The $300 billion housing bailout bill, currently stalled in Congress, promises to rescue homeowners and save the economy. Comprising the core of the bill is a $300 billion increase in FHA lending permitting banks to offload their riskiest mortgages onto American taxpayers in exchange for realizing losses that would be all but a certainty. In order to ensure there are sufficient special interests handouts to appease everyone, a new policy has been included that enables homeowners to deduct up to $1,000 in property taxes even if the homeowner does not itemize. Additionally, the bill provides money to local governments to buy foreclosed properties in an attempt to reduce “blight” and prop up the values of houses in depressed areas. All of these proposals may have noble intentions, but they are misguided pork-laden attempts at preventing further pain in the housing market.
Politicians, always quick with the handouts and forgetful of past mistakes, prefer to ignore the ineffectiveness of prior intervention, both by Congress and the Federal Reserve. The Federal Reserve lowered interest rates to 2% in order to support the housing market and ease the pains of the credit crunch. Aside from propelling inflation to lofty new heights, this policy has been relatively ineffective in stalling the free fall of the housing market. As a result, Congress sprung into action and authorized Freddie Mac and Fannie Mae to buy jumbo loans and increased their portfolio limits despite growing quarterly losses on their insured loans and low capital levels. The GSEs have seized upon this opportunity, not to expand their loan portfolio through new lending, but instead to repurchase loans that they insured but previously sold to investors. Therefore, this policy had little simulative effect on lending and failed to relieve the credit crunch facing homeowners. Instead of utilizing their congressional authority to buy jumbo loans, Fannie and Freddie have spent $32.4 billion to buy back their own securities compared to $244 million in jumbo loans.
The Federal Housing Authority (FHA), Congress’s new savior of the housing market, is backed by the government and should cover mortgage losses with the insurance premiums it collects. Unfortunately for taxpayers, the FHA has experienced mounting losses of its own, including a $4.6 billion loss last year. An attempt by the Clinton administration to expand FHA market share in 2000 by lowering insurance premiums to 1.5% from 2.25% has left the agency facing substantial shortfalls and delinquencies of 12-13% compared to 5-6% on all mortgages nationwide. A further expansion of FHA lending, especially precipitated by banks’ desire to offload their most risky loans, is a recipe for disaster and major taxpayer financed bailout. Congress’s proposed housing bill benefits builders and lenders more than homeowners by temporarily supporting housing prices and enabling banks to jettison their most risky loans. Banks and investors with significant exposure to mortgages and housing realize the potential bonanza this bill represents and have lobbied extensively. Lehman Brothers alone spent $190,000 in the first quarter of 2008 lobbying on behalf of this bill eagerly anticipating a bailout of billions of dollars of subprime securities that the investment bank owns.
Congress’ housing bailout bill is misguided and will ultimately prolong the housing crisis. It will prevent necessary market adjustments and postpone the realization of losses that must occur before housing can rebound. The FHA is one of the only intuitions offering 3% down payment loans and allowing seller financed down payment assistance effectively creating no money down loans. As can be expected, governmental institutions do not accurately appraise the consequences of their policies but instead focus on the short term political benefits of a decision. The housing market will rebound naturally once the homeowners that can’t afford their homes exit the market and banks realize all losses from the excesses of the housing boom. By offering new low down payment loans to homeowners that got in over their heads, Congress only prolongs the housing downturn by preventing necessary adjustments that will facilitate a return to normalcy in the housing and credit markets.
DIGG IT!
Sunday, June 29, 2008
Thursday, June 26, 2008
Alternative Energy: Panacea or Placebo?
Skyrocketing global demand and diminishing supply of oil has spawned an energy crisis that threatens economic growth and political stability. In order to secure access to critical energy resources, governments and corporations have sacrificed human rights, negotiated with terrorists, and bribed public officials (e.g. UN Oil for Food Program, Iraq’s invasion of Kuwait, etc.). The true cost of most sources of energy cannot be measured solely in dollar terms, but must also incorporate the environmental impact resulting from pollution, habitat destruction, and geological alteration. A growing movement towards “alternative energy” has emerged as wealthy nations consider the negative externalities of energy consumption as opposed to simply its financial cost. The allure of clean domestically produced energy warms the hearts of environmentalists, but it seems unlikely to pragmatists that a few windmills and solar panels can displace carbon based fuels.
Based on the Energy Information Administration of the U.S. Department of Energy (source), the U.S. derives 85% of its energy from fossil fuels comprised of 39% petroleum, 23% natural gas, and 23% coal. The remaining 15% of domestic energy is split between 8% nuclear and 7% renewable energy.
Digg It!
Based on the Energy Information Administration of the U.S. Department of Energy (source), the U.S. derives 85% of its energy from fossil fuels comprised of 39% petroleum, 23% natural gas, and 23% coal. The remaining 15% of domestic energy is split between 8% nuclear and 7% renewable energy.
Renewable energy is comprised of 36% hydroelectric power and 53% biomass, which primarily consists of ethanol. The remaining 11% consists of wind, solar, and geothermal power. Therefore, less than 0.8% of total U.S. energy consumption is derived from wind, geothermal, and solar.
The ability of renewable resources to displace fossil fuels as a meaningful source of energy appears limited. Despite billions in investment, wind power currently contributes less than 1% of the energy consumed in the U.S. While energy consultants suggest that wind power has the potential to contribute 5-7 percent of U.S. energy consumption, the inconsistency of wind and the limited distribution of suitable windy locales expose the structural inferiority of wind compared to fossil fuels as a source of energy. Even less promising, despite similar hype, is solar energy. Concentrating Solar Power, the most productive of solar technologies, requires a large geographic footprint and is only productive during daylight hours. While it holds promise as a supplement to traditional power generation during peak daytime hours, solar power is not capable of displacing fossil fuels due to its relative inefficiency, inability to produce an uninterrupted supply of energy, and extensive real estate requirements for the construction of a meaningful generating facility.
While more established than wind or solar, biofuels and hydroelectric energy have well documented consequences to mass production. Hydroelectric energy is capacity constrained due to the limited number of rivers that can be utilized for energy and has devastating side effects on marine life and wetlands ecosystems. Alternatively, biofuels have increased demand for agricultural commodities and the cost of food, spurring greater inflation throughout the economy and transferring wealth from the poor to large industrial farms. Despite decades of research and development, biofuels remain incapable of producing significantly greater energy output than consumed during production and are dependent on government subsidies and protectionism to support their existence. Any expansion of biofuel production starves other industries of essential commodity inputs and encourages a reallocation of agricultural production away from other crops, ultimately triggering dramatic price increases and system-wide inflation.
Renewable energy is an essential and growing contributor to the energy portfolio of the U.S. It is not, however, a viable replacement for fossil fuels. Instead of dreaming of a fantastical world of windmills and golden beams of sunshine powering our energy intensive economy, the U.S. would be better served by realistic policies that incorporate a greater percentage of nuclear power combined with domestically produced fossil fuels as a means of achieving energy independence. The wealthy may purchase carbon credits and alternative energy to allay their concerns of a destructive carbon footprint, but pragmatists realize that the global economy will be crippled, with the poor suffering disproportionately, without an expansion of nuclear and fossil fuel energy. Clean coal and nuclear technologies, both with viable long term prospects, are more worthy of government assistance than alternative energy proposals that are incapable of contributing meaningfully to our energy needs. The U.S., representing 25% of global energy demand, must wake up to the reality that an energy policy based solely on conservation and alternative energy is an unrealistic utopian notion that is causing rampant inflation, global economic tension, and personal financial hardship. The longer the problem is ignored, the more dangerous are the consequences.
Digg It!
Tuesday, June 24, 2008
America For Sale
History, once again, repeats itself. Prior to the crash of the Nikkei in the early 1990s, the acquisition of U.S. real estate and corporations by the Japanese was a source of substantial anxiety and prognostication of future economic dominance. The 1980s might have been the pinnacle of the Japanese economic revolution, but the speculation that propelled stock and real estate prices to lofty heights is similar to the mania that incited the technology and housing bubbles in the United States. Now, with real estate values depressed, the credit markets in turmoil, the dollar progressively weakening, and the stock market teetering on the breach, U.S. assets are attractive to foreign buyers prompting significant capital inflows. While foreign direct investment provides a substantial stabilizing force during a period of capital constriction, it also provokes deep consternation among a populace facing the potential for a deepening recession and extensive job losses.
The media has reported extensively on sovereign wealth funds which are state owned investment pools used to invest reserves and government funds in financial assets such as stocks, bonds, and real estate. The growing debate over sovereign wealth funds follows the 2006 controversy in which Dubai World, a company owned by the government of Dubai of the United Arab Emirates, acquired the Peninsular and Oriental Steam Navigation Company (P&O) of the United Kingdom along with the operating rights to six major U.S. port facilities. Congress expressed their innate protectionist bias and blocked the acquisition of the U.S. ports in the name of national security. The Dubai World controversy culminated a burgeoning trend of protectionism that arose in 2005 when Congress orchestrated the acquisition of Unocal (Union Oil Co. of California) by Chevron after the Chinese National Offshore Oil Corporation (CNOOC) made an aggressive bid for the company. Again, Congress opposed the acquisition based on the guise of national security as they ostensibly feared that China would hoard the oil resources to meet their growing demand.
In response to these failed attempts at foreign direct investment, governments resorted to sovereign wealth funds to invest assets primarily through investment managers and advisors around the globe. The unbridled consumerism in America leads to a persistent trade deficit leaving many trading partners flush with dollars. Additionally, the depreciation in the dollar combined with inflation in energy and commodities has exacerbated our trade deficit with many resource rich countries. As these countries amass stockpiles of dollar reserves and generate “windfall” profits through their state owned companies, government officials must evaluate their relative appetite for American goods and services versus financial and real assets. Historically, many of these countries invested their reserves in U.S. Treasury notes and bonds, but the current negative real interest rates encourage diversification of their portfolios.
Many sovereign wealth funds are deploying their reserves across a diverse set of investment vehicles including hedge funds, separately managed portfolios, private equity, and direct investment. As major banks deleverage by raising capital and selling assets to cope with the effects of the housing implosion, sovereign wealth funds have purchased direct stakes in many banks including a $7.5 billion investment in Citigroup by Abu Dhabi, the largest sovereign wealth fund at over $875bb in assets, and a $5 billion investment in Merrill Lynch by Singapore’s Temasek Holdings. Sovereign wealth funds, with assets totaling an estimated $3 trillion, have made more than $30 billion in direct investments in U.S. financial institutions. Generally, to avoid the ire of protectionists and the associated regulatory scrutiny, these funds have remained under the 5% ownership threshold and have forgone voting rights. Even so, the sovereign wealth funds’ growing direct investment in U.S. corporations and less transparent investment through hedge funds and separately managed accounts has raised public concern and prompted Congressional hearings.
Contrary to the populist movement towards a more insular economy, the United States should embrace the capital infusions provided by sovereign wealth funds during a credit crisis that ultimately claimed one of the largest investment banks in the country, Bear Stearns. The willingness to provide sizable capital infusions to the U.S. financial system in a time of crisis reflects a global confidence in the resilience and attractiveness of the American economy. Populist complaints reflect a desire to change the terms of the game, a common desire amongst a populace accustomed to bailouts and intervention (e.g. the proposed housing bill in Congress). The American people have mortgaged their futures for the sake of current consumption. It can only be expected that claimants, otherwise defined as the holders of dollars, will eventually collect by exchanging their dollars for U.S. goods and services, financial assets, and direct investment in corporations and real estate. America is for sale because the populace has an insatiable appetite for consumption that is checked neither by reason nor by income. Eventually, the risk premium for financing this consumption manifests itself in the form of higher nominal interest rates, inflation, and currency devaluation.
Ultimately, the global economic system relies on the belief that the dollar is readily exchangeable for U.S. goods, services, and assets. It has obtained global preeminence as a reserve currency due to the confidence in the property rights protections, financial stability, and credit of the United States. After decades of borrowing to finance an voracious appetite for consumption, the American debtor society must show restraint by reducing imports and paying down personal debt. Government policies against domestic drilling, nuclear and coal power plants, and refining capacity assure a dependence on foreign oil and the further mortgaging of America. Unless U.S. consumers redirect their income from excessive consumption to investment in domestic infrastructure, the United States will continue to rely on foreign capital and imported commodities to sustain our economy. And rest assured, this debt will eventually come due!
Digg It!
The media has reported extensively on sovereign wealth funds which are state owned investment pools used to invest reserves and government funds in financial assets such as stocks, bonds, and real estate. The growing debate over sovereign wealth funds follows the 2006 controversy in which Dubai World, a company owned by the government of Dubai of the United Arab Emirates, acquired the Peninsular and Oriental Steam Navigation Company (P&O) of the United Kingdom along with the operating rights to six major U.S. port facilities. Congress expressed their innate protectionist bias and blocked the acquisition of the U.S. ports in the name of national security. The Dubai World controversy culminated a burgeoning trend of protectionism that arose in 2005 when Congress orchestrated the acquisition of Unocal (Union Oil Co. of California) by Chevron after the Chinese National Offshore Oil Corporation (CNOOC) made an aggressive bid for the company. Again, Congress opposed the acquisition based on the guise of national security as they ostensibly feared that China would hoard the oil resources to meet their growing demand.
In response to these failed attempts at foreign direct investment, governments resorted to sovereign wealth funds to invest assets primarily through investment managers and advisors around the globe. The unbridled consumerism in America leads to a persistent trade deficit leaving many trading partners flush with dollars. Additionally, the depreciation in the dollar combined with inflation in energy and commodities has exacerbated our trade deficit with many resource rich countries. As these countries amass stockpiles of dollar reserves and generate “windfall” profits through their state owned companies, government officials must evaluate their relative appetite for American goods and services versus financial and real assets. Historically, many of these countries invested their reserves in U.S. Treasury notes and bonds, but the current negative real interest rates encourage diversification of their portfolios.
Many sovereign wealth funds are deploying their reserves across a diverse set of investment vehicles including hedge funds, separately managed portfolios, private equity, and direct investment. As major banks deleverage by raising capital and selling assets to cope with the effects of the housing implosion, sovereign wealth funds have purchased direct stakes in many banks including a $7.5 billion investment in Citigroup by Abu Dhabi, the largest sovereign wealth fund at over $875bb in assets, and a $5 billion investment in Merrill Lynch by Singapore’s Temasek Holdings. Sovereign wealth funds, with assets totaling an estimated $3 trillion, have made more than $30 billion in direct investments in U.S. financial institutions. Generally, to avoid the ire of protectionists and the associated regulatory scrutiny, these funds have remained under the 5% ownership threshold and have forgone voting rights. Even so, the sovereign wealth funds’ growing direct investment in U.S. corporations and less transparent investment through hedge funds and separately managed accounts has raised public concern and prompted Congressional hearings.
Contrary to the populist movement towards a more insular economy, the United States should embrace the capital infusions provided by sovereign wealth funds during a credit crisis that ultimately claimed one of the largest investment banks in the country, Bear Stearns. The willingness to provide sizable capital infusions to the U.S. financial system in a time of crisis reflects a global confidence in the resilience and attractiveness of the American economy. Populist complaints reflect a desire to change the terms of the game, a common desire amongst a populace accustomed to bailouts and intervention (e.g. the proposed housing bill in Congress). The American people have mortgaged their futures for the sake of current consumption. It can only be expected that claimants, otherwise defined as the holders of dollars, will eventually collect by exchanging their dollars for U.S. goods and services, financial assets, and direct investment in corporations and real estate. America is for sale because the populace has an insatiable appetite for consumption that is checked neither by reason nor by income. Eventually, the risk premium for financing this consumption manifests itself in the form of higher nominal interest rates, inflation, and currency devaluation.
Ultimately, the global economic system relies on the belief that the dollar is readily exchangeable for U.S. goods, services, and assets. It has obtained global preeminence as a reserve currency due to the confidence in the property rights protections, financial stability, and credit of the United States. After decades of borrowing to finance an voracious appetite for consumption, the American debtor society must show restraint by reducing imports and paying down personal debt. Government policies against domestic drilling, nuclear and coal power plants, and refining capacity assure a dependence on foreign oil and the further mortgaging of America. Unless U.S. consumers redirect their income from excessive consumption to investment in domestic infrastructure, the United States will continue to rely on foreign capital and imported commodities to sustain our economy. And rest assured, this debt will eventually come due!
Digg It!
Monday, June 23, 2008
A Losing Battle: Inflation Takes Control
While the effects of the housing market implosion continue to ripple throughout the economy, the Federal Reserve resorts to its favorite bailout strategy of cutting the fed funds target rate. The slightest sign of weakness in the US economy prompts the Fed to blindly jump to action even as more prudent heads prevail in Europe. Both the bailout of the technology bubble and the ongoing rescue of the housing implosion injected massive amounts of liquidity into the economy leading to market distorting behavior. The original liquidity infusion following the bursting of the tech bubble started the dollar on the slippery slope of devaluation against the world’s major currencies. Weakness in the dollar combined with the global commodities boom resulting from the industrial emergence of China and India have affected a dramatic rise in core inflation that further threatens our fragile economic stability.
The structural imbalances of large trade deficits and significantly lower domestic interest rates debase the value of the dollar. As the dollar weakens, our globally integrated economy suffers as goods and services procured from overseas operations become more expensive to dollar based consumers. The raw materials, manufactured goods, and energy resources that are obtained from our trading partners around the world are ingrained in the American economy with suitable alternatives not immediately available. Large capital investments and extensive human resource development would be required to provide substitutes for the products and services that we import. Such endeavors would require years of investment, deferring any anti-inflationary effects and mitigating the benefits of a reallocation of resources.
The rapid growth in emerging market economies combined with a lack of foresight and planning by the largest energy consumer, the United States, has seriously constrained the system and destabilized global prices. While politicians try to deflect the blame by “investigating” price manipulation, speculator impact, and “excessive” corporate profits, they are neglecting any real solutions and postponing serious responses to the problem. Environmentalists and politicians prefer to focus on “alternative energy” while ignoring the fact that, despite significant investment, wind power contributes only 1% and solar 0.01% to electricity production. This suggests that there are no realistic short term alternatives to carbon based and nuclear energy. The growing demand for scarce resources, which will only accelerate with China and India’s ongoing industrial revolutions, is a threat to global economic stability and subjects economies to drastic price shocks in commodities and energy. The price of coal is up over 6% since the beginning of June and instability around the globe threatens oil supplies from the Middle East and Africa. Additionally, the U.S. uses 10-20 times more oil per capita than developing countries such as China and India portending significant future demand as these nations further develop and desire energy intensive “luxury” goods. Absent domestic responses to these issues, the stability of the United States’ economy will continue to erode with greater risk of price spikes, rolling blackouts, rationing, and hoarding of basic commodities and resources.
In order to combat the growing threat of dependence on unstable regimes for the lifeblood of our economy, it is essential that the United States make significant domestic investments in a diversified energy portfolio and eliminate sources of inefficiency in the global market for food and agricultural commodities (e.g. import barriers, farm subsidies, quotas). Despite opposition from various activist groups, policymakers must approve and facilitate the construction of new nuclear and clean coal power plants to leverage our domestic energy resources. Alternative energy resources such as waste to energy facilities and wind power should continue to be encouraged as a means of utilizing natural sources of energy in a more efficient manner. With the United States’ electric grid operating in fragile balance and new electric production capacity trailing demand increases, electricity will likely become the next commodity to inflict serious economic damage. The regulated nature of the electric utility industry limits participants’ ability to respond to market forces through investment in new facilities or through market based pricing. The fragility of the electricity grid is disguised by excessive regulation which will lead to significant bankruptcies, operational disruptions, and system failures if wholesale energy prices were to spike again as they did in the early part of this decade.
The political agendas of misguided special interest groups combined with a lack of initiative in Congress has led to a global commodities and energy crisis that threatens economic stability and increases inflationary pressures. While many companies have resisted the urge to pass along costs increases to the end consumer, they are no longer able to absorb the growing costs that result from commodity and energy price spikes as well as increases in raw materials import prices. Cost push inflation is growing at a rapid pace as demonstrated by dramatic increases in airline ticket prices, grocery bills, shipping costs, and gasoline prices. These costs will continue to trickle through the economy and, when combined with higher import costs, seriously debase American consumers’ spending power at a time when they are suffering from the housing crisis and dramatic constrictions in the access to credit. Political leaders must stand up to special interest lobbies and enact a comprehensive energy policy that focuses on energy independence, infrastructure investment, and diversity in procurement. Additionally, the Fed needs to raise interest rates to protect the dollar despite further risk to economic growth. Failure to address these issues will relegate the U.S. economy to substandard growth, increasing inflation, and regular price spikes and supply disruptions in both energy and food commodities.
DIGG IT!
The structural imbalances of large trade deficits and significantly lower domestic interest rates debase the value of the dollar. As the dollar weakens, our globally integrated economy suffers as goods and services procured from overseas operations become more expensive to dollar based consumers. The raw materials, manufactured goods, and energy resources that are obtained from our trading partners around the world are ingrained in the American economy with suitable alternatives not immediately available. Large capital investments and extensive human resource development would be required to provide substitutes for the products and services that we import. Such endeavors would require years of investment, deferring any anti-inflationary effects and mitigating the benefits of a reallocation of resources.
The rapid growth in emerging market economies combined with a lack of foresight and planning by the largest energy consumer, the United States, has seriously constrained the system and destabilized global prices. While politicians try to deflect the blame by “investigating” price manipulation, speculator impact, and “excessive” corporate profits, they are neglecting any real solutions and postponing serious responses to the problem. Environmentalists and politicians prefer to focus on “alternative energy” while ignoring the fact that, despite significant investment, wind power contributes only 1% and solar 0.01% to electricity production. This suggests that there are no realistic short term alternatives to carbon based and nuclear energy. The growing demand for scarce resources, which will only accelerate with China and India’s ongoing industrial revolutions, is a threat to global economic stability and subjects economies to drastic price shocks in commodities and energy. The price of coal is up over 6% since the beginning of June and instability around the globe threatens oil supplies from the Middle East and Africa. Additionally, the U.S. uses 10-20 times more oil per capita than developing countries such as China and India portending significant future demand as these nations further develop and desire energy intensive “luxury” goods. Absent domestic responses to these issues, the stability of the United States’ economy will continue to erode with greater risk of price spikes, rolling blackouts, rationing, and hoarding of basic commodities and resources.
In order to combat the growing threat of dependence on unstable regimes for the lifeblood of our economy, it is essential that the United States make significant domestic investments in a diversified energy portfolio and eliminate sources of inefficiency in the global market for food and agricultural commodities (e.g. import barriers, farm subsidies, quotas). Despite opposition from various activist groups, policymakers must approve and facilitate the construction of new nuclear and clean coal power plants to leverage our domestic energy resources. Alternative energy resources such as waste to energy facilities and wind power should continue to be encouraged as a means of utilizing natural sources of energy in a more efficient manner. With the United States’ electric grid operating in fragile balance and new electric production capacity trailing demand increases, electricity will likely become the next commodity to inflict serious economic damage. The regulated nature of the electric utility industry limits participants’ ability to respond to market forces through investment in new facilities or through market based pricing. The fragility of the electricity grid is disguised by excessive regulation which will lead to significant bankruptcies, operational disruptions, and system failures if wholesale energy prices were to spike again as they did in the early part of this decade.
The political agendas of misguided special interest groups combined with a lack of initiative in Congress has led to a global commodities and energy crisis that threatens economic stability and increases inflationary pressures. While many companies have resisted the urge to pass along costs increases to the end consumer, they are no longer able to absorb the growing costs that result from commodity and energy price spikes as well as increases in raw materials import prices. Cost push inflation is growing at a rapid pace as demonstrated by dramatic increases in airline ticket prices, grocery bills, shipping costs, and gasoline prices. These costs will continue to trickle through the economy and, when combined with higher import costs, seriously debase American consumers’ spending power at a time when they are suffering from the housing crisis and dramatic constrictions in the access to credit. Political leaders must stand up to special interest lobbies and enact a comprehensive energy policy that focuses on energy independence, infrastructure investment, and diversity in procurement. Additionally, the Fed needs to raise interest rates to protect the dollar despite further risk to economic growth. Failure to address these issues will relegate the U.S. economy to substandard growth, increasing inflation, and regular price spikes and supply disruptions in both energy and food commodities.
DIGG IT!
Thursday, June 19, 2008
Caught in the Crunch? Try Peer to Peer Lending
It is no secret that the demise of the housing boom and seizures in the debt markets have led to a constriction of credit leaving many cash strapped borrowers scrambling for funds. The ongoing de-leveraging of bank balance sheets combined with the lack of liquidity for securitized debt has forced banks to limit loans to only the most trustworthy borrowers. An alternative that has emerged in the past few years is “peer to peer” lending. This can be generally defined as an individual or collective group lending to another individual. One of the pioneers in this fledgling industry is Prosper.
Prosper is a web site founded by the former CEO and founder of E-Loan that facilitates personal loans of up to $25,000 negotiated between potential borrowers and lenders. The lenders bid on a portion of a loan, with a minimum bid of $50, in a Dutch auction format where the clearing rate on the funded loan is the highest reserve rate of the winning bidders. Thus, hundreds of lenders could jointly fund a loan to a single borrower. Borrowers are evaluated based on credit statistics provided and verified by Prosper, but only summary level data is displayed as opposed to a full credit report. A wide range of borrowers request loans for business investment, loan consolidation, real estate improvement, or other expenses. All of the loans are unsecured personal loans so lenders have no collateral and limited recourse in the event of default.
I have been a lender on Prosper since spring 2007 and have reviewed loan performance extensively. Lenders must be cognizant of the potential for adverse selection as borrowers will most likely exhaust all conventional sources of funds prior to resorting to Prosper. The limited credit reporting does not allow lenders to delve into payment histories, credit usage, and debt distribution across loan types. Therefore, one is making credit decisions based on a Prosper credit rating, summary credit data, and the borrower’s self description. It is possible to identify viable loan options, but it requires significant investigation and review. Thus far, I have completed 14 loans with two paying off early. Of the remaining twelve, two have been over 30 days late at least once and one is habitually late, but it always cures. I have earned an annualized return of more than 14%, but a single default could quickly wipe out all returns to date (View My Loan Portfolio). In fact, most lenders with seasoned loans have very low or negative returns. Focus on higher credit quality borrowers with no public records and no recent late payments. Lending on Prosper presents an asymmetric return proposition with the upside limited to the stated interest rate (after Prosper’s servicing fees) while the downside is only limited by the remaining outstanding principal.
If you are a borrower, it is essential that you provide an in depth and accurate description for why you are borrowing the money, how you intend to repay the loan, and your current financial situation. Any lender that thoroughly vets borrowers will quickly see through poor applications and you will not get funded. Frequently, loans by self employed borrowers or those with difficult to verify details are cancelled by Prosper after fully funding. This is a frustrating phenomenon for both the borrower and the lender as significant time and resources have been invested. If your income, employment history, or other details lack reasonable corroboration, it is better to understate these characteristics in order to facilitate the funding of your loan. It is also advisable to set your initial loan rate as high as possible. If you are a qualified borrower, your loan will quickly be funded and your rate will be bid down. Once lenders have invested the time to research your loan, they will be more hesitant to walk away a loser. The sunk costs of researching your loan application combined with an intrinsic desire not to lose leads most bidders to experience escalating commitment resulting in lower borrowing costs. Rates that average 8-10% for high quality borrowers and more than 30% for high risk borrowers are common.
Peer to peer lending possesses the promise of revolutionizing the lending industry. Until the credit summary provides a more complete picture and the borrower proffered details are vetted in advance, the full promise of peer to peer lending will fail to be realized. Peer to peer lending is a growing industry that is must continue to innovate and refine the process in order to realize its potential. In the mean time, borrowers and lenders alike may mutually agree to terms that provide much needed liquidity in the credit markets.
NOTE: This is not to be construed as financial advice, investment guidance, or a recommendation. I have previously loaned funds on Prosper, but I am currently evaluating the potential investment returns that can be realized. The insufficient loan and payment history makes comparison and evaluation on a broad scale difficult. Returns will likely differ from that which I have achieved thus far (most likely lower) and my returns could change at any time with defaults. Please do your own homework prior to making any lending decisions, and consider talking to a financial planner or debt counselor prior to borrowing additional funds on Prosper.
DIGG IT
Prosper is a web site founded by the former CEO and founder of E-Loan that facilitates personal loans of up to $25,000 negotiated between potential borrowers and lenders. The lenders bid on a portion of a loan, with a minimum bid of $50, in a Dutch auction format where the clearing rate on the funded loan is the highest reserve rate of the winning bidders. Thus, hundreds of lenders could jointly fund a loan to a single borrower. Borrowers are evaluated based on credit statistics provided and verified by Prosper, but only summary level data is displayed as opposed to a full credit report. A wide range of borrowers request loans for business investment, loan consolidation, real estate improvement, or other expenses. All of the loans are unsecured personal loans so lenders have no collateral and limited recourse in the event of default.
I have been a lender on Prosper since spring 2007 and have reviewed loan performance extensively. Lenders must be cognizant of the potential for adverse selection as borrowers will most likely exhaust all conventional sources of funds prior to resorting to Prosper. The limited credit reporting does not allow lenders to delve into payment histories, credit usage, and debt distribution across loan types. Therefore, one is making credit decisions based on a Prosper credit rating, summary credit data, and the borrower’s self description. It is possible to identify viable loan options, but it requires significant investigation and review. Thus far, I have completed 14 loans with two paying off early. Of the remaining twelve, two have been over 30 days late at least once and one is habitually late, but it always cures. I have earned an annualized return of more than 14%, but a single default could quickly wipe out all returns to date (View My Loan Portfolio). In fact, most lenders with seasoned loans have very low or negative returns. Focus on higher credit quality borrowers with no public records and no recent late payments. Lending on Prosper presents an asymmetric return proposition with the upside limited to the stated interest rate (after Prosper’s servicing fees) while the downside is only limited by the remaining outstanding principal.
If you are a borrower, it is essential that you provide an in depth and accurate description for why you are borrowing the money, how you intend to repay the loan, and your current financial situation. Any lender that thoroughly vets borrowers will quickly see through poor applications and you will not get funded. Frequently, loans by self employed borrowers or those with difficult to verify details are cancelled by Prosper after fully funding. This is a frustrating phenomenon for both the borrower and the lender as significant time and resources have been invested. If your income, employment history, or other details lack reasonable corroboration, it is better to understate these characteristics in order to facilitate the funding of your loan. It is also advisable to set your initial loan rate as high as possible. If you are a qualified borrower, your loan will quickly be funded and your rate will be bid down. Once lenders have invested the time to research your loan, they will be more hesitant to walk away a loser. The sunk costs of researching your loan application combined with an intrinsic desire not to lose leads most bidders to experience escalating commitment resulting in lower borrowing costs. Rates that average 8-10% for high quality borrowers and more than 30% for high risk borrowers are common.
Peer to peer lending possesses the promise of revolutionizing the lending industry. Until the credit summary provides a more complete picture and the borrower proffered details are vetted in advance, the full promise of peer to peer lending will fail to be realized. Peer to peer lending is a growing industry that is must continue to innovate and refine the process in order to realize its potential. In the mean time, borrowers and lenders alike may mutually agree to terms that provide much needed liquidity in the credit markets.
NOTE: This is not to be construed as financial advice, investment guidance, or a recommendation. I have previously loaned funds on Prosper, but I am currently evaluating the potential investment returns that can be realized. The insufficient loan and payment history makes comparison and evaluation on a broad scale difficult. Returns will likely differ from that which I have achieved thus far (most likely lower) and my returns could change at any time with defaults. Please do your own homework prior to making any lending decisions, and consider talking to a financial planner or debt counselor prior to borrowing additional funds on Prosper.
DIGG IT
Wednesday, June 18, 2008
The Demand for Drilling
Not since the years of Jimmy Carter has the United States faced a greater energy crisis. While there are no shortages at the pump or plans to ration supplies, our nation’s neglect of energy infrastructure combined with a collective “not in my backyard” mentality has sentenced us to dependence on unstable and hostile regimes around the world. With supply and demand in such fragile balance, any political instability, terrorist attack, or shift in diplomatic relations could quickly send oil prices soaring further crippling our economy. We need more domestic drilling and we need it now.
In an attempt to bailout the credit crisis, the Federal Reserve has lowered its fed funds target interest rate to two percent. This has fueled a surge in inflation, debased our currency, and further precipitated the rise in the cost of oil. Opposition to domestic drilling by environmentalists has channeled government policy into “alternative energy” and led to the promotion and subsidization of corn based ethanol. As a result, commodity farm prices have soared as farmers shift production to corn while reducing acreage of wheat or soybeans. Ethanol has done little to solve our energy problems, but has further fueled core inflation in essential products such as food and energy. Combined with the tightening of credit following the mortgage and housing implosion, the increase in core inflation hits middle class consumers particularly hard and results in a significantly lower quality of living.
While alternative energy is the future, it will take years of additional research and development before any revolutionary technologies become available at affordable costs to consumers. Additionally, the high network and infrastructure barriers facing automobile producers create an uncertain environment and encourage innovation based on petroleum derived fuels. Honda’s new FCX Clarity fuel cell vehicle is a promising new technology, but the structural barriers facing innovative and revolutionary change discourage the allocation of capital to research and development. Mass production and distribution of hydrogen fuel cell vehicles is decades away and face significant barriers to widespread adoption. Despite much hype there are only 38 hydrogen fuel stations in California, with many of these owned and operated by the state, universities, or automobile manufacturers. Without significant infrastructure investment, consumers will be hesitant to buy such vehicles, but it is unlikely that current gas station owners will invest in hydrogen distribution without strong consumer demand. Ethanol fuel, known as E85, is a perfect example. Even with mass production and distribution of flex fuel vehicles, a very small percentage of gas stations sell E85 fuel. The substantial barriers imposed by the network externalities of alternative fuel technologies will create a significant impediment to mass adoption.
Despite optimistic projections by environmentalist groups, the ability of alternative energy to provide for our needs is limited without significant improvements in efficiency and conservation. These developments will take many decades before they are refined into commercially viable alternatives suggesting that further exploration and development of petroleum resources is required. Virtually all sources of domestic production have been off limits for more than 20 years. Congress has thwarted President Bush’s efforts to increase domestic drilling and develop a comprehensive energy policy, greatly contributing to the energy crisis that exists today. Until we develop the vast proven reserves in Alaska, the outer continental shelf, and shale formations in the West, we will continue to depend on others for critical energy needs. The lead time for diversifying our energy portfolio and constructing new facilities is significant, making us even more vulnerable to unstable foreign regimes and subject to growing competition for scarce resources. The time for action is upon us. Any further delays could lead us back to the dark ages – literally!
DIGG IT!
In an attempt to bailout the credit crisis, the Federal Reserve has lowered its fed funds target interest rate to two percent. This has fueled a surge in inflation, debased our currency, and further precipitated the rise in the cost of oil. Opposition to domestic drilling by environmentalists has channeled government policy into “alternative energy” and led to the promotion and subsidization of corn based ethanol. As a result, commodity farm prices have soared as farmers shift production to corn while reducing acreage of wheat or soybeans. Ethanol has done little to solve our energy problems, but has further fueled core inflation in essential products such as food and energy. Combined with the tightening of credit following the mortgage and housing implosion, the increase in core inflation hits middle class consumers particularly hard and results in a significantly lower quality of living.
While alternative energy is the future, it will take years of additional research and development before any revolutionary technologies become available at affordable costs to consumers. Additionally, the high network and infrastructure barriers facing automobile producers create an uncertain environment and encourage innovation based on petroleum derived fuels. Honda’s new FCX Clarity fuel cell vehicle is a promising new technology, but the structural barriers facing innovative and revolutionary change discourage the allocation of capital to research and development. Mass production and distribution of hydrogen fuel cell vehicles is decades away and face significant barriers to widespread adoption. Despite much hype there are only 38 hydrogen fuel stations in California, with many of these owned and operated by the state, universities, or automobile manufacturers. Without significant infrastructure investment, consumers will be hesitant to buy such vehicles, but it is unlikely that current gas station owners will invest in hydrogen distribution without strong consumer demand. Ethanol fuel, known as E85, is a perfect example. Even with mass production and distribution of flex fuel vehicles, a very small percentage of gas stations sell E85 fuel. The substantial barriers imposed by the network externalities of alternative fuel technologies will create a significant impediment to mass adoption.
Despite optimistic projections by environmentalist groups, the ability of alternative energy to provide for our needs is limited without significant improvements in efficiency and conservation. These developments will take many decades before they are refined into commercially viable alternatives suggesting that further exploration and development of petroleum resources is required. Virtually all sources of domestic production have been off limits for more than 20 years. Congress has thwarted President Bush’s efforts to increase domestic drilling and develop a comprehensive energy policy, greatly contributing to the energy crisis that exists today. Until we develop the vast proven reserves in Alaska, the outer continental shelf, and shale formations in the West, we will continue to depend on others for critical energy needs. The lead time for diversifying our energy portfolio and constructing new facilities is significant, making us even more vulnerable to unstable foreign regimes and subject to growing competition for scarce resources. The time for action is upon us. Any further delays could lead us back to the dark ages – literally!
DIGG IT!
Monday, June 16, 2008
Social Bias in the Workplace
Bias, either conscious or subconscious, dominates decision-making and perceptions of others. Whether it is stereotypes, ethnocentrism, or socialized preferences, humans are prone to making errors in judgment and biased decisions that, in the aggregate, tend to promote the status quo and restrict opportunities. Social norms are institutionalized by the successful and powerful in society creating barriers to ascending the socio-economic ladder. Without a conscious effort to eliminate all forms of bias, society will continue to preclude the advancement of the underprivileged and promote a false “diversity” in our organizations.
Young children are a blank slate of opportunity, full of promise and potential. They are influenced by social interaction and parental conditioning in their development of a sense of self as well as their perceptions of others. These values are perpetuated throughout their lives, influencing the social norms that dictate the success of every ethnic group or social class. While most businesses, organizations, and politicians superficially promote diversity and unbiased decision-making, it is impossible to divorce the ingrained perceptions and prejudices from highly subjective decisions.
Admission policies at elite schools in America are dominated by cronyism and bias. Family heritage, financial donations, and “diversity goals” are more significant factors in the process than academic achievement and future potential. Academic institutions further socialize students, ingraining in them a thought process that is often based more on self affirmation and self aggrandizement than higher education. As a result of their “prestigious” heritage, these students often receive preferential appointments and ultimately dictate access to important entry level positions that are critical to careers in many industries. The majority of gifted students, either due to a lack of financial resources or a personal heritage that deviates from the model Ivy League profile, find themselves at public universities and colleges receiving a rigorous education second to none.
Once the chosen elite have established their sphere of control, the years of socialization and conditioning emerge as a self preservation and self affirmation mechanism. Years of conditioning led these individuals to believe that they are the chosen few that are destined for power and greatness. Biases favoring candidates, colleagues, and associates that resemble themselves dominate any assessment of merit or potential. Examples proliferate, including the relative dearth of women on Wall Street, the disproportionate concentration of Indians and Chinese in engineering, and a parochial view of the ideal candidate.
Despite a broad base of qualified women candidates, the investment banking and finance industry continues to be an egotistical male dominated society. A preference for preservation of the “old boys” frat life culture of most investment banks combined with a strong aversion to emasculation by successful and powerful women leads to a distinct gender bias on Wall Street. Alternatively, the engineering industry is dominated by immigrants, with a high proportion of Indian and Chinese descent. This phenomenon is likely due, at least in part, to a degree of ethnocentrism and bias towards providing opportunities for young immigrants. The suppression of wages and tight social networks that emerge from a significant concentration of immigrant employees creates a perception of employment barriers and a lack of desirability among native employees. Finally, many managers and senior executives have a need for self affirmation through confirmation that their schooling, career path, and achievements were justified. In order to reinforce these beliefs, they pursue candidates of similar background and pedigree, once again perpetuating the status quo and a singular ingrained set of beliefs.
Bias in society is a viciously brutal phenomenon that destroys dreams and fosters resentment. Even programs designed to reduce bias, such as affirmative action, often lead to a perception that the gifted are the beneficiaries of preferential treatment while the underperformers displace other more qualified candidates from other groups. The United States will continue to perpetuate a bourgeoisie class until society embraces values of inclusion, objective acceptance, and equality. In the interim, resentment and frustration will continue to fester among the resulting proletariat class as they suffer from a lack of fulfillment and underachievement while the bourgeoisie strengthen their control over the wealth and keys to success. It is a sad commentary on America if success is determined by one’s ability to suppress the unique experiences, interests, and beliefs that distinguish one’s personality in favor of morphing into the stereotypical “ideal candidate” defined by a collective group of well conditioned drones whose only claim to power is the school they attended or the pedigree of their father.
DIGG IT!
Young children are a blank slate of opportunity, full of promise and potential. They are influenced by social interaction and parental conditioning in their development of a sense of self as well as their perceptions of others. These values are perpetuated throughout their lives, influencing the social norms that dictate the success of every ethnic group or social class. While most businesses, organizations, and politicians superficially promote diversity and unbiased decision-making, it is impossible to divorce the ingrained perceptions and prejudices from highly subjective decisions.
Admission policies at elite schools in America are dominated by cronyism and bias. Family heritage, financial donations, and “diversity goals” are more significant factors in the process than academic achievement and future potential. Academic institutions further socialize students, ingraining in them a thought process that is often based more on self affirmation and self aggrandizement than higher education. As a result of their “prestigious” heritage, these students often receive preferential appointments and ultimately dictate access to important entry level positions that are critical to careers in many industries. The majority of gifted students, either due to a lack of financial resources or a personal heritage that deviates from the model Ivy League profile, find themselves at public universities and colleges receiving a rigorous education second to none.
Once the chosen elite have established their sphere of control, the years of socialization and conditioning emerge as a self preservation and self affirmation mechanism. Years of conditioning led these individuals to believe that they are the chosen few that are destined for power and greatness. Biases favoring candidates, colleagues, and associates that resemble themselves dominate any assessment of merit or potential. Examples proliferate, including the relative dearth of women on Wall Street, the disproportionate concentration of Indians and Chinese in engineering, and a parochial view of the ideal candidate.
Despite a broad base of qualified women candidates, the investment banking and finance industry continues to be an egotistical male dominated society. A preference for preservation of the “old boys” frat life culture of most investment banks combined with a strong aversion to emasculation by successful and powerful women leads to a distinct gender bias on Wall Street. Alternatively, the engineering industry is dominated by immigrants, with a high proportion of Indian and Chinese descent. This phenomenon is likely due, at least in part, to a degree of ethnocentrism and bias towards providing opportunities for young immigrants. The suppression of wages and tight social networks that emerge from a significant concentration of immigrant employees creates a perception of employment barriers and a lack of desirability among native employees. Finally, many managers and senior executives have a need for self affirmation through confirmation that their schooling, career path, and achievements were justified. In order to reinforce these beliefs, they pursue candidates of similar background and pedigree, once again perpetuating the status quo and a singular ingrained set of beliefs.
Bias in society is a viciously brutal phenomenon that destroys dreams and fosters resentment. Even programs designed to reduce bias, such as affirmative action, often lead to a perception that the gifted are the beneficiaries of preferential treatment while the underperformers displace other more qualified candidates from other groups. The United States will continue to perpetuate a bourgeoisie class until society embraces values of inclusion, objective acceptance, and equality. In the interim, resentment and frustration will continue to fester among the resulting proletariat class as they suffer from a lack of fulfillment and underachievement while the bourgeoisie strengthen their control over the wealth and keys to success. It is a sad commentary on America if success is determined by one’s ability to suppress the unique experiences, interests, and beliefs that distinguish one’s personality in favor of morphing into the stereotypical “ideal candidate” defined by a collective group of well conditioned drones whose only claim to power is the school they attended or the pedigree of their father.
DIGG IT!
Sunday, June 15, 2008
Education and Immigration in America
Education in America
The political rumblings about the American education system can be felt from coast to coast, but no one can deny the global superiority of the colleges and universities in the United States. Every year more than two hundred thousand foreign students study at American universities because of the strong primary research, world renowned faculty, and incredible facilities. There are more than 150,000 college students from China and India alone, with all of them hoping for a great education and a chance for a better life. While some of these foreign students inevitably plan on studying in the US and returning to jobs at home, the appeal of the opportunities and lifestyle that can be attained by working in the United States is too great for the vast majority. After years of study, new friendships, and adapted lifestyles, many students would find leaving the U.S. to be difficult and possibly a sign of failure.
It is often reported that relatively few American students pursue careers in engineering or computer science compared to students in Asia or India. The vast majority of students in these fields, both at American and foreign universities, are non-Americans with the Chinese and Indians dominating these fields. Pundits rationalize this phenomenon by asserting that an inferiority of primary and secondary math and science education in the United States leads to poor preparation for technical careers. Thus, the critics profess, American students either choose less rigorous fields or are unable to compete in the global marketplace for engineering talent. The possibility that American students make rational informed decisions regarding their career prospects is often ignored, and instead focus is placed on the perceived disparity in primary education.
The Case for Immigration
Facing a void of native born engineering talent, American companies clamor for foreign born engineering and computer science talent. The cries for an expansion of the H-1B visa program, a non-immigrant visa for skilled workers in specialty occupations, grows louder as the quota of available visas is depleted at an accelerating rate. Employers, on behalf of their foreign employees, can apply for these three year visas (with a possibility for a three year extension) regardless of the availability of qualified local talent. Once an employee obtains an H-1B visa, he or she can apply for a green card and attempt to obtain permanent legal status.
For foreign students educated in the United States, the acquisition of an H-1B visa is the first step towards achieving their goals of permanent residency and a better life. Employees quickly learn that this visa does not come without a price. Immediately, the employee becomes dependent upon his employer for his right to reside in the United States much as slaves depend on their masters. The desperate quest to secure employment after school leads many immigrants to accept below market salaries or less interesting work due to the conveyed value of the visa. Once employment is accepted, the foreign worker can often be exploited and abused due to the structural restrictions on job mobility. If an employee wished to leave her current employer, she would have to find another employer willing to sponsor her for an H-1B visa and must ensure continuity of employment. More than 10 days of unemployment violates the terms of the visa and results in eviction of the employee from the United States.
From the employer’s perspective, the characteristics of the visa program lead to very desirable employees that will often ignore employer abuses and expect less compensation while effecting low turnover rates, higher levels of productivity, and greater stability. The constant threat of involuntary termination leads foreign workers to exhibit very cooperative behavior as they understand the penalties for pursuing greater rights within the workplace. It is no mystery why employers embrace the H-1B visa program. They obtain cheap labor trained at the best US schools and willing to subjugate their needs to that of their employer. Compared to the more demanding and highly mobile native born employee, skilled immigrant labor in the United States has impaired free will, less career flexibility, and little negotiating power leading to abuse and exploitation.
The indentured servitude of skilled H-1B workers differs little from the exploitation of illegal aliens in the United States except for the implied Congressional approval. In both cases, American workers suffer due to depressed wage rates, poorer working conditions, and reduced career opportunities. One’s career success is often dependent on the learning opportunities in the formative years, yet the exploitation of foreign workers for the sake of greater profits restricts access to entry level positions for many Americans. The wide predominance of foreign born workers in occupations such as engineering and computer science combined with rampant outsourcing leads Americans to perceive these jobs as less stable and financial rewarding. Employers have secured a workforce of submissive highly trained employees that, through the conveyance of visa and residency benefits, suppress the average salary and make the positions less desirable to capable intelligent Americans.
Conclusions
While skilled foreign workers fill essential roles at American employers, the current immigration policies are flawed in their bias towards exploitation of immigrants at the expense of both the immigrant and the American workforce. Companies are not required to identify the best candidate or ensure that there is no qualified American that can fill the position. It is against the law, however, to pay the foreign workers less than the prevailing wage rate and use these workers to displace non-immigrant workers. Compliance monitoring is week at best, and attempts to litigate violations of the law have often resulted in court ordered reforms rather than monetary damages (see Santiglia v. Sun Microsystems 2005 Decision). Until modifications to existing laws are enacted which prohibit the displacement of qualified American workers and provide greater rights to immigrants with visas, both parties will be disadvantaged while executive management and the wealthy elite are enriched at their expense.
DIGG IT!
Thursday, June 12, 2008
The Dirt on Housing
The public and politicians alike have cast accusatory aspersions on a myriad of people, groups, and companies for the current state of the housing market. In an attempt to add to the noise, let’s examine some of the primary factors that have fueled the boom and precipitated the bust in housing.
The Federal Reserve
Home of the celebrated Alan Greenspan and his replacement Ben Bernanke, the Federal Reserve has probably done more to precipitate the boom and bust in housing than any other source. Their actions provided the raw fuel – easy money – that their coconspirators needed to set the wheels in motion. As the economy strengthened following the recession of the early 1990s, the Fed raised rates to a range of 5-6% for much of the decade. The technology boom was creating vast “wealth” and Greenspan was warning of “irrational exuberance”. Following the inevitable collapse of the tech bubble, the Fed attempted to mitigate the impact on the economy by cutting rates aggressively to 1%. Thus, the housing boom was born.
Home of the celebrated Alan Greenspan and his replacement Ben Bernanke, the Federal Reserve has probably done more to precipitate the boom and bust in housing than any other source. Their actions provided the raw fuel – easy money – that their coconspirators needed to set the wheels in motion. As the economy strengthened following the recession of the early 1990s, the Fed raised rates to a range of 5-6% for much of the decade. The technology boom was creating vast “wealth” and Greenspan was warning of “irrational exuberance”. Following the inevitable collapse of the tech bubble, the Fed attempted to mitigate the impact on the economy by cutting rates aggressively to 1%. Thus, the housing boom was born.
Figure 1 – Fed Funds Target Rate (Source: Bloomberg)
Banks & Mortgage Brokers
The rapid decline in short term rates instigated by Fed policy led to a significant steepening in the yield curve thereby increasing the appeal of adjustable rate mortgages. The availability of very low introductory rate mortgages greatly reduced perceived monthly costs of owning a home and led to a dramatic spike in home price appreciation. Financial market innovation enabled a boom in the mortgage brokerage industry as small shops could sell their pipeline of loans to investment banks to be pooled and securitized. These smaller shops operated with very little capital, minimal regulation, and had limited reputational risk resulting in a higher incidence of churning and abusive sales practices.
As the mortgage sales network expanded, banks developed new securitized products that further reallocated risks and enabled banks to reap huge rewards. The subprime loan market burgeoned as banks were convinced they could slice and dice risk with surgical precision, accommodating sales of complex instruments to investors at premium prices. This house of cards was based on the borrowers’ ability to readily refinance their loans and continue to extract equity against the appreciation in their homes. Ultimately, the strong HPA led to low realized credit losses which further supported the marketing of securitized products. Additionally, the rapid home price appreciation veiled any association between down payments and credit losses in the minds of lenders, bond rating agencies, and investors allowing home owners to borrow at incredibly low levels of equity. These borrowers were effectively renters with a call option on home prices.
Figure 2: Home Price Appreciation Year over Year (Source: Bloomberg)
Government Incentives
Government incentives for home ownership significantly influence home prices and exacerbated the excessive rise in home prices. The tax deductibility of interest alone leads to significant market distortions by encouraging borrowing against home equity, which is directly correlated with the current foreclosure rates. By enabling borrowers to use their home as collateral with tax advantaged treatment, the government has promoted excessive consumption by reducing the after tax cost of funds for spending on purchases that were often depreciable assets unrelated to housing (e.g. cars, electronics, vacations, etc). As home prices began to decline, many borrowers were quickly under water on their mortgages and had strong incentives to default on their loans.
The exemption of capital gains on a primary residence also induced greater investment and speculation in housing. After two years, the government enables home owners to extract up to $250,000 in capital gains for singles (twice as much if you are married) tax free. Targeted tax credits and deductions like this lead to significant market distortions as people began view their house as a leveraged tax favored investment which, at the time, seemed more favorable than conventional investments.
TV and the Media
It is no secret that the media looks to dramatize and sensationalize the mundane for the sake of ratings. The vast coverage of the housing boom combined with an overwhelming replication of “Flip This House” and other home design television shows made it fashionable to deplete your home equity loan at Lowe’s in an attempt to replicate the abode recently seen on HGTV. While the home improvement stores experienced dramatic earnings growth, Americans were exhausting the equity in their home while increasing their debt burden. Clearly homeowners resisted obvious indications, either due to naiveté or self-denial, which suggested that the rate of home price appreciation could not persist indefinitely.
Solutions
Congress, despite its complicity in creating the current housing “crisis”, is quick to cast blame upon unscrupulous mortgage lenders, greedy investment bankers, and a dearth of regulation. The solution, however, is not further intervention by Congress through additional market distorting tax credits or an expansion of government agencies that transfer the credit risk from private investors to the public. Increasing Fannie Mae and Freddie Mac’s loan limits and instituting new mandates for the Federal Housing Authority (FHA) places at risk public funds that will be required to cover the inevitable defaults. Fannie and Freddie’s extremely low capital levels and current credit losses should dictate a contraction of their mortgage portfolio instead of greater credit guarantees.
Ultimately, the market will absorb the losses efficiently and home prices will adjust to market clearing levels without government intervention. In fact, further government intervention will likely forestall the necessary adjustments and only lead to more pain and losses in the future. Let us not forget that a previous attempt to bailout the technology bubble ultimately resulted in boom-and-bust in the housing market. Alas, the politicos cannot resist “coming to the aid” of the struggling home owner, especially in an election year. Be prepared for the inevitable destruction that is sure to ensue.
DIGG IT!
Wednesday, June 11, 2008
Do Speculators Cause Oil Price Inflation?
Previously, the esoteric notion of speculators as a predatory investor class was discussed. Many of these institutional investors and pension funds are acting as agents of retirees, public servants, and individual investors in their quest for greater diversification and higher returns. The media has demonized this anonymous notion of speculators while presidential candidates have proffered images of exploitive hedge fund managers that earn billions in fees while Americans suffer at the pumps. Somewhere amongst all this noise lies the truth.
There are two markets for oil that differ in function, but are intrinsically related. The spot market is a delivery market with the spot price representing the current value of oil flowing from the giant oil tankers offloading their black gold in Texas, New Orleans, or other major refining centers. The futures market represents contracts for future delivery of oil consistent with a certain quality level. Futures prices and spot prices often differ, but due to arbitrage relationships are related based on the factors of storage costs, interest rates, and the convenience yield (the current value of holding physical oil vs. oil for future delivery). As the expiration of futures contracts nears, all of these factors become less relevant and the futures price and spot price must converge.
Speculators’ influence on spot oil prices is dubious at best. Ultimately, on any given day, the supply and demand for oil determine the market price. The large sunk costs incurred by previous capital investment in vehicles, power plants, machines, and equipment that require petroleum for fuel results in highly inelastic demand for oil (i.e. a relatively low impact on demand with changes in price). While oil prices have risen well over 100% in the past year, recent reports suggest that fuel consumption in California has only dropped 4% year over year.
With the inelasticity of demand established, consumers plead for additional supply. The large capital investments required to locate oil reserves, build oil wells, and construct pipelines for delivery necessitates long lead times before new production can be brought online. A strong opposition to domestic drilling has further exacerbated this growing problem over the past 5 to 10 years. Currently, supply and demand are in such fragile balance that small shocks can send oil prices soaring (or plummeting).
Speculators, characterized as investors with no intent on taking delivery, have little impact on the market price of oil. If the futures contract expiration date nears and futures are trading rich to the spot price, a speculator could buy oil in the spot market and sell oil futures. When the contract comes due, the speculator would deliver oil to the counterparty of the futures contract, which would be an actual oil consumer. This arbitrage will occur until spot prices and futures prices converge, effectively clearing the market based on supply and demand. Conversely, if spot prices are rich to futures, oil producers would want to sell oil in the spot market at higher prices. That increase in supply will drive spot oil prices down forcing convergence with futures prices.
Ultimately, spot market supply and demand will determine prices in commoditized markets such as oil. The only means of reducing oil prices is to enact structural changes that reduce the demand for oil while concurrently investing in additional supply. While alternative energy sources may possess long term promise, the degree of research and development as well as infrastructure required to support these new technologies ensures that widespread integration is decades away. It would be much more prudent for Congress to avoid meaningless witch hunts and hearings about “excess profits” and instead learn from their prior mistakes by crafting a meaningful energy policy for America.
DIGG IT!
There are two markets for oil that differ in function, but are intrinsically related. The spot market is a delivery market with the spot price representing the current value of oil flowing from the giant oil tankers offloading their black gold in Texas, New Orleans, or other major refining centers. The futures market represents contracts for future delivery of oil consistent with a certain quality level. Futures prices and spot prices often differ, but due to arbitrage relationships are related based on the factors of storage costs, interest rates, and the convenience yield (the current value of holding physical oil vs. oil for future delivery). As the expiration of futures contracts nears, all of these factors become less relevant and the futures price and spot price must converge.
Speculators’ influence on spot oil prices is dubious at best. Ultimately, on any given day, the supply and demand for oil determine the market price. The large sunk costs incurred by previous capital investment in vehicles, power plants, machines, and equipment that require petroleum for fuel results in highly inelastic demand for oil (i.e. a relatively low impact on demand with changes in price). While oil prices have risen well over 100% in the past year, recent reports suggest that fuel consumption in California has only dropped 4% year over year.
With the inelasticity of demand established, consumers plead for additional supply. The large capital investments required to locate oil reserves, build oil wells, and construct pipelines for delivery necessitates long lead times before new production can be brought online. A strong opposition to domestic drilling has further exacerbated this growing problem over the past 5 to 10 years. Currently, supply and demand are in such fragile balance that small shocks can send oil prices soaring (or plummeting).
Speculators, characterized as investors with no intent on taking delivery, have little impact on the market price of oil. If the futures contract expiration date nears and futures are trading rich to the spot price, a speculator could buy oil in the spot market and sell oil futures. When the contract comes due, the speculator would deliver oil to the counterparty of the futures contract, which would be an actual oil consumer. This arbitrage will occur until spot prices and futures prices converge, effectively clearing the market based on supply and demand. Conversely, if spot prices are rich to futures, oil producers would want to sell oil in the spot market at higher prices. That increase in supply will drive spot oil prices down forcing convergence with futures prices.
Ultimately, spot market supply and demand will determine prices in commoditized markets such as oil. The only means of reducing oil prices is to enact structural changes that reduce the demand for oil while concurrently investing in additional supply. While alternative energy sources may possess long term promise, the degree of research and development as well as infrastructure required to support these new technologies ensures that widespread integration is decades away. It would be much more prudent for Congress to avoid meaningless witch hunts and hearings about “excess profits” and instead learn from their prior mistakes by crafting a meaningful energy policy for America.
DIGG IT!
Tuesday, June 10, 2008
"Speculators"
The American media, rarely known for in-depth investigative reporting, has jumped on the popular bandwagon by crucifying an esoteric group of demonized investors: speculators. Speculators have been blamed for the housing bubble, the rise in oil prices, the collapse of the mortgage market, and other market calamities without much clarity on just how this vaguely defined group has single handedly caused such pain. CNBC, while recently indicting speculators for the volatility and spikes in the oil market, defined “speculators” as institutional and pension fund investors. Lets further elucidate the parties that comprise these investor classes.
Institutional investor is a broad term used to generally classify mutual funds, exchange traded funds (ETFs), endowments, and hedge funds. While some of these groups are private investors with broad investment authority, the majority can be classified as conduits for individual investors to participate in global markets. It seems hardly sensible to castigate individuals for attempting to diversify their portfolios and participate in one of the best performing asset classes of this decade through mutual funds and ETFs. The dramatic growth in natural resources and commodity funds has been a result of their strong recent performance and the endless promotion of these asset classes by the “seers” on CNBC and other media outlets.
Pension funds are a dying breed in America with the dominant trend towards self directed retirement plans such as 401(k) accounts and IRAs. Many of the remaining pension plans cover unionized workers in the airline or automotive industries along with public service employees such as teachers, fire fighters, and police. I challenge any politician to inform these highly mobilized groups that they are going to impair their retirement security by prohibiting the pension trustees from diversifying into alternative asset classes. Without obfuscating the truth, these bureaucrats will suffer a short and unheralded career as their constituents swiftly removed them from their post.
It appears much more expedient to cast negative aspersions on “speculators”, which is as ill conceived in the public psyche as the more favorably cast “middle class”, rather than identify the market participants that transact in these markets. The sacred middle class, the object of affection of all political aspirants, can seldom be divorced from the demonized speculators as they benefit directly from the speculators’ actions as their investment agent. Without a scapegoat, however, the politicos and pundits would have to introspectively reflect on their own actions (e.g. excessive expansionary monetary policy, failure to develop a comprehensive energy policy, tax advantaged treatment of housing speculation, etc) and their role in the current "crisis".
In my next post, I will discuss how speculators cannot possibly have the influence on oil and gasoline prices that the media suggests. Check back soon!
Institutional investor is a broad term used to generally classify mutual funds, exchange traded funds (ETFs), endowments, and hedge funds. While some of these groups are private investors with broad investment authority, the majority can be classified as conduits for individual investors to participate in global markets. It seems hardly sensible to castigate individuals for attempting to diversify their portfolios and participate in one of the best performing asset classes of this decade through mutual funds and ETFs. The dramatic growth in natural resources and commodity funds has been a result of their strong recent performance and the endless promotion of these asset classes by the “seers” on CNBC and other media outlets.
Pension funds are a dying breed in America with the dominant trend towards self directed retirement plans such as 401(k) accounts and IRAs. Many of the remaining pension plans cover unionized workers in the airline or automotive industries along with public service employees such as teachers, fire fighters, and police. I challenge any politician to inform these highly mobilized groups that they are going to impair their retirement security by prohibiting the pension trustees from diversifying into alternative asset classes. Without obfuscating the truth, these bureaucrats will suffer a short and unheralded career as their constituents swiftly removed them from their post.
It appears much more expedient to cast negative aspersions on “speculators”, which is as ill conceived in the public psyche as the more favorably cast “middle class”, rather than identify the market participants that transact in these markets. The sacred middle class, the object of affection of all political aspirants, can seldom be divorced from the demonized speculators as they benefit directly from the speculators’ actions as their investment agent. Without a scapegoat, however, the politicos and pundits would have to introspectively reflect on their own actions (e.g. excessive expansionary monetary policy, failure to develop a comprehensive energy policy, tax advantaged treatment of housing speculation, etc) and their role in the current "crisis".
In my next post, I will discuss how speculators cannot possibly have the influence on oil and gasoline prices that the media suggests. Check back soon!
Capital Gains Shenanigans
While I attempt to be unbiased in my political and philosophical commentary, I find a glaring inconsistency that necessitates elucidation. Barack Obama notes that investors such as Warren Buffet are aligned with his proposals to raise the capital gains to at least 20%. In a recent Bloomberg News article, Obama is quoted as saying that Warren Buffet and other investors have indicated that capital gains tax rates of 20% “will probably not have any significant impact in terms of investment.”
In fact, this may very well be the case as Jesse Drucker (WSJ, page A1, “IRS Targets Billionaire's Lucrative Tax Strategy”, June 9, 2008) exposed a popular tax scheme used by wealthy individuals to effectively sell their shares but postpone capital gains taxes. This scheme involves “lending” the shares to a major investment bank in exchange for cash and an agreement turn over ownership of the shares at some point in the future, effectively postponing tax liabilities for often more than a decade. The middle class investor, obviously, does not have the same access to such tax avoidance schemes.
Perhaps it is time for politicians of all political stripes to realize that targeted tax cuts, special interest tax credits, and punitive tax rates on capital distort market behavior and lead to unintended consequences. By progressing towards a flatter and simpler tax system, inefficiencies will be reduced and markets will behave more efficiently. Then again, such an environment would leave politician impotent in the field of political favors and kickbacks that dominate Washington so don’t hold your breath.
In fact, this may very well be the case as Jesse Drucker (WSJ, page A1, “IRS Targets Billionaire's Lucrative Tax Strategy”, June 9, 2008) exposed a popular tax scheme used by wealthy individuals to effectively sell their shares but postpone capital gains taxes. This scheme involves “lending” the shares to a major investment bank in exchange for cash and an agreement turn over ownership of the shares at some point in the future, effectively postponing tax liabilities for often more than a decade. The middle class investor, obviously, does not have the same access to such tax avoidance schemes.
Perhaps it is time for politicians of all political stripes to realize that targeted tax cuts, special interest tax credits, and punitive tax rates on capital distort market behavior and lead to unintended consequences. By progressing towards a flatter and simpler tax system, inefficiencies will be reduced and markets will behave more efficiently. Then again, such an environment would leave politician impotent in the field of political favors and kickbacks that dominate Washington so don’t hold your breath.
Monday, June 9, 2008
Institutional Dependence
The United States was born of the libertarian principles of Life, Liberty, and the Pursuit of Happiness. As our society has progressed, the pure principals of capitalism have given way to noble social welfare objectives. Our global economy efficiently provides for the basic needs of humanity, allowing people to search for ways to improve the delivery of higher order needs. One that has incited years of debate is healthcare.
While there is no doubt that the health care system in the US can be improved, institutionalizing health care through a single payer, government controlled system would expand the dependence of the masses on governmental organizations. Without competition, American consumers would lose all choice and would be completely dependent on the government to determine the extent of their health care coverage. Under any system in which the government determines the extent of coverage (e.g. Medicare/Medicaid), there will either be an explosion in program costs due to excessive coverage or extensive frustration and disappointment with “inadequate” coverage, poor quality care, and lengthy delays in “discretionary” services.
In Life of a Slave, the impact of excessive consumption and poor financial discipline on the servitude of the masses was discussed. The socialization of industries, services, and markets institutionalizes a dependence on the government that furthers the degree of servitude experienced in American society. Bureaucrats, who possess a demonstrated proclivity towards self preservation enabled by pandering to special interest groups, would command significant control over our health care choices. Not only could they dictate personal choice, but they would pool their infinite wisdom to determine the direction of the health care industry, pharmaceutical development, and compensation of all industry participants. All the while, these fountains of innovative thought would sell their votes to special interest groups in exchange for campaign contributions rather than permit market forces to appropriately allocate resources to the projects most valued by consumers.
Only through promoting the goals of financial independence, free market competition, and responsible consumption can we avoid the shackles of governmental dominance and institutional dependence. Our current health care system promotes excessive consumption by divorcing the payer from the decision maker. Third party payers are unable to control costs that are driven solely by the decisions of the patient, who obviously feels entitled to the highest quality of service regardless of cost or viability. Until the patient has greater “skin in the game”, the health care system in America will continue to be characterized by excessive cost increases and overuse.
In the face of significant expansion of governmental programs and control over our existence, one must ponder in what type of society he wishes to live. One must decide what type of man he wishes to be.
A Slave is beholden to his employer [master] and destined to toil with the masses to service the debt incurred as a result of excessive consumption. The slave, deeply in debt and without financial reserves, is beholden to the government for charity, bailouts, and special treatment in order to perpetuate an overextended lifestyle.
An Emancipated Slave possesses sufficient financial reserves and fiscal prudence to provide for his or her family in the event of an unexpected change (e.g. job loss, unexpected expenses, weak housing market). The emancipated slave has the ability to walk away from an abusive employer in search of more favorable conditions, but lacks the wealth and financial backing to completely determine his or her destiny.
A Free Man is one with sufficient reserves and wealth to set upon his or her own path free of any authoritative influence. The free man has achieved the utopia of independence as she lacks financial need or dependence on patriarchal support.
My next post will address the evil capitalist speculators that plunder the global financial markets in pursuit of wealth at the expense of the common man. Stay tuned!
While there is no doubt that the health care system in the US can be improved, institutionalizing health care through a single payer, government controlled system would expand the dependence of the masses on governmental organizations. Without competition, American consumers would lose all choice and would be completely dependent on the government to determine the extent of their health care coverage. Under any system in which the government determines the extent of coverage (e.g. Medicare/Medicaid), there will either be an explosion in program costs due to excessive coverage or extensive frustration and disappointment with “inadequate” coverage, poor quality care, and lengthy delays in “discretionary” services.
In Life of a Slave, the impact of excessive consumption and poor financial discipline on the servitude of the masses was discussed. The socialization of industries, services, and markets institutionalizes a dependence on the government that furthers the degree of servitude experienced in American society. Bureaucrats, who possess a demonstrated proclivity towards self preservation enabled by pandering to special interest groups, would command significant control over our health care choices. Not only could they dictate personal choice, but they would pool their infinite wisdom to determine the direction of the health care industry, pharmaceutical development, and compensation of all industry participants. All the while, these fountains of innovative thought would sell their votes to special interest groups in exchange for campaign contributions rather than permit market forces to appropriately allocate resources to the projects most valued by consumers.
Only through promoting the goals of financial independence, free market competition, and responsible consumption can we avoid the shackles of governmental dominance and institutional dependence. Our current health care system promotes excessive consumption by divorcing the payer from the decision maker. Third party payers are unable to control costs that are driven solely by the decisions of the patient, who obviously feels entitled to the highest quality of service regardless of cost or viability. Until the patient has greater “skin in the game”, the health care system in America will continue to be characterized by excessive cost increases and overuse.
In the face of significant expansion of governmental programs and control over our existence, one must ponder in what type of society he wishes to live. One must decide what type of man he wishes to be.
A Slave is beholden to his employer [master] and destined to toil with the masses to service the debt incurred as a result of excessive consumption. The slave, deeply in debt and without financial reserves, is beholden to the government for charity, bailouts, and special treatment in order to perpetuate an overextended lifestyle.
An Emancipated Slave possesses sufficient financial reserves and fiscal prudence to provide for his or her family in the event of an unexpected change (e.g. job loss, unexpected expenses, weak housing market). The emancipated slave has the ability to walk away from an abusive employer in search of more favorable conditions, but lacks the wealth and financial backing to completely determine his or her destiny.
A Free Man is one with sufficient reserves and wealth to set upon his or her own path free of any authoritative influence. The free man has achieved the utopia of independence as she lacks financial need or dependence on patriarchal support.
My next post will address the evil capitalist speculators that plunder the global financial markets in pursuit of wealth at the expense of the common man. Stay tuned!
Sunday, June 8, 2008
Life as a Slave
Slavery
1: Drudgery, Toil
2: Submission to a dominating influence
http://www.merriam-webster.com/dictionary/slavery
Officially Abraham Lincoln abolished slavery with the Thirteenth Amendment in 1865, but the masters of servitude have been unable to resist the appeal of wealth and power derived off of the backs of others. Modern slavery has taken on a more subtle and devious approach, but its effects on the lives it touches is no less tragic and devastating.
The consumption society that dominates American culture is perpetuated by major corporations and the government. Its goal: to entice the masses to spend their paychecks on new cars, clothes, electronics, and toys. Companies skillfully use marketing – product placements, targeted advertising, and celebrity endorsements – to create perceived “needs” in the minds of American consumers. The government sends token “stimulus” checks to prevent any slowdown in consumer spending and discourages savings through taxes on wealth (capital gains, dividends, and estate taxes). Banks lavish financing and debt on consumers to facilitate the demand motivated by the innumerable societal influences that drive consumerism in America.
You might wonder how consumerism is related to modern day slavery. According to Wikipedia, slavery “is a social-economic system under which certain persons — known as slaves — are deprived of personal freedom and compelled to work”. Consumerism compels those who lack self control and the ability to see beyond the constant barrage of propaganda to spend beyond their means and accumulate overwhelming debt all in the name of keeping up with the Joneses. They become burdened with onerous debt and are unable to break the shackles of consumerism, all the while enriching the wealthy elite and filling the government coffers. In order to satisfy their needs and financial obligations, they become trapped in a vicious cycle of work for the very people that profit from their behavior. Modern day slaves toil at the crucible chasing a fleeting dream of financial independence. Until America wakes up to the value of thrift, savings, and wealth accumulation we will continue to live in a society dominated by consumerism and burdened by overwhelming debt, trade deficits, and currency depreciation.
DIGG IT!
1: Drudgery, Toil
2: Submission to a dominating influence
http://www.merriam-webster.com/dictionary/slavery
Officially Abraham Lincoln abolished slavery with the Thirteenth Amendment in 1865, but the masters of servitude have been unable to resist the appeal of wealth and power derived off of the backs of others. Modern slavery has taken on a more subtle and devious approach, but its effects on the lives it touches is no less tragic and devastating.
The consumption society that dominates American culture is perpetuated by major corporations and the government. Its goal: to entice the masses to spend their paychecks on new cars, clothes, electronics, and toys. Companies skillfully use marketing – product placements, targeted advertising, and celebrity endorsements – to create perceived “needs” in the minds of American consumers. The government sends token “stimulus” checks to prevent any slowdown in consumer spending and discourages savings through taxes on wealth (capital gains, dividends, and estate taxes). Banks lavish financing and debt on consumers to facilitate the demand motivated by the innumerable societal influences that drive consumerism in America.
You might wonder how consumerism is related to modern day slavery. According to Wikipedia, slavery “is a social-economic system under which certain persons — known as slaves — are deprived of personal freedom and compelled to work”. Consumerism compels those who lack self control and the ability to see beyond the constant barrage of propaganda to spend beyond their means and accumulate overwhelming debt all in the name of keeping up with the Joneses. They become burdened with onerous debt and are unable to break the shackles of consumerism, all the while enriching the wealthy elite and filling the government coffers. In order to satisfy their needs and financial obligations, they become trapped in a vicious cycle of work for the very people that profit from their behavior. Modern day slaves toil at the crucible chasing a fleeting dream of financial independence. Until America wakes up to the value of thrift, savings, and wealth accumulation we will continue to live in a society dominated by consumerism and burdened by overwhelming debt, trade deficits, and currency depreciation.
DIGG IT!
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