Posts Tagged ‘finance’
Welcome back Franco fan! Please share your thoughts and leave some comments!
The final episode of this series opens in summer of 2006 at the peak of the US housing markets. Consumers have been leaning on their home equity to finance their spending and drive economic growth. In addition, the advent of the credit default swaps have made risk a transferable and tradeable product. The perception that risk can be stripped out of an investment vehicle and transferred to another counter party has driven credit spreads (the difference between the cost of risky, corporate debt and the risk free US government debt) to historically low levels. Tight credit spreads have made it very cheap to borrow money and create leverage to amplify returns. But all that is about to change as the era of easy money and excessive leverage comes to a screeching halt.
In the first two parts of this series, we covered the rise of securitized loans and birth of credit default swaps. We left off in the throngs of a raging bull market being driven by a new era of technology companies. With the exception of a few hiccups, Wall Street has perpetuated almost 20 years of wealth creating, bull market returns on the backs of financial leverage, innovation, and good ol’ fashion greed.
Anyone who has read Liar’s Poker (and even those who have yet to read it) will enjoy this recently penned article by Michael Lewis. In it, he explores the mortgage market meltdown through the eyes of a bearish hedge fund manager and revisits the synthesis he drew from his brief stint with Solomon Brothers in the mid 80’s. I recommend both the article and his book for a “colorful” look at some of the inner workings of the US financial markets.
Enjoy!
Franco
We last left off with a red hot financial market in the mid 1980’s being led by the fancy MBS (mortgage backed security) and CMO (collateralized mortgage obligation) securities running in tandem with a leveraged paradise known as the junk bond market. The easy money and lavish lifestyles of the 1980’s were not isolated to Wall Street. Savings and loan (S&L or “thrifts”) institutions across the nation were taking advantage of the newly implemented Tax Reform Act of 1986. The new act was passed to update “old banking standards” and allow thrifts to take on more risk in order to better compete in the “complex financial markets” of the 1980’s. Thrifts ran with their new found freedom and grew like wild fire. Some of the more aggressive ones were doubling in size every year with less than ethical lending practices. All this easy money was making thrift executives very rich and further compounded the greed running rampant through the markets of the 80’s.
Falling home values, growing unemployment, plunging stock prices; how did we get into this mess? Well, in order to fully understand our current economic funk, we need to go back and examine the roots of what has now been coined the credit crisis. So take a walk with me down memory lane while we explore the origins of securitized loans and unregulated swap contracts in a fascinating tail of innovation, riches, stupidity, and good ol’ fashion greed.
Books:
Buffett: The Making of an American Capitalist by Roger Lowenstein. A biographical look at the forces and events that shaped the world’s most sucessful investor.
The Davis Dynasty by John Rothchild. A biographical look at one family’s investment acumen over three generations of investment management.
Common Stocks and Uncommon Profits by Philip A. Fisher. A classic investment book that explores some of the aspects that differentiate superior companies from the pedestrian ones.
Active Value Investing: Making Money in Range-Bound Markets by Vitaliy Katsenelson. An excellent book that lays out the “Quality, Valuation, & Growth” framework for buying and selling stocks.
In my very first post I talked about the advantages of using a credit card with rewards for everyday purchases. Recently, a frugal fan sent me a link to a great online tool to help people chose the best cash back reward card. One need only input their annual expenditures into each category and decide whether to use multiple cards to maximize the rebate or a single card for convenience. For those that are running a budget, this exercise should be easy. For those that do not have a budget, it’s time to start!
