Scary Banks

Halloween is supposed to be the time or make-believe ghouls and goblins. But there are some real-life zombies out there that are really scary.

I’m referring to zombie banks. These are banks that, if you marked their balance sheets to market, have no equity. But because the FDIC guarantees their deposits they can sell CDs and keep operating.
GMAC bank, AIG bank, and IndyMac Federal all offer 1-year CDs online that pay over 4%. Notice anything similar? Yeah, they’re all bankrupt, or almost. In a rational world they’d be out of their misery. But the government guarantee means they compete with healthy banks on an equal footing, and they raise the cost of funds for everybody.

So prudent banks get punished by the imprudent. This is an example of the law of unintended consequences. Government intervention distorts the market, and the Feds need to intervene again to kill off the zombies.

Douglas R. Tengdin, CFA
Chief Investment Officer
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Oh, Grow Up

Do the presidential candidates live in a fantasy world? Or do they assume that we just can’t handle the truth?

In the real world people need to pay their bills. So why do the candidates assume that they can hand out goodies to all and sundry and no one has to pony up?

Barack Obama says he’ll reduce taxes for 95% of working families. John McCain plans to cut corporate taxes. Neither specifies where he will make up for the lost income. But if they don’t offset the lost revenue and just add to the deficit, future taxes will have to go up.

Everyone wants to cut taxes. No one wants to say how he’ll pay for it. Milton Friedman said there’s no such thing as a free lunch. Someone has to pay. We all know this. If the politicians acted like grown-ups and treated us like adults—leveling with us—maybe we would trust them just a little bit more.

Douglas R. Tengdin, CFA
Chief Investment Officer
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Oil Slick

Everyone is worried about deflation and recession now. But I’m looking across the valley.

When oil prices were over $140 a barrel and everyone was screaming “inflation,” why didn’t I worry? Because I was confident that the higher prices would bring on supply and that in a year or so we would be facing an oil glut. That’s what we saw in the ‘80s.

But now that oil is back under $70, I’m worried. Why? Because the combination of drastically lower prices and a credit crunch could interfere with this supply response. The result? Higher oil prices even if the economy weakens. That could lead to stagflation.

So what do we do? It still makes sense to strengthen the banks. They can make sure that oil servicers and other energy providers get the capital they need to keep the new supplies coming. Because lower energy prices are the one silver lining to the market’s pullback. If prices rise again, consumers and the market could be seriously hurt.

Douglas R. Tengdin, CFA
Chief Investment Officer
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Fed Up

This is Doug Tengdin from Charter Trust with the Global Market Update for Tuesday, October 28th, 2008. Remember the Fed? We used to stop everything and watch. Not lately

It seems rather quaint to be talking about the Federal Reserve and interest rates. Kind of like soldiers coming back from a war zone being warned about various health risks. When you’ve looked at the end of the world, other issues pale in comparison.

But even if the credit crisis has been taking center stage, interest rates are important, if only as a signal. Because with the Fed acting as a clearinghouse for bank lending now, the Fed’s target rate will have a real impact on bank profits.

I know, why should we care? Well, I care because if the banks can earn a profit on low-risk investments, then they can pay back some of that $700 billion they’re borrowing. And if the Fed engineers some kind of quick recovery from this economic funk that we’re in, we can all breath again.

They’re meeting again today. Let’s hope their actions have some positive consequences.

Douglas R. Tengdin, CFA
Chief Investment Officer
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No Pain, No Gain

Are we there yet?

After the volatility of the past two months, everyone wants to know if we’ve seen the worst that the market can dish out. The answer is, it all depends.

Now that the Federal Government has shown itself a willing partner in the banking system, it seems like the worst of the financial panic is behind us. Even if a further decline in the housing market burns thought the capital infusion that the banks have received, the Feds have shown that they’re not prepared to let the banks sink.

The pain that we’re seeing now—that of a “normal” recession–should set us up for better returns in the future. That’s because bear markets cause investors to adapt their strategies, companies to shore up their balance sheets, and consumers to adjust their buying patterns. And unless our elected reps do something really dumb, these adjustments will strengthen the economy in the long run.

A friend in the Marines tells me that “pain is weakness leaving the body.” In the case of the market today, the sharper the short-term pain, the greater the long term gain.

Douglas R. Tengdin, CFA
Chief Investment Officer
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The Maestro in Concert

“The only thing people like more than a hero is to see a hero fall.”

As I listened to Alan Greenspan testify before Congress, I heard Representatives insult him, question his judgment, and repeatedly interrupt him. Say what? This is “The Maestro.” In years gone by, a politician’s main economic qualification might be his friendship with Alan the Mighty. How have the mighty fallen!

In the go-go years of the internet bubble no one could criticize the Chairman Now that cracks are appearing in the edifice of his worldview, these ladies and gentlemen are trying to paint him as one of the principal villains of the sub-prime crisis.

Anyone who follows this blog knows that I’m no fan of our celebrity culture. But when I hear a private citizen excoriated by our elected legislators, I have to agree with The Green Goblin’s statement above. If Greenspan had a failing, it was listening to the praise we formerly heaped on him.

Douglas R. Tengdin, CFA
Chief Investment Officer
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On Ice

Here we go again.

Iceland was home to a hot banking sector. Focusing on trade finance, the Icelandic banks attracted deposits from abroad and had assets four times larger than their entire economy. But their undercapitalized banks made some bad loans, and now there isn’t enough cash in the country to bail out the banks.

So the banks are getting loans from the IMF, the English government, and even the Russians. But there’s a hitch. Leveraged financial institutions bought leveraged financial instruments and the Icelandic losses are being magnified through the system. Even a nondescript bank in Lititz, Pennsylvania lost over 18 million dollars.

So expect more headlines about financial losses especially at European banks. It’s not just liar-loans in California anymore. Through the wonders of modern finance, we’re all Icelandic now.

Douglas R. Tengdin, CFA
Chief Investment Officer
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Personnel Responsibility

Where were they?

Everyone wants to know where the risk managers were. Where were the regulators? Where were the rating agencies? Where were the internal controls when all this sub-prime debt was inflating a real-estate bubble?

One of the answers is that they were right there, but nobody was listening–in part because of a culture where successful traders and loan originators get paid seven to fifteen times what a risk manager gets paid. And for the most part it seemed like they were worth it: the sales people put bread on the table. The risk managers just made the auditors happy. One was a revenue center; one was a cost center. You can guess who got the free Red Sox tickets.

Think of it as the jocks versus the geeks. No one listens to the geeks when they tell the jocks not to play chicken with the Principal’s car. Until there’s a crack-up.

Douglas R. Tengdin, CFA
Chief Investment Officer
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Of Plans and Power

So what do you thing about the rescue plan?

That’s a question I must hear a dozen times a day. And I tell people: I don’t see a credible alternative, but I’m deeply troubled by the new power of the U.S. Treasury.

Think about it. One man has the authority to invest money greater than most countries’ economies. He can also tell the banks he supports whether they can pay dividends to their investors, whether their CEOs are entitled to a bonus, and whether they should expand their lending or pull it back.

Yes, he’s subject to political review, but that seems a formality. Fannie and Freddie had a government guarantee, and that didn’t work out so well. Now the much of the banking sector gets to join the same club.

Lord Acton once said that absolute power corrupts absolutely. The power now vested in the Secretary of the Treasury is immense. Maybe Paulson will prove to be the exception to Acton’s rule. I certainly hope so.

Douglas R. Tengdin, CFA
Chief Investment Officer
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Looking Backward

120 years ago Edward Bellamy wrote a novel about a socialist utopia. In the ’30s, John Dewey listed it as the most influential novel of the previous 50 years. While his book seems to predict innovations like debit cards and radio stations, the bulk of his text compares his utopia to what came before.

Looking Backward is the title of his work, and today many people make their financial plans with their gaze fixed firmly on the rear-view mirror. When times are good, they see nothing but prosperity ahead. When times get tough, they can only envision a stormy future.
But the past isn’t always prologue: the current market turmoil has created many of the conditions necessary for recovery. Oil prices are dramatically lower. The dollar has stopped its slide. The government’s intervention has restored activity in the interbank market.
As a prediction of the future, Bellamy’s novel was spectacularly wrong. But as a description of how people behave today, he’s right on the money.

Douglas R. Tengdin, CFA
Chief Investment Officer
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