Adminstrative Announcement

This weekend I will be attempting to switch this blog over from one hosting environment to another, something that will allow for more flexibility and features in the future. The look of the blog will change somewhat right away, and probably continue to morph over the next few weeks as I twiddle with things.

I mention this because the switch-over may cause a short term outage at some point today or tomorrow. Of course, if you are reading this, the blog is obviously currently up.

[Update: Blog is now safely up in WordPress on new host, so hopefully no more downtime.  But theme is ugly and none of the internal links function.  Workin' on it....]

The Wall Street Journal Guide to The End of Wall Street as We Know It by Dave Kansas, Part 1

Of the passel of hastily written books now on the shelves discussing the financial crisis and what to do about it, The Wall Street Journal Guide to the End of Wall Street as We Know It by Dave Kansas may have the best title. But like the other members of its micro-genre, it is not likely to become an enduring classic. Kansas is a web and newspaper reporter by trade and the entire book can be usefully thought of as an extended magazine article, what in an earlier age might have been called a pamphlet. It was written over a few weeks in the last months of 2008, was on shelves as a paperback by the end of January, and will probably outlive its usefulness by late summer. It will next be seen many years from now when unearthed by a graduate student doing research into the contemporaneous reaction to the Panic of ’08, or whatever it is that the current crisis winds up being called.

But as a long magazine article, the book has its merits. If you weren’t paying close attention to events in the financial world last year and now feel at a disadvantage at dinner parties, The End of Wall Street will help. Even relatively close readers of news accounts will find tidbits and pieces of the big puzzle they have missed. For example, the book points out that the average FICO scores of sub-prime borrowers actually improved as the housing bubble grew. While the sub-prime borrower of ten or fifteen years ago might have been sub-prime due to a bad credit history, by 2006 a sub-prime borrower typically had adequate credit but was buying more house than he could truly afford.

Kansas also provides a modicum of analysis and reflection, roughly what you would expect from a reporter given a book to fill but only a short time to do it. He deftly points out that the troika at the helm of the government’s handling of the crisis in the fall of 2008 was made of Fed Chairman Ben Bernacke, New York Fed President Tim Geithner and Treasury Secretary Henry Paulson. Kansas does not say it, but he clearly means the reader to notice that the new administration has merely contracted that troika into a duo.

And although he cannot resist blaming the Usual Suspects of crooks and overly clever bankers, Kansas does so with a light hand. The fiasco in mortgage bonds was propelled by the same forces that propel the economy in good times, avarice and optimism. As Kansas deadpans, “Creating new regulations that will eliminate greed is practically impossible.” Nor, he might have added, is it necessarily a good idea.

The fuse for the powder keg was lit in June 2006 when, according to the S&P Case-Shiller Indexes, house prices in the US peaked, having gone up 190% in ten years. It took some time to play out, but after years of aggressive lending and borrowing on the almost universally held theory that house prices never go down, the result was nearly pre-ordained. There are wrinkles that made it worse, such as the peculiar structure of the mortgage bond market, but as Kansas makes clear, these are complications to the core disease. A truly vast number of bad loans got written and, due to the nature of the beast, they all went south at the same time.

It is what happened next that made our current situation dire. As Kansas tells us, within living memory there have been several large-scale financial crises that failed to destroy Wall Street, and some of those failed even to cause a recession. The tech-telecom bubble burst at the start of this decade, vaporizing trillions in stock market wealth and littering Wall Street with worthless telecom debt. That came only a few years after the Asian Crisis and Russian Default Crisis culminated in the collapse of Long Term Capital Management, which caused dramatic late night meetings of the leaders of Wall Street, but not, apparently, any long term repercussions. And a few years before that, almost the entire S&L industry went up in flames.

Kansas calls these disasters Dog That Didn’t Bark moments, events that historians will realize hold significance for what did not happen rather than what did. Indeed, the fact that no really terrible damage was done only encouraged further risk taking. But in retrospect, the financial system was lucky to weather those storms as well as it did. The seawalls were just strong enough and the ad hoc and somewhat haphazard government rescue efforts were just adequate enough to see us through. When a slightly bigger hurricane made landfall it was revealed just how insufficient the financial system’s defenses had really been all along.

The levees were breached on Monday, September 15, 2008. That was the day Lehman Brothers failed, defaulting on its debt and turning what had been an atmosphere of fear and foreboding into one of panic. Investors reasoned that if the debt of a firm as significant as Lehman could become worthless then nothing was safe. All of a sudden everybody started hoarding cash, refusing to lend to anybody under any circumstances.

Lehman had been widely known to have been in serious trouble for some time, so a person might wonder why its failure could have come as such a shock to the system. As late as the Friday before, the credit default market was pricing the likelihood of a Lehman default in the following year at only 7%. This apparent incongruity can be explained by the fact that almost everybody on Wall Street believed that even though Lehman was probably insolvent, the government would never allow such a key player to default. Of course, that is exactly what happened.

[Stay tuned for part 2 of this review early next week.]

Frugal Friday Feb. 27

Another quiet week in the frugalosphere.

In a follow-up to last week, I must report that Almost Frugal gave into temptation and bought a new dishwasher after all. This in spite of the dozens of encouraging comments she got, cheering her on in her efforts to live dishwasher-free. It almost makes you wonder why she bothers blogging if she’s going to lose her mind and spend money like a drunken sailor.

Speaking of blogging, today’s Little People Wealth has helpful post about how you can get some free cheese. All you have to do is review the cheese on your high traffic cheese-related blog. Finally, a tip we can all use.

As true devotees of frugalism know, being frugal is not merely a way to get rich, it is a lifestyle. Frugal posts this week explored taking this further and transcending the Frugal Lifestyle (FL) and living what might be called the Substance Abuser Lifestyle, or SAL.

Money Saving Blog brings us a list of 20 things in your house you can sell. This post begins with the commonplace observation that “the first thing that I do when I suddenly realize that money is getting tight towards the end of the month is to look around my home to see if there is anything that I can sell.” This is a good start, but I think that really living the SAL would mean looking around in other people’s homes for things you can sell.

Bargaineering suggests Dumpster Diving. The post is short on details, but apparently in some garbage heaps there are more things you can sell.

The Greenest Dollar picked up the SAL pace with a post on living in shipping containers. It’s an informative post, but the author lost my interest when she started discussing how much it costs to buy a container. Of course, a serious SAL practitioner would find one.

Not to worry. Tight Fisted Miser has an informative post, with a follow-up the next day, on what he calls “Extreme Frugal Housing Options.” His first suggestion is to live in a van, which he thinks he would really enjoy, but concedes that his “GF” would not. (I’m not sure what GF stands for. In context, girlfriend seems unlikely. Goldfish? Grandfather?) If not a van, he suggests an RV, which again he worries that GF would not like. Also, they’re hard to handle on the road and burn a lot of gas. But, then again, there’s no room for a dishwasher.

Firm Grasp of the Obvious Week at WSJ

Yesterday Wall Street Journal columnist Brett Arends reported that from 1995 you would have been better off in a money market fund than the stock market. Apparently the meaning of the Dow hitting a twelve year low took a while to sink in. Arends also tells us that “Thanks to inflation, investors have lost ground simply if they haven’t gained it.”

Today Jason Zweig picks up the theme with a column entitled “After the Crash, Stocks May Face Long Road Back; History Suggests There’s No Guarantee of Quick Rebound; Buy and Hold — for Decades?” Zweig reveals the not at all shocking truth that just because the stock market went down a lot in the last year or two that does not mean it will necessarily go back up a lot in the next year or two.

He cites a soon to be released report from a professor of finance saying that the expected time that it will take the Dow to regain its 2007 high is nine years. That is, it has an equal likelihood of getting back to its peak after 2018 as before. Zweig says that this “shocked” him. Really? In round numbers the stock market is down 50% from the peak, so getting back up requires a gain of 100%. If you are a little pessimistic and assume an 8% average return from stocks, that will take 9 years. If you think 10% sounds right, then it will take about 7 1/2 years.

There is a powerful psychology of denial that affects many people, personal finance columnists at national newspapers included. The numbers on the 401(k) statement in early 2007 just seemed so real and substantial that it is hard to acknowledge that today’s much lower numbers are just as real. People tend to expect a V pattern in stock prices, that a few really bad years are inevitably followed by a few really good years.

The stock market doesn’t work that way. It can’t. It’s like a law of nature. The market cannot let itself be so easily predicted. Knowing what happened one year tells you (almost) nothing about what will happen the next. Since 1871 the stock market (as measured by the S&P 500) has had 38 down years. Excluding this year, the average return the year after losing money is +11.63%. The S&P has also gained more than 20% in a year 38 times. The average return in years following big gains is +12.27%.

There is obvious incredulity in the question “buy and hold — for decades?” But the straightforward answer is “Yes, of course.” Did you think that you could guarantee fat stock market returns if you were willing to stick it out for five or ten years? You can’t, and that’s something that all stock market investors, and all Wall Street Journal columnists, need to know.

Amex Paying Customers $300 to Go Away

There’s much buzz in the blogosphere (e.g. here, here, and here) about the latest from American Express. They have offered certain of their customers $300 if they will close and pay off their credit card accounts by April 30. (Are there other businesses that will pay me not to do business with them? I could use the money.)

What is going on here? Amex is letting the accounting tail wag the business dog. They feel pressure to reduce their book of consumer debt. Investors are very worried about financial companies that are overly leveraged with too many (possibly bad) loans to consumers. Bribing some customers to beat it addresses this problem because it will reduce both the total that Amex is owed and the total that its customers could borrow. Amex may also be targeting customers with low credit scores or other characteristics of which investors are particularly leery.

Does this make good business sense? Not even close. Imagine separating credit card customers into two categories. Group A is made up of those willing and able to pay off their balance in 60 days in exchange for $300. Those in Group B are either uninterested or unable. Everything else being equal, with which group would you rather continue to do business? Amex has concocted a scheme that efficiently and expensively drops the customers it need not worry about and keeps the ones that might have trouble paying what they owe. Brilliant.

Does this mean that the people who run Amex are idiots? Not necessarily. They are probably acting rationally and making what are, from their point of view, sound economic decisions. Wall Street wants them to improve their balance sheet and will pay them to do this, in the form of a higher stock price and lower borrowing costs. From this, the managers of Amex can do the math and work out that paying some customers, even relatively good ones, to get lost is profitable. The fact that this ought not to be the case, that the markets should not be rewarding Amex for doing something that actually harms itself, does not enter into the calculation.

This scheme may not be the ideal implementation of the lose customers to improve balance sheet strategy, e.g. I have trouble believing that offering everybody the same $300 is optimal, but it’s not a sign that the folks at Amex have lost their marbles. It is, however, a sign of the times. We currently live in a world where the appearance of improving a balance sheet outweighs the substance of shrinking a business.

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