinDC licensed under Creative Commons

     

    Tuesday will mark the three-year anniversary of the fall of Fannie Mae (FNMA) and Freddie Mac (FHLMC).  On September 6, 2008, the federal government placed both housing agencies into “conservatorship,” effectively taking over the management of both organizations. 

     

    FNMA and FHLMC are government-sponsored enterprises (GSEs) that were created to help banks lend money to homeowners.  They did this by buying existing mortgage loans from banks so that banks could lend new money to new homeowners.  As long as the borrowers repaid their loans, all went according to plan.

     

    And then things went downhill.

     

    Banks started lending money to buyers with less-than-stellar credit and selling these mortgages to FNMA and FHLMC.  Losses increased as the quality of the loans decreased.  According to the 2008 statement by Director Lockhart of the Federal Housing Finance Agency (FHFA),

     

    “Between them, the Enterprises have $5.4 trillion of guaranteed mortgage-backed securities (MBS) and debt outstanding, which is equal to the publicly held debt of the United States….

     

    Unfortunately, as house prices, earnings and capital have continued to deteriorate, their ability to fulfill their mission has deteriorated.  In particular, the capacity of their capital to absorb further losses while supporting new business is in doubt.”

     

    As the anniversary of that day approaches, the FHFA is expected to file a lawsuit against several of the big banks that sold loans to Fannie and Freddie.  According to the NY Times, “The suits will argue the banks, which assembled the mortgages and marketed them as securities to investors, failed to perform the due diligence required under securities law and missed evidence that borrowers’ incomes were inflated or falsified.”

     

    With the three-year anniversary approaching, the FHFA will have to move fast to beat the statute of limitations.

     

    Discussion Questions:

     

    1.    Describe the securitization process. What is a mortgage backed security?

     

    2.    What are the risks faced by the investor who buys a mortgage-backed security?

     

     

  • Every Silver Lining Has a Cloud

    There may be investment opportunity in cloud computing.  The advent of this new technology is described as a “major platform shift” by venture capitalist Ray Lane, the Chairman of Hewlett Packard.  Businesses will no longer need to install their own software on their local computers. Instead, they can employ the services of firms who can make the same software available anywhere and at anytime on the “cloud.”

     

    MSN Money describes cloud computing as a “mainframe in the air,”

     

    The cloud offers so many benefits to consumers and businesses that there's still a decade's worth of huge spending as companies try to catch this trend. This should help drive up the stocks of the key companies involved, including Salesforce.com (CRM), Apple (AAPL), Google (GOOG), Microsoft (MSFT), Amazon.com (AMZN), EMC (EMC), VMware (VMW), International Business Machines (IBM) and Accenture (ACN). (Microsoft is the publisher or MSN Money.)

     

    For investors, this means the big software providers like Oracle and SAP are facing competition. Evolve or become extinct. The small cloud computing providers have an opportunity to gain market share and be profitable. Carpe diem.

     

    Discussion Questions:

     

    1.    How would an investor take advantage of this investment trend? What risks do investors face in these stocks?

     

    2.    Go to Yahoo Finance and look up the stock ticker SKYY. How would you describe this investment?

     

     

    Title by Mary Kay Ash, founder of Mary Kay Cosmetics, 1963