The Coming Economic Crash and How to Profit from It
--by Dennis Hudson, quant trader
|Be sure to read updates- See Below|
|Personal Disclosure: I'm not presently
in any stocks, except for a
(long) bagholder (PAIV) which I can't liquidate 'til mid-2008. I
am in FOREX, which I trade long or short, as it comes.
Banks Setting Up 'Superconduit'?-
Monday, Oct. 15, 2007
'Superconduit', or just another fast track to hell?
Netbank Shutdown- Monday, Oct. 1, 2007
ING Bank to Preside Over Wreckage
Full Stories in Updates- See Below
|If ever there were
a doom and gloom
book, this is
definitely it. The upside is, you can protect yourself
by its observations.
Let me summarize some protective issues now- later we'll cover profit issues...
1. If you're invested in stocks long-term, sell them now.
2. If you're trading stocks short-term, long, stay at cash as much and as often as you can.
3. If you're trading stocks, set your account up for shorting and learn how to do it.
4. If you're holding real estate, sell it now.
5. If you have cash in any financial instrument or platform that can be devalued, get out now and
find a more stable instrument, like a savings account or cd- and those will be risky too.
6. If you own an expensive vehicle or boat or aircraft, sell it now. Get something cheaper.
7. If you're a stock trader, learn forex, and get good at it.
Alright, I think you got the flavor. We are headed for some of the most disastrous and monumentally profitable times in recorded history, and which side of it you come out on depends on what you do next.
Some general facts, which I'll detail in a bit, will shock you... here they are, in no particular order...
1. Of your present stock holdings, somewhere between 10-50% are very likely counterfeit.
2. Your present real estate holdings are very likely to devalue by as much as 60% or more in the
very near future.
3. Even before your real estate devalues, if you have an A.R.M. (adjustable rate mortgage), the
rate changes will likely force you into foreclosure anyway.
4. If you own your property outright, foreclosures will flood the market with real estate and devalue
your holdings anyway.
5. Easy, "no questions asked" financing on everything from cars to furniture to refrigerators, all
sold at inflated original prices, is going to mean massive repossessions and overall economic
chaos very soon.
Now do I have your attention? You may be mystified by only one of the above general facts- counterfeit stocks, which will be explained later, but the rest are obvious to you. All you're lacking is an understanding of the depth and breadth of the trouble we're about to see, and a full grasp of the kind of profit you can make if you're sharp.
This economic train wreck is no accident. It was engineered by the usual suspects. We'll touch on that later, especially concerning counterfeit stocks. But mainly this book is not about conspiracies or catching the bad guys or even fixing how things are done; in fact there's very little that lone individuals can do about it anyway- we're up against an unimaginably huge and determined juggernaut. So the best we can do is profit from it. So stick around, learn, and profit.
|The Old Order
The old wisdom was, buy a house and let it appreciate; buy stock and don't touch it 'til you retire. In other words, put your money in something and leave it there. It will grow. Things have changed.
The change has quietly crept upon us, unseen and unheralded. It is operating stealthily behind the scenes even now, engineering the undoing of literally millions of property owners and stockholders. And it's not just your average one house and $30,000 portfolio folks who are about to be dropped through the trapdoor of the crash- people and businesses with millions in assets may actually fall faster and harder than the rest of us.
The old wisdom worked well enough before two key phenomena appeared: computers and the internet. These powerful tools make information more accesible to more people faster than ever before. They make comparative analysis and sharing of that information easier. As a result, more people now have at least the perception that they are better informed about economic affairs, and they are usually right. And they share those perceptions and analyses with their electronically deprived neighbors.
So, in the past, bad economic news could be more easily contained while matters slowly worsened; but now large parts of the population can know- often months in advance- of the coming demise of a bank, or the imminent merger of one company with another, if we read the tea leaves correctly. And that's the sticky part- reading those pesky tea leaves and, increasingly, finding among the mountains of information the right tea leaves to look at in the first place. Bottom line: the tools are in place, and the tea leaves are coming into view. All it's going to take is a couple of medium-sized events like the ones described in this book to make folks connect the dots and realize that the old wisdom is now dangerous.
|A House of
And Nervous People
This train wreck has a half-dozen or more triggers lying around, any one of which can set off the others. Once the wreck is underway, there will scarcely be any stopping it. Let me tell you a true story...
One day back in March 2007, China's stock market suffered a remarkably violent hiccup. Stocks on the Chinese exchange crashed. In turn, so did North American and European stocks. The next day, oddly enough, Chinese traders snapped up the fresh China market bargains and restored overall prices within 24 hours of the crash. Not so the western markets, which languished in anxious uncertainty for months afterward. My point is, in the West, we have a sneaking but widely unspoken suspicion that something is wrong, that something is about to happen. Part of this is the "Puritan ethic" that we've had it too good for too long at the expense of too many other people, and a major correction is due. But the other part of this suspicion of something being wrong is based in reality, whether the average person can articulate it or not.
The rest of the story struck me as even more telling. At the time I was living in a mildly upscale part of town in the American southwest- Albuquerque, New Mexico. Within days of the original crash I noticed "for sale" signs popping up in my neighborhood like mushrooms after a spring rain. But, as U.S. markets settled again, the signs gradually disappeared. Somebody out there is on a hair-trigger already. They are ready to dump their assets at a moment's notice. But practically everybody publicly spouts the party line, "Things are booming and will keep on booming." What a disconnect!
Now let's cover the triggers in detail, and in no particular order of power or importance...
Bearing in mind that any trigger can set off the others, perhaps the most intriguing and overtly threatening is the issue of counterfeit securities. Be sure of it, if you own stock or mutuals, you are almost certainly holding from 10-50% counterfeit or more.
Most people are not terribly sophisticated about stocks (they have better things to do, like having a life), so we need to first explain a few things so everyone can see the true nature of the counterfeit threat. You may own only blue chips, the trading of which is mediated by two parties, your broker and a floor specialist. Trades in lesser stocks are mediated by your broker and a market maker ("mm"). For practical purposes, market makers and specialists perform much the same function- they bring buyers and sellers together. Stocks listed on the Amex involve neither market maker nor specialist- the Amex is fully computerized. For the sake of simplicity, I'll talk only about how market makers operate, and that can be roughly translated into how specialists operate as well. But the Amex is not immune from what I'll describe, merely by virtue of lacking mm's and specialists, and you'll see why.
Do you have a pension coming to you one day? A lot of pension money goes into stocks. You might want to keep that in mind while reading this.
To be fair to legislators, regulators, mm's and specialists alike, whether they deserve it or not, I want to begin by explaining why counterfeit shares, up to a point, actually benefit the markets. This brings us to the perfectly legal procedures known as naked short selling ("nss") and short selling ("shorting") in general. Let's start with shorting.
In a normal stock trade, you try to buy low and sell high. In a short, you try to sell high and buy low, i.e., you are taking the position that the price will go down- and if it does, you will make money. A short works this way... let's say you believe that ABC Cookies (we'll call its symbol ABCC) is about to drop in price. You tell your broker you want to short $10,000 worth of ABCC. Your broker then lends you a number of shares equal to that amount for you to sell into the market (this whole process is at the click of a mouse or with a phone call). And you were right, the price drops 20%, at which point you instruct your broker to close the position. Your broker promptly buys the shares back for you at this new lower price. You sold the shares you borrowed at $10,000 and now you buy them back at $8,000 (note that if you're wrong and the price instead goes up, you will lose money). So your broker gives you your $2,000 profit, takes back the shares that were loaned to you, and all is well. Or is it?
The truth is, your broker often never owns the shares they loan you to begin with. This is called naked short selling (nss). All was done on trust and handshakes among you, the broker, the market makers, the buyer's broker, and the buyer. As long as the trade settles and everybody got what they wanted (or deserved), no harm appears to have been done. But what if you sell those phony shares but the buyer never liquidates their position (you might liquidate yours, but you'd be buying the shares back from someone else willing to sell)? The buyer is living under the old wisdom we talked about- buy and hold for years and years. So now there's $10,000 worth of phony ABCC stock just sitting out there, right? And if you multiply that times millions of transactions daily, times 250 days per year, times dozens of years since the practice began... well, you get the picture. But, there's supposed to be a legal mechanism to prevent this accrual of counterfeit in our financial markets.
Supposedly, before or seasonably after executing a naked short trade, mm's and brokers have to make arrangements to borrow or otherwise acquire the actual shares in question. It's an admirable concept, providing the markets with the benefits of liquidity while supposedly preventing massive counterfeiting. After all, when you make a trade, you want to do it now, not sometime next week after the real shares have been delivered to your broker for loan to you. But for many years, there was virtually no oversight of this, nor enforcement, nor even any apparent penalties for failure to comply. In other words, it put brokers and mm's on an "honor system", a ludicrous oxymoron if ever I heard one when applied to key players in financial markets.
And there's more to this. By putting counterfeit shares out there, and then failing to deliver the actuals shares in a seasonable manner (called "ftd's"- "fails to deliver"), brokers and market makers are constantly diluting the stock and either forcing its price down or at least preventing it from rising as it should over time. Why? Because the greater the supply is, relative to demand, the lower the price. I'll give you some concrete and disastrous examples of the effects of nss and ftd's on particular stocks in a minute, but first let's look at a much larger example of this unpleasant phenomenon.
As already noted, if you short a stock you profit by the price going down, not up, and you lose money if it goes up. Keep in mind also that shorting is the process of first selling and then buying back, the exact reverse of normal "long" trading. Back to the example of ABCC: suppose that a lot of people want to buy ABCC (we call them "longs") because some news just came out that the company might get bought by RJR Nabisco. Assume the stock is sitting at $30 when news hits. With this type of news, you would easily expect the price to jump to $45 that day. Longs flood into it, mm's start shorting (selling to the longs) and quickly run out of real shares, but they keep selling ghost shares anyway, more and more of them. So at first the price jumps to $33, then $35, then starts to stall at $37, until the longs (scratching their heads) stop buying. Meanwhile, the longs who have already bought fear a reversal and start selling like crazy, profit-taking, we call it.
The process gains momentum, even triggering automatic stop-losses in the accounts of longs who weren't even watching the market at the time, price finally settling at $25. A handful of longs who got out above $30 made money; all the other longs got screwed. So where'd all that other money go? Right into the pockets of the mm's. Remember, the mm's were shorting; at first they were losing money as the price rose from $30, but as it dipped back below $30, they started making money hand over fist. So you can see that it's always in their best interest to naked short a stock to death, which is exactly what they do whenever they can get away with it, which in turn gives you some idea of just how much of your own stock may be counterfeit.
In 2005 the United States SEC (Securities and Exchange Commission) implemented a rule called Reg SHO concerning ftd's. It was a halfhearted effort. The rule required the creation and publication of a list of stocks with ftd's beyond a certain percentage of the total outstanding shares of same, where those ftd's have persisted beyond a certain period of time. The percentage is too large, and so is the timeframe.
Moreover, the rule provides "amnesty" for previous ftd's, which means that, as far as the SEC is concerned, all those previous counterfeit shares can remain out there forever, continuing to hold down the stock's price. Also, this rule says nothing about even more massive ftd's that go on between brokers and mm's- it only refers to ftd's occurring in normal retail trading.
But now it gets interesting. A company, or any of its stockholders, can of course demand actual certificates for their shares from the mm's and brokers. In other words, "Show me the stock, or give me the money!" They can also sue for damages because of how the nss has depressed the stock's price. And they have. It's been quietly kept, but here's a recent example:
Overstock.com Wins Ruling in Prime Brokerage Litigation
Court Gives Overstock.com the Okay to Proceed and Denies Prime Brokerages
Attempts to Derail Exposure
SALT LAKE CITY, July 18 /PRNewswire-FirstCall/ -- Overstock.com, Inc.
(Nasdaq: OSTK) (http://www.overstock.com) announced today a favorable
ruling... against most of the largest prime brokerage firms in the country,
including Morgan Stanley & Co. Incorporated, Goldman Sachs & Co.,
Bear Stearns Companies, Inc., Bank of America Securities LLC, Bank of New
York, Citigroup Inc., Credit Suisse (USA) Inc., Deutsche Bank Securities,
Inc., Merrill Lynch, Pierce, Fenner & Smith, Inc., and UBS Financial
...ruled that Overstock and it co-plaintiffs have stated viable claims for
market manipulation ...against the defendant prime brokerage firms
based on those defendants allegedly executing naked short sales of the
stock of Overstock with the intent of manipulating the market price
for the shares of those companies' stocks...
alleges that the defendant[s]... participated in a massive, illegal stock market
manipulation scheme and that the defendants had no intention of covering
such orders with borrowed stock... The company is seeking damages of
$3.48 billion. [emphasis mine]
|Another interesting case comes directly
from a company website. Florida juries have awarded Universal Express, Inc. (otcbb:
symbol USXP) $700 million
in cases against major market makers (now on appeal by
defendants). The site also describes extraordinary harassment by-
amazingly- the U.S. SEC
itself for even raising the issue.
|So why have these stories been so quietly kept? In whose interest is it to keep them so quiet? And why aren't more companies (practically all companies) taking similar action?|
|I think the reasons are pretty
clear. I also think that very soon
they will have no choice but
to demand a full accounting from all brokers so they can get a clear
idea of how much stock is "supposedly" out there, and compare that to
their OS ("outstanding shares", i.e., the number of shares the
company's board has really issued) and to their float (the number of
shares available for public trading, which is a subtraction of OS minus
restricted shares). They can get some of the data from DTCC (Depository Trust & Clearing Corp.),
clearinghouse for retail stock trades, but it would not reveal the
backdoor trades between brokers and mm's.
I believe that this will happen fairly soon because of the visibility of lawsuits like this one and because so many websites have published on the problem. It works like this: As more stockholders become aware of all this counterfeiting and dilution of share value, they will ask themselves, "Why haven't the companies I hold stock in forced an accounting?" This in turn leads to a recognition that these companies have failed in their fiduciary obligation to shareholders to protect the stock from wrongful assault. In other words, what the public companies are doing amounts to fraud, i.e., they are selling shares of stock based on a statement of condition (attested OS and float) which they know to be false, or ought to have known to be false. And then shareholders start to sue these companies, their management, and their boards. So, to protect themselves from ruinous suit, publicly traded companies will soon begin to demand the full accounting mentioned above.
|But let's go back to our other questions-
why it's been kept so quiet
and why nearly all public companies have yet failed to act. Ask
yourself, In whose interest would it
be to keep this quiet? Who profits by keeping it quiet? And
who loses if a company takes appropriate action?
CEO's, board members, and favored stockholders benefit by maintaining stock price growth. That's a lot of yachts, Mercedes, summer homes, and college educations for their spoiled kids to worry about. Taking appropriate action means an instant hit to the stock price: FLASH- ABCC Claims Half Its Stock Counterfeit, blares the headline. And down goes the stock. Yes, that would also hurt ordinary small shareholders, but only short term, since as matters would later unfold, the real stock would likely triple in value (or be given as cash, plus any damages awarded). The problem for the really big shareholders, however, is much more damaging and complex...
Big shareholders' stakes are often strongly leveraged as collateral for other projects (including summer homes and yachts, etc., but here I'm mainly talking about loans to operate other enterprises). Let's use an example... suppose Big Green Sage, Inc. board member Sally Bigbucks holds a modest $10 million of BGS common stock at $20 a share (500,000 shares). On Friday, after market close, the board votes to sue 22 brokers, the DTCC, and a dozen or so mm's for fraud and racketeering related to the counterfeit scam. Bear in mind that a racketeering (RICO) suit threatens treble damages- three times the actual, compensatory, and punitive damages found.
|The news gets splattered all over the
place during the weekend. FLASH-
BGS Claims Half
Its Stock Counterfeit.
Monday, BGS opens at $16; a
few minutes later, it's at $12, and by lunch you can buy it for $9 or
Sally Bigbucks (who was prevented by law from selling her shares based on insider knowledge) owns a large chunk of Florida real estate, the purchase of which was collateralized by some of her BGS stock. Worse, because BGS was considered such a stable company, the lender gave her 3:1 leverage on it. Now they want their money. By noon, Sally has to either liquidate a huge piece of her BGS holdings or come up with cash to cover. Sally also maintains several highly leveraged margin accounts with different stockbrokers- again, collateralized by some of her BGS and highly leveraged. She gets margin calls from each of them, and they liquidate more of her BGS stock and some other unrelated stocks as well. And that should about do it for Sally. By midafternoon, she's bankrupt and thinking- with some slight seriousness- about taking the fastest way to ground from her 60th-floor Park Avenue office.
itself has major interests in other companies and in commodity markets-
collateralized by its stock and real assets- again, highly
leveraged. But now bargain hunters have flooded in and BGS issues
more stock, which the bargain hunters hungrily snap up in anticipation
of an eventual jump in price when the lawsuit gets resolved. BGS
uses the proceeds to clear up its immediate problems. So the
company itself remains sound.
|Besides Sally Bigbucks, there are others-
before the lawsuit- who have
an interest in preventing it. They lobby the board hard against
the idea. Let's take them one at a time.
Market Makers. First, understand that most mm's are multi-billion dollar enterprises. They have tremendous economic and political power, including the power to destroy a company by conspiring to crash its stock price (which is basically what the suit is about anyway). And it's not only BGS stock they threaten with this swagger, but every stock where BGS and board members have major interests.
Other Companies. Their refrain is, "Hey- don't rock the boat! If you do this then we'll have to do the same, so cut it out!" Their power to enforce this command is considerable and multifarious. They can interfere with dealmaking; they can choose to compete harder in selected areas. They have long memories and can turn board members' lives into science experiments gone awry (and many board members serve on the boards of several companies at once). In other words, the "corporate culture" itself is opposed to taking action against counterfeiting.
Let me say first off that I don't care diddly
about politics. This isn't about any particular administration or
politician. If you're looking for somebody to blame for the
counterfeiting, take your pick among politicians from the last 20
years. The main thing is to
study this landscape and profit from it.
The last thing any elected official wants is a major economic crash on their watch. Somehow, it's just not conducive to getting re-elected; neither is ticking off big money contributors like the mm's. And they know that, initially at least, balancing the counterfeit stock books will mean a major economic correction. So they bring pressure to bear on the BGS board- either directly or by popular legend. They also, by legislation and by implication, restrain regulators from doing anything to cause the correction.
But in fact, the correction, although severe, wouldn't last that long and in the end will be good for the national and world economy. But for politicians, even a five-minute correction is bad news. This article by Mark Faulk, details the repeated postponement and eventual cancellation of a U.S. Senate hearing on naked shorting:
The Media. Big money controls the media. Don't believe it? A Dateline NBC producer labored for a year and a half to put together an exhaustive and stunning expose of nss and the show was first cancelled in early 2005, but eventually aired as a grossly watered-down version, equivalent to presenting "September 11" as just an unfortunate drive-by shooting. See this link:
At the same link we see how the DTCC caused the Yahoo newsfeed shutdown of a legitimate wire service (financialwire.com) because it was raising nss issues. It turns out that DTCC is run by people directly connected to major market makers, including some mentioned as defendants in the above referenced lawsuit.
There are other consequences of naked shorting. Some estimates state that as many as 6,000 companies have been bankrupted by nss because these smaller companies rely heavily on stock sales to raise fresh capital. And then there's the issue of how terrorist groups are using nss to raise capital for terrorist attacks. They hide behind overseas hedge funds, claiming to actually own stock shares when in fact, just like U.S. market makers, they own nothing. One organized crime scandal was traced all the way back to Moscow.
Oh, earlier I mentioned that just because the AMEX doesn't use market makers or specialists, this doesn't make them immune to naked shorting. Now that you know more about market mechanics, you can see why: there is absolutely nothing to prevent a broker or market maker from selling counterfeit shares directly into the AMEX, even though they are not AMEX players. They just belly up to the bar and sell their shares just like anybody else; they're licensed, they say they have the shares to sell, and AMEX simply takes their word for it. There are plenty of AMEX stocks appearing on the Reg-SHO list every day to prove it.
Bottom line here-- as the lawsuits and demands for full accounting grow, it's just a matter of time 'til big financial houses fall, taking the rest of the economy with them.
anybody really big saying out loud that they expect a crash? Consider this leaked memorandum
from Carlyle Group, a private
equity firm on the scale of KKR
|3Among those poised to
profit from the crash is the Carlyle Group, the equity fund that
includes the Bush family and other high-profile investors with insider
government connections. A January 2007 memorandum to company managers
from founding partner William E. Conway, Jr., recently appeared which
stated that, when the current “liquidity environment”—i.e., cheap
credit—ends, “the buying opportunity will be a once in a lifetime
from http://economicapocalypse.blogspot.com/ , blog by Donald Hunt
Is this an important statement? You bet it is. As a ranking member of the financial community, someone who controls billions of dollars in cash assets, Conway is certainly not given to making rash statements. These are marching orders to his top execs. Of the many statements and analyses in this ebook, I consider the Conway memo the most chillingly provocative.
Sub-prime Lending- The Mortgage Debacle
You have no doubt already heard about the default problems with sub-prime loans. Some lenders have made mountains of property loans to people who were only marginally able to keep up the payments on those loans. As a result, they default on their obligations and the properties end up in foreclosure. The matter soon disappeared from the evening news so what you may not realize is that it is steadily worsening, gradually taking down an increasing number of mortgage companies. First, a quick tour of the basics...
In the last several years, more than six million subprime loans have been made (in the USA), mainly as home loans. There's also been a lot of appraisal fraud, allowing many property owners to get bigger home equity loans than the property is worth. It's a mess.
Many subprime loans- hundreds of billions of dollars worth- have ended up bundled and sold as securties (junk bonds, some call them), widely believed to have been snapped up mostly by hedge funds. This is called securitization. Bondholders are now demanding buybacks, an ominous sign in itself.
Many subprime loans have a "honeymoon period" of low interest before rate hikes kick in. The Mortgage Bankers Association expects that as much as $1.5 trillion of these loans will step out of the honeymoon period and into higher interest rates this year alone (2007). Only about half of these can be refinanced to avoid higher payments.
|In December, 2003, combined subprime
delinquencies and foreclosures were running at about 7%; by December,
2006, they'd reached nearly 13%. In May 2006, there were about
88,000 foreclosures. In May 2007, there were twice that many-
Many subprime loans are keyed to short-term interest rates (set by the Federal Reserve). Recent hikes based on these ARMs (adjustable rate mortgages) have meant monthly payment increases of as much as 30%-50% for already strapped homeowners, causing increasing defaults and foreclosures.
Some economists believe the overall effect is so drastic that they've cut their 4% economic growth forecast to only 3%. Other economists disagree, but almost always with the caveat, "But we are in uncharted territory here- so who knows."
As foreclosures rise, housing prices flatten (rising inventory outrunning demand), worsening the problem by making it even harder for subprime borrowers to get enough in equity loans to save themselves- as long as prices were rising, it was no problem. It's basically a death spiral. Moreover, as housing inventories rise due to foreclosures, new home starts (a major economic index) decline, taking with them all the industries and jobs involved in building new homes. This is serious stuff.
|But what does all this mean,
exactly? It means that a lot of people- not just subprime
homeowners- are about to get hurt very badly. Prime homeowners
are going to take a major hit as property values tumble. Hedge
fund stocks are going to slide south. Stockholders in hedge funds
are going to start getting margin calls- cash to cover. Mortgage
banking bankruptcies and layoffs (already well underway) will
increase. Southbound hedge fund stocks are even now making the
rest of the market antsy; another 10% dip and the panic will begin in
earnest up and down Wall Street. It's a house of cards.
|Other Toxic Financing
Unless you're a nightowl like me, you may have missed the trend in recent years in latenight TV advertising. A few years ago, the late-summer latenight furniture ads blared, to the surprise of many (myself anyway), "Buy now! No payments 'til January!" Well, I thought at the time, a four-month float ain't bad- I guess the furniture stores can carry that. But as time wore on, the ads became bolder, until recently I noticed a couple offering an 18-month float! I began to wonder how they were financing this stuff. Even Sears has taken to this kind of delayed payments financing for durable goods- major appliances.
I still don't know for sure how they do it, but the fact that somebody is financing it should be a cause of deep concern to anybody looking to prosper in today's markets, whether in housing or stocks. True, the furniture is crap, garbage, bought for a dime and sold for a dollar to desperate people who just want some nice stuff to brighten their lives. Pure predatory marketing, to be sure. But like most shoddy merchandise, the stuff wears out fast and people start to default on the loans almost before the first payments come due. In a way, I don't blame them. But what happens when they default? Hmm- there's no value in the repo. Litigation costs for a garnishment are kind of steep, assuming that it's even worth it against someone with a minimum-wage job. And there's always the defective merchandise defense. Well, what's a banker to do? They write it off. This in turn makes stockholders nervous, and next thing you know, the bank's stock is in the tank. And more banks, and more banks. Another death spiral waiting to happen.
|And that's not all I've noticed after the
late show. They're now doing the same with cars and trucks.
That's really bad news.
folks default- and many of them will- it will force down the price of
new cars and capital goods because of the market glut caused by the
repos. It will also affect some very specific federal economic
benchmarks, as will the coming housing glut, all of which will in turn
devalue the dollar in the currency markets. A devalued dollar
might be a plus in some respects, like how it could affect exports, but
that's of dubious worth in the midst of widespread economic carnage.
|An Interesting IPO
In early March 2007, Blackstone Group announced that it was going public (initial public offering, or IPO) and that a major stockholder would be a very large Chinese investment fund, i.e., the Chinese government, to the tune of $3 billion dollars (a 10% interest as non-voting shares). Let me first be very clear: I have absolutely nothing against foreign capital or the idea of a global economy- I consider such opposition wrongheaded and stupid in today's world.
But why is this so interesting? And what does it tell us about a possible coming crash? And who the hell is Blackstone anyway? Let's start with the last question first...
Blackstone Group buys publicly traded companies. Big companies. In 2006 alone they bought $370 billion worth of big companies- outright. They have a penchant for then taking those companies private. That answers that question; now let's put it in context...
KKR (Kohlberg Kravis Roberts) is a similar (also private) company. But, masters of the LBO (leveraged buyout), KKR tends to leave its target takeovers intact as public companies. Its most famous LBO- though by no means its largest- was the 1988 takeover of RJR-Nabisco, a deal which incidentally produced both a book and a movie (Barbarians at the Gates, book by Burrough and Helyar). My assessment of KKR's style is that they operate as lean, nimble, and scrappy prosecutors of their LBO deals, as do most LBO operators. If someone told me there was a rumor that they were about to go public, I'd laugh. Impossible! I'd say. Just not their style- and it just doesn't fit the model for an LBO outfit anyway. Now, however, with Blackstone's recent move, I'm not so sure.
NEWS FLASH-- While writing this ebook, I learned that in April 2007 KKR announced that it was presenting its own IPO. However, they have opted not to be publicly traded like Blackstone (BX). Obviously, KKR wants the money but they're keeping their legendary flexibility by not having to deal with public stockholders.
[I know a bit about KKR (and somewhat less about Blackstone) because I'm an LBO hobbyist, a rare occupation for a small-time daytrader like myself, but it has often provided me with some unique financial insights.]
Let me explain some of the details of company takeovers in general and you'll see why I find Blackstone's going public so interesting- and potentially ominous. Taking over a public company raises some complex financial, human, and legal hurdles...
Starting with the money, you must first assemble a consortium of institutions with sufficient capital to pull it off, and their officers must be willing to put the money on the table. The deals are of necessity very fluid, since at the outset nobody really knows the true financial condition of the target company. Public companies are very good at hiding both assets and liabilities from their balance sheets and SEC filings (they hide assets and positive info tidbits specifically to discourage takeovers). Even though the law requires disclosure of any matters which might materially affect stock price, there's still a lot of wiggle room and, often as not, outright wrongful concealment or fraud. So preparing for the approach is fraught with uncertainty. As an LBO player who is also a public company, you're faced with certain constraints to doing a deal, i.e., you have to get your own board to agree to let you make such a huge deal; as the deal changes, you have to run back to your board to get the okay or a counter-proposal. But as a nimble private player, you can turn on a dime. And raw speed is often the difference between making millions and having a bag lunch the next day.
|So right away I see that Blackstone has sacrificed speed and
nimbleness for something, but
non-voting 10% stake is one thing, but the common "voting" shareholders
are guaranteed to trim their nimbleness considerably). They sure
didn't "need" to do this IPO just for the cash it provides. With
their track record, huge amounts of private and corporate equity
capital are readily available. It has to be the cash and
something else. Or, it is all about the cash, but a need
for much more of it than they'd normally require.
But let's first deal with our second hurdle in takeovers- the human element. Besides government takeover, there are two ways to seize a public company- hostile and friendly, the friendly takeover being much preferred. In a friendly takeover, the suitor persuades the target company's management and board that the takeover will be good for them personally and for the stockholders. This helps keep the buyout cheaper (usually). In a hostile takeover, a proxy fight ensues, driving the stock price through the roof and, consequently, the ultimate cost of the takeover, not to mention some fierce legal battles along the way and some even fiercer competition. Bottom line: you want as many friendlies in the target as possible. One way to make people friendly is to offer them a thought experiment, for example: what do you suppose will happen to your fortunes if we instead target your biggest competitors?
So far we've seen how complex a task it is to raise takeover money; and we can infer from this that each deal requires a new consortium of the willing. So, offering the above thought experiment is a kind of laughable extortion, since everybody knows what you'd have to go through for each supposed competitor. But what if you already had the capital, and your own board of directors giving you a blank check to do what it takes? You would then have nimbleness, speed, capital, and, accordingly, the power to persuade people to become friendlies. But this kind of power won't last long- the blush will come off the rose with your first bad deal. So for Blackstone to take this risk, make this sacrifice, they must be after pretty big game- and it's most likely a relatively near-horizon, short-term strategy. Remember, their metier is taking companies private, and there's ample evidence to suggest that they're eminently capable of reversing course after awhile and taking their own public company private again.
|Finally, the legal element of
takeovers. Governments have all sorts of regulations controlling
how takeovers get done. Even in a legal climate where you know
all the rules, red tape can sometimes strangle a deal to death.
While it's true that Blackstone has long had a Far East presence, with various
offices strewn about, it's also true that probably no major economic
power understands the Far East
the way China does, nor does anyone likely have the kind of political
clout in the region to generate some creative rule-bending the way
China does. Further, it doesn't take a Ph.D. in business to
speculate that Blackstone
undoubtedly knew beforehand that China would be
coming into its IPO with all that money.
|Time to tie up all my Blackstone IPO
speculation with a ribbon and bow. I propose to you two
scenarios, and ask you to think like Blackstone Group. Ask
yourself which is more likely...
In the first scenario, you assume- and your quant and business experts tell you- that all national economies will continue to grow at their current rates, meaning only incremental increases in stock values. Do you then choose to do an IPO, risking your legendary nimbleness and speed, merely for the sake of greater working capital, while expecting only to get pretty much the same kinds of gains as you had before?
In the second scenario, you assume- and your quant and business experts tell you- that all national economies are headed for a major crash, with stocks and companies at bargain-basement prices, followed by an eventual and tremendous rise in value relative to their crash prices. Do you then choose to do an IPO, risking your legendary nimbleness and speed, for the sake of huge gains, like none you've ever dreamed of?
What was your answer? I like Door #2. The rats are at the cheese. And I want to be on their side of the trade- the winning side. I want to be as fat and shrewd a rat as possible. Let me flavor this a little, though I'm perfectly happy with the present analysis: if you doubt my conclusions, keep a close eye on the likes of KKR (see above NewsFlash) and TPG (Texas Pacific Group) to see if they follow suit with IPOs of their own, or watch Goldman Sachs and American Express and Wachovia and Bank of America to see if they begin issuing more stock and debentures, i.e., loading up cash for the kill; by then, it may be too late for you to position yourself but at least you'll feel "in the know". And while we're on the subject of major financiers, Door #2 gives them plenty of reason to foreclose on properties and sell them without giving the original owners the slightest of second chances; they'll be doing that more and more, and when you see it happening you'll know why: they want cash for the crash.
|Wild Card: Wars and Rumors of Wars
I hardly wish to be known as a war monger. I think peace is the greatest invention since the rock. I don't think war is a good way to make money. And, contrary to the cynical pronouncements of many of the rich, it clearly is not the only way to brighten an economy, and this time around war may in fact be the most disastrous economic stratagem the world has ever seen.
I'd also like to emphasize that in my further comments I am not taking a position one way or another in the current debate concerning America's Mideast wars- I prefer to leave that to governments and politicians to figure out.
But, in our discussion here we have to take account of how present and coming wars might affect the global economy.
Briefly, in previous "large" wars (let's include the U.S.-Vietnam and U.S.S.R.-Afghanistan debacles among the most recent "large" wars), the economic interdependence of nations was not nearly as significant a factor in life as it is today. At the time of these conflicts, due to the nature of the Cold War itself, nations were pretty much economically insular, certainly far more so than at present.
|But now there is
at least some trade between virtually all the nations on earth.
And along comes a major war. Nations
choose sides, trading stops,
economies flounder. That's it in a nutshell. But add
this the sheer cost of waging war; even now, the capital costs- and I
do not overlook the far worse human costs- but the capital costs alone
of the two "small" wars being waged by the U.S. are staggering. And slowly, we're
finding out that the costs of caring for our returning injured may be
an even bigger bill. On the Iraqi
and Afghani side, their
burdens in cash and human suffering are far worse- and we're going to
end up paying for a lot of that too before it's over.
|It is difficult to know if or when we'll
have another major war. The other day (June 2007), I heard a
Russian leader making empire noises again. Experts say it was
just posturing, not serious stuff. I watch as other nations move
steadily towards developing nuclear arsenals. And I wonder.
I don't take a position one way or the other on whether they should be
doing this- remember, we're having this discussion only to consider
some possibilities, to profit and protect. I look at the extremes
of religious partisanship, overt in some parts of the world, and more
guileful elsewhere, such as here in the U.S., and I wonder. I
observe the extremes of poverty and wealth among and within nations,
and the often angry stirrings of poor peoples everywhere, and again I
|It may be that we shall escape the fire
of grievous global conflict- let us all earnestly hope so- but if it
there can be no doubt about its potential for adverse economic impact.
|Another Wild Card: the Environment
One cannot discount the economic dislocation potential of environmental catastrophe. One also cannot speak with certainty as to the timing of such a far-reaching event; we know only that it is already in progress. Scientists recently learned that the polar ice-caps are melting faster than anticipated but they hesitate to venture an opinion as to when this will reach disaster proportions. Nor do scientists know how this might escalate adverse weather patterns. This leaves the rest of us to speculate- here in the U.S., for example, that any given winter in the next year or two could turn out to be one of steady, phenomenal cold; or that any given summer might be of the nature of extreme drought.
|So we don't know for sure what is happening, or when bad things may happen, but we
can easily imagine the economic effects.
Deep and prolonged cold will mean fuel scarcity, as primary supplies
are diverted away from industry to home use. This in turn means
much higher prices for goods and services of all kinds. Demand
itself for for those goods and services will drop, due not only to
price increases but to general public pessimism. In concert with
these effects will be layoffs, salary reductions, reduced industrial
output, stock price declines, and- here we are again- foreclosures with
resulting declines in property values.
An extreme summer won't treat us much better. Drought means food scarcity and higher food prices. Household budgets historically and pessimistically over-compensate for this by sharply reducing other purchases. The same wicked spiral described above ensues.
In extremis, coastal flooding will drain government resources and private capital will be called upon to fill the gap- capital that will no longer be available for business enterprises, like capital goods loans, construction loans, purchasing, home loans, and a host of other uses on which a healthy economy depends.
In addition, extreme climate changes will mean extremes in epidemiology- pandemics will roar through the population unchecked, wreaking economic havoc and producing economic pessimism on a scale difficult to imagine or foresee.
|The Quant Picture
Most people have never heard of quants. Simply put, a quantitative analyst is one who studies mathematical relationships in an effort to understand the causes of past events and forecast future events. Quants can be found in medicine, industry, volcanology, earthquake science, physics, astrophysics, computer science, environmental science, and finance, to name just a few of the fields where their talents find usefulness. Usually, though not always, quants are Ph.D. holders in mathematics, physics, or computer science.
In finance, they are often a dark and secretive lot; after all, a working algorithm can be worth literally millions of dollars during its viable lifetime. I happen to be a quant- I cut my quant teeth in engineering research in the late 60's and later, when I entered the markets as a trader, I brought that talent to bear again.
are among the few people in the world who can compare apples to oranges
and call it science. For example, a biological quant might
correlate with precision the moulting rates of California caterpillars
with the migration of whales. They see relationships where none have
noticed them before. The logic of the correlation is sometimes
unimportant- the only question is: Does
one phenomenon accompany or forecast the other? If so,
that's a working or reporting algorithm.
I've examined certain aspects of the market and overall economy from a quant perspective. Here are some of my findings...
|The 20-Year Rule:
Deadly Correlation or Just Crying Wolf?
Most of what I'm going to talk about in this section is well known to traders and economists. The difference between them and myself is that most of them will only hint at the elephant in the room, whereas I'm jumping up and down screaming and yelling and pointing at it. You see, I don't have an agenda- I don't have any long-term financial positions of consequence, I work only for myself, I can root for bulls or bears, depending on what I see, because I am positioned to make money in any market. I just don't care which way the market goes. It goes down, I short it, it goes up, I go long, it goes sideways I play cycles and breakouts. I'm not an "investor"- I'm a trader, and for traders money talks from all directions.
Here's what's commonly believed by the experts...
(and for once, as a quant, I agree with a lot of this)...
About every 20 years- almost exactly- there is a strong bearish market correction, i.e., the "20-year cycle". It's also noted by experts that years ending in "7" are quite often bearish years. Further, as pointed out by Garrett Jones of stockmarketcycles.com, in the June 2007 edition of Futures Magazine, a respected futures and options journal, only thrice in the last 80 years has the DOW had at least 18 up days out of 21: the first completed in early July 1929, with 21 out of 23; the second completed in early October 1968 with 18 out of 21; the third just happened in late April 2007 with 19 out of 21.
(Incidentally, I forecasted the top weeks ahead of time using a quant optic, c.f., http://www.marketmillionaires.com/big-board/7834-indices-s-p-dow-nas-etc-2.html )
In both the 1929 and 1968 cases, as Garrett notes, "Exactly two months later in each instance, the market made its most significant tops of the prior century." These were each followed, within a year or less, by the start of stunning declines in market values: a 90% dip in the Great Depression, and an 80% crash by 1974. And here we sit on what could be yet another ticking time bomb, the April 2007 benchmark of 19 out of 21 days of the DOW up.
|I wasn't really cognizant of this 20-year cycle until I began
for this book. But I found it so thought-provoking that I ran it
through a great many quant
algorithms of my own, a few of which I think you'll find
needn't always be a mile deep in higher mathematics- often the most
obvious algorithms are the most revealing, as illustrated by the chart
All that this algorithm amounts to is a simple comparison of 20-year periods of DOW performance over the last 80 years (although the first cycle is only 18.75 years). The simple average value of the DOW is computed for each period, represented by the horizontal lime-green line. For viewing convenience I shrunk the charts, but you can see the full charts with numerical DOW values by clicking here. First, notice the overall shapes of the DOW plots. Two are quite similar, 1947-1967 and 1987-2007. Second, notice where in each chart the DOW firmly and determinedly crosses the green average line. Again, the 47-67 and 87-07 charts show almost identical times of crossing, in both cases at cycle midpoint. Third, in each chart, the ratio of the last month's DOW value to the green average is most similar between, again, the 47-67 and 87-07 charts. This ratio is a loose proxy for slope or rate of increase in the DOW over its average period value, a more complex computation.
would this set of facts capture the attention of a quant? Well, let us assume
four events A, B, C, and D. Let A represent the 47-67
chart; let B represent the 67-87 chart; let C represent the 87-07
chart; and let D represent the future beyond 6/1/07. If A logically "produces" B, and if A and C are nearly identical in shape,
crossover timing, and ratio of final DOW to average DOW, then it isn't
much of a stretch to form the hypothesis that C will "produce" in D something nearly identical to B. This leads us to the
logical question, What did A produce
in B? The answer may suggest what we can expect in D, our future beyond 6/1/07.
If you open the link to the full charts mentioned above (here it is again), it opens an extra window so you can easily follow the rest of this chart's discussion. We first look at what B produced in C, and then compare that to what A produced in B. (cont'd below...)
|Simply stated, what B produced in C was
an 18% drop from 2466.04 on 6/1/87 to 2019.56 on 12/1/87, and
full recovery did not occur until 5/1/89 at 2521.63, a down period of
months. What A produced
in B was also an 18% drop,
from 892.8 on 6/1/67 to 728.23 on 6/1/70, but this time a much longer and
more erratic period of ups and downs resulted, lasting until 2/1/71,
when the DOW high finally rose to 898.14 on 2/1/71 and never looked
back (there were interim highs in the 900's but these did not hold), a
down period of 44 months, nearly twice
the length of the C
So if we compare B's effect to A's effect, we conclude that an "A" pattern presages a more lengthy down period than does a "B" pattern. And since C is most similar in behavior and structure to A, we are able to forecast that our future, D - after 6/1/07- is likely to be more like B than C. And that's not good.
Although an 18% drop in the economy is very serious, those who remember the late 1960's might be inclined to minimize its personal effects. But it should be borne in mind that this crash could be very different. For example, consider that in 1967 there was no imminent threat of anyone demanding a full accounting of the vast number of counterfeit stocks in the market; in 1967, there was no imminent threat of a complete meltdown in the mortgage banking industry; in 1967, there was no imminent threat of banking failures due to millions of soft loans for furniture, cars, refrigerators and other capital goods; and, in 1967, there were not the millions of people trading stocks online or any other way that we have today, all of them with significant capital at risk. Today, all of these threats are present. Moreover, the only other comparable period in American history, in terms of numbers of people buying stocks, was the period 1927-1929, when stock trading was all the rage.
|Derivatives and Why They're Scary
A derivative financial product is literally one that is derived from some other financial product. For example, a stock has its own inherent value; you can buy it, own it, and sell it to someone else. But the purchaser of an options contract on that same stock never actually owns the stock. But the options trader, in a market totally separate from any stock market, and in which no stock is being traded, is placing money at risk based only on changes in the price of the stock. In effect, derivatives traders are matching wits against each other that price will move up or down.
I wish to avoid saying that they are "betting" on these changes because it implies gambling. And believe it or not, most successful traders of any kind rarely gamble. Decisions are usually made based on very careful, rational interpretations of a given state of facts, be it charts or fundamentals. Risk arises because different traders can have different interpretations, a fact which can have its own self-fulfilling effect on a given instrument.
|However, in the overall sense of a
derivatives marketplace, it
could be viewed as a tremendous gambling hall, since nothing of intrinsic value is being
traded, even though the astute traders in it are not gamblers.
Today, the global derivatives marketplace is so huge that it would require several large volumes to adequately describe them all. It ranges from stock options contracts to mortgage derivatives and dozens of other types created by, as one analyst referred to them, the sorcerer's apprentices known as financial engineers, whose main function is to devise ever newer ways to skim a few pennies off the top of the heaps and mountains of capital lying about.
In home mortgages, there is risk. The mortgagee (lender) must somehow calculate the risk that the mortgagor (owner) will default on the loan, factor in the likely auction price at the estimated time of default, along with the administrative costs of the whole affair, and still come up with a profit. To defray much of this risk, the mortgagee sells some of it to a bank, hedge fund, mutual fund, retirement fund, or other large institutional capital source, who in turn creates derivative instruments. That third party in turn sells a piece of the risk to yet another capital source, and so on, in a confusing array of risk-managed and cross-covered deals.
|So what's wrong with that? Well,
first of all, nobody in this (except for the first mortgagee) is
dealing in anything with
intrinsic value; they are just selling risk. Ideally, even this
should be okay, except for one important fact: the original risk
assessment of the first mortgagee could be wrong, and as we are now
discovering in antics of the suprime mortgage industry, fraudulently wrong. What this means is
that the risk has all along been understated,
which includes the estimates of borrower trustworthiness and original
property value. So, as these frauds become apparent, those with
the biggest chunks of risk start calling their notes due, triggering a
chainwave of such calls and demolishing all in its path.
And since this involves a host of very large financial parties, it quickly begins to affect the ordinary person, like someone who has money in a mutual fund or pension fund. Credit begins to tighten, making it nearly impossible for industry or ordinary consumers to obtain loans at satisfactory rates, if they can obtain them at all. So new cars don't get bought, refrigerators don't get sold, companies can't expand their operations and, bottom line, the entire economy goes into the tank, taking jobs and salaries along with it. This is technically called a depression. As one analyst said:
"It’s all very clever, but layering the enormous size– $370 trillion dollars [in mortgage derivatives], far more than the net worth of all the financial institutions in the world – on top of all that complexity is downright scary."
|As I already mentioned, there are many
types of derivative instruments in the world but they all work on the
same principle: nothing of inherent
value ever gets traded. It's a worldwide system of
derivatives trading, highly leveraged, its total cash value at any
given moment exceeding by many times the total amount of institutional
cash in the world. As fantastic as this sounds, it's true, and
all it will take to set off the firestorm is a couple more debacles
like what happened recently to the Wall Street firm of Merrill
Lynch as they
tried desperately to liquidate part of Bear
Stearns' accumulated bad debt by auction:
Banks 'set to call in a swathe of loans'
By Ambrose Evans-Pritchard
Charles Dumas, the group's global strategist, said the failed auction of assets seized from one of the Bear Stearns funds by Merrill Lynch had revealed the dark secret of the CDO [collateralized debt obligation] debt market. The sale had to be called off after buyers took just $200m of the $850m mix.
"The banks were not prepared to bid over 85pc [percent] of face value for CDOs rated "A" or better," he said.
"God knows how low the price would have dropped if they had kept on going. We hear buyers were lobbing bids at just 30pc [percent].
"We don't know what the value of this debt is because the investment banks shut down the market in a cover-up so that nobody would know. There is $750bn of dubious paper out there in the form of CDOs held by banks that have a total capitalisation of $850bn."
I find that astonishing, and this Telegraph article was June 26, 2007! At this rate, I might not finish this book before it all comes crashing down. In case you missed it, buyers only bought 24% of that bad debt- read between the lines: they're saying that 76% of it is so bad they wouldn't touch it unless they got a 15-70% discount. And that final sentence is a knockout, basically noting that the involved banks are in almost upside down, with $750 billion in questionable loans and reserves of only $850 billion.
|How to Save Yourself
I want first to make the strongest of disclaimers. The last thing I want to happen is for my speculation to turn out to be unsuited to your situation, and for you to lose money, peace of mind, and maybe your marriage as a result. I only want to present what "I" would do in a given situation, and this may or may not be suitable for you. So please, do some research of your own and by all means take this with a grain of salt. I'm no expert; I'm just like you- I read the tea leaves and this is how I'd play it.
As the saying goes, different strokes for different folks. You may be an "investor", a "trader", or not in the markets at all. You may own property, or not; it may be encumbered, or not; you may have a lot of equity, or not. You may have a lot of cash to invest, or just a little. Maybe you're married or single, raising kids, providing care for your parents, retired, or working a 9 to 5 job. You may have strong expertise in some financial areas, or not. Each situation calls for a different remedy.
Key questions to ask yourself about real estate are, What is my position? How much equity do I have now? Do I have an A.R.M.? How much can I get for this property if I sell it now, and how much cash will that leave me? And is it enough to allow me to find suitable housing for the next two years and still leave me enough to invest with? How strong is my local market? And, if I wake up one day next week and my property has lost 30% of its market value, what will that mean to me in practical terms? In a crash, will I still be able to make my mortgage payments? Do I care about my credit rating?
You should answer these questions bearing in mind that a rebound from a serious crash can take anywhere from 5-25 years. And also remember that in a serious crash your earnings are also likely to be adversely affected.
All markets work the same. So I'm going to use stock market explanations in preference to real estate ones, since both are simply about people and money. The first thing to know about is what traders call momentum, or momo. Momo can be defined as strong polarized price movement with high volume of trades and plenty of speed. If lacking any of these qualities, trading activity is not in a state of momo. Unless one is an active trader, it's difficult to adequately appreciate the sheer power of momentum. Playing momo correctly or incorrectly can make or break an active trader. In the following illustration, imagine yourself as the pro trader, the stock price as real estate prices, and the stock itself as your property in shares of stock...
You can see what's happening. Initially, amateur buyers come in because they think housing prices are about to climb, but they're disappointed and many of them sell, depressing the price for a bit. Then price improves and more amateurs come in, creating momo, which is what the pro traders have been waiting for. Most pro traders ride the momo but get out before the top, though some get out the other side of the top (a more delicate strategy and one I don't recommend to the average person). The pros have a sense of where the top is because they read quant and technical indicators, which in a sense you're doing here by reading this book.
Meanwhile, the amateurs, like lemmings everywhere, have been holding on, despite the obvious signs of a coming crash. Suddenly, panic ensues, in itself depressing prices further, and the lemmings are desperately trying to jump ship. In the end, many of them sell for a loss to the shorters- remember them? Well, they're also in the housing sector and the principle is the same: somewhere along the way, they acquired property at a low price, sold it to the lemmings at a high price, and they're now buying it back cheaper than they sold it. You may sense an opportunity here.
are there so many lemmings? The herd
mentality is what creates lemmings. The idea of safety in numbers appeals to a
great many people- nearly all of them, in fact. Until they hear
it on the evening news, or until all their friends and relatives say
it's true, they simply don't believe anything bad (or good) is about to
their investment. And they're greedy-
they keep thinking they can get more and more. And, as the crash
begins, they have false hope,
thinking constantly that the market
will come back. Finally, they know actual fear, gut-rotting terror. It's all human
nature. And all of
this stupidity is reinforced
by the media and its so-called "experts", the idiot talking heads in
the newspapers, magazines, on the news and talk shows. Few people
realize that these clowns get
paid to paint a rosy
picture, one way or another- and later, when the fatcats are good and
ready- they get paid to paint
an ugly picture.
|Some lemmings think of themselves as independent thinkers. They
imagine that all they have to do is wait until the handwriting is
literally on the wall, with prices crashing, and then they'll get out,
slick as a goose. But they have failed to account for the dreaded
momo. Pro traders live for momo because they know its
power. They have also learned from bitter experience to respect it. Caught in a trade
when momo turns against them, they post their exit price far from the
crowd; if they're long, and price is crashing, down to $14, they post
an exit for $12 because they know that by the time the order goes
through the price will be a lot less than $14. So maybe they'll
only get $12.50 or $13, but that's a whole lot better than getting
bypassed altogether and later having to settle for just $9. They
understand and respect momo, and you should too. If you believe a
crash is imminent and you decide to sell your property- sure, try for
market value- but be prepared to take less if it doesn't sell fast,
because you are about to be in competition with a lot of lemmings.
have substantial equity, consider selling now. Be willing to
accept somewhat less than market value if you have to. Do not list with a broker.
Most brokers want a six-month exclusive listing from you, which is too
long for this situation. Brokers will promise you the moon just
to get the listing, and when the property doesn't sell, they come back
six months later and suggest lowering the ask. And six months
later the same story. Meanwhile you're losing value. Also, if you look at
the action of shorters in the above illustration, it's not unreasonable
to suspect brokers of possible monkeybusiness: they actually may not want to sell your property-
instead, they may be wanting to buy it as cheaply as possible. I
dislike painting such a dark picture of so large a group, and no doubt
there are many honest brokers. But for safety's sake, I'd
strongly suggest trying to sell it yourself; there are books and tons
of free info on the web about fsbo
(for sale by owner) selling
and its pitfalls and how to make it succeed. Study up and get
Take your realized gain and bank most of it. Rent or buy something cheaper to live in. Dig in and plan to stay there for 2-5 years. At some point, you should see a genuine opportunity to cheaply buy something comparable to or better than what you had at the start. As just a rule of thumb, look for a property that's similar in quality to what you had but selling for at least 50% less. Certainly, it may drop more in value after you buy it, but within a few years it should come back above your buyin price, at which point you're green, as we say in the market. Even if it takes longer, you've still got substantially the same property as you had to begin with but now at half the price or less.
|What's this "bounce" thing about? During a bounce, people believe that the worst is over and that
price will again go up forever, so a quick sale is more possible.
In their book, Contrarian Investing, authors
Anthony Gallea and William Patalon III cite studies to inferentially
support this idea, although they are discussing stocks, not real
estate. The fact is, only rarely does any market go straight down
or even straight up, our above illustration notwithstanding.
Markets generally move jaggedly up and down. So with each upward
move- even in a strong downtrend- hope springs eternal and buyers come
back in, however briefly. Gallea
and Patalon III were
reviewing some research that showed how people overreact to recent news
and underreact to older news, and here's what they said...
"As we have seen from available research, this short-term focus causes investors to bid up shares more than is justified, and drive shares down below their true value."
Bottom line, the pro stands a "decent" chance to get out on a bounce, unless the market at the time is in the full thrall of momo. As I said at the start, you must be very risk tolerant to play this game.
|If you don't have substantial
equity, there are many issues to consider, and you will of
course give each its appropriate weight to fit your circumstances.
What are your financial condition and prospects? If your financial condition and prospects for continued income at present or higher levels is good, and if this is your dream home (i.e., you don't care what happens with the economy), you might consider riding out the storm, which could take 5-15 years. You'll be able to pay the mortgage and keep the house.
Do you have an A.R.M. and doubtful financial resources? If this is the case, you want to think about selling now, before you get hit with unsustainable higher notes and simultaneous declining value and eventual foreclosure. Even if you sell and end up with a slight deficit, you might make arrangements to make small payments on the deficit while you live in a cheaper rental. But if you don't care about your credit then by all means hang on 'til they kick you out. Technically, you'll still owe the mortgagee the difference between the auction price and original mortgage balance, plus fees, but there might be a way to gain a few months of working capital in the process. If you figure that you're going into foreclosure in a few months because there's no way you can meet the note increases, try negotiating something whereby you don't pay anything further for at least a year. Then take the extra cash and try to invest it somehow, maybe in a cheap property with an fsbo land contract or something.
have substantial equity and you're profit-minded, consider doing
as above but instead of buying a new comparable residence, look around
for industrial and office properties which have dropped at least
70%. Do a careful assessment of what kind of property you want,
its location and its overall structure. Then buy as much of it as you can and wait.
If you have chosen carefully, you should presently be able to lease it
out and eventually sell it for an obscene profit. Residential
property probably won't offer as fast a turnaround but you might
consider apartments- you could live in one apartment and rent the
others out while waiting for crash recovery.
have substantial equity and have very
high risk tolerance, consider hedging
against a crash. Well, actually, this isn't true hedging but it works on the
same principle. True
hedging is where you buy one security to offset a possible loss in
another. In this case your home is not a security but you can
trade in certain simple binary options to help offset a drop in your
property value. It works like this...
At hedgestreet.com, you can buy a position that says you believe median housing prices in a particular market area will go down or up (hence, "binary" option). If correct, you will make a specified amount of money; if incorrect, you lose the amount invested. Your potential gain is specified at the time of option purchase. I've seen it as high as 9:1 (Boston, July 2007), and others much lower. You are estimating an outcome as much as three months away, so how early in its cycle you buy the option can affect the stated payout, as well as other factors. Hedgestreet is federally regulated as an options market.
The CBOE (Chicago Board of Options Exchange) was supposed to have its housing options platform up and running by mid-2007 so you might want to look into that as well (http://www.cboe.com). CBOE already has a working relationship with Hedgestreet and the collaboration should soon result in many more tradable housing index options than Hedgestreet alone now offers (Hedgestreet presently offers only Boston, New York, San Diego, Los Angeles, San Francisco, Washington/D.C., Chicago, Miami, Denver, and Las Vegas).
kind of risk is not for eveybody, but at least you know from the
start exactly how much you can gain or lose. At Hedgestreet there's also a "Mock
Trader" platform where you can learn how to trade with fake
money. Index prices are based on quarterly NAR (National Association of Realtors)
reports. You can see these at http://www.realtor.org/research.nsf/Pages/MetroPrice.
At Hedgestreet, you can also
trade binary options on oil, metals, natural gas and other issues.
Now, lest I leave you thinking I'm a commercial for Hedgestreet or CBOE, let me point out why binary housing options can be so risky and tricky. First of all, housing prices within a country do not all move in the same direction at the same time; some may go up while others dip. Let's take Boston as an example. The other night I was thinking to short the Boston index, since I firmly expect prices to crash. Then I had a second thought: What if we get into a widening war at the same time as housing prices are dropping? Well, in some parts of the country, prices would continue to drop; but in Boston, an area with a strong military presence, shipyards, and military contractors, prices might actually go up due to increases in related personnel who need housing. So there's a lot to consider before you plunk down your hard-earned cash.
kinds of binary options can be equally difficult to gauge. Is
going up? Normally, when the USD drops, gold goes up; but as recently
as early 2007 we saw a corruption of this principle: the dollar
dropped and so did gold!
So carefully assess your personal risk tolerance before doing anything
in these markets. You can open at Hedgestreet with as little as
$100. Most people will not be greatly disturbed if they lose that
amount. But what if you trade $1,000 and lose it all? Will you still
like yourself the next morning? Think about it.
you're in stocks as a passive player,
through your employer you have invested in mutuals or stocks.
Consider closing these out, taking the cash and waiting for an
opportunity such as one of the strategies described earlier. As
a passive player (one who leaves the driving to someone else), you
are poorly positioned and probably lack the time and technical
knowledge to be able to protect yourself day to day. By the way,
careful studies have concluded that people who don't take an active
interest in their investments tend to have lower returns and greater
losses than people who do take an active interest.
If you're in stocks or other securities as an active trader, keep a short tether on your holdings- shorter than ever before. The China hiccup of March 2007 should have been instructive. And then there was the early June hiccup. The blow may or may not come from China, but when it comes there'll be no looking back. You should be in and out of trades in less than a day or even within minutes if possible. Overnights should worry you to distraction. Look more to movers in premarket trading (try prnewswire.com) where news has already crystallized and vector is clear; take a certain profit and get out before open.
I know we all hate posting stoplosses where the mm's can see them, but these may be an absolute necessity if you're trading during regular hours- that, or keep your finger on the trigger all day.
|Personally, I would avoid derivative
instruments, such as "regular" options (unlike binary options discussed above),
futures, and index funds.
Admittedly, until now I've never traded these myself and therefore my
reasoning is subject to question. But my theory of the case is
that individual stocks will be far less subject to short term
volatility (i.e., across minutes or hours) than will these
others. I say this because the impact of fundamentals on
derivatives can be expected to be much greater, while the immediate
impact on most single stocks will be muted. Further, in any
aggregated investment such as an index fund, a strong move in a single
stock therein can significantly move the index and touch off a virtual
firestorm of sudden volatility. These are the circumstances I
expect in a hard crash.
Learn to short and set up for it. Shorting is a tough racket with a downside limited only by your available margin. You can get absolutely killed here if you don't know what you're doing. Use a practice account 'til you're confident, then a few very small trades to get used to the risk. As with long trades, don't trust the market for more than a few hours; get in, get out, suck it up and pay profitless broker fees if you have to, but don't trust the market. We all know that crash momo isn't always straight down, and on a bounce you may lose your nerve.
Learn forex and get good at it. Surprisingly, in my opinion, the currency markets will be the least volatile of all markets short term, i.e., on charts ranging from minutes to a couple of hours. And yet, there should be enough local volatility to keep you entertained and profitable.
|My reasoning for this is a little complex
but I think you'll see my point. Stock trading is populated by a
relatively large contingent of inexperienced traders mixed in with the
pros. The newbies will be looking for bargains. With true
mentality, again and again, they will think they've seen the bottom and
the sky's the limit! They will of course be disappointed;
shorters will hunt them, and you know what that means: killer volatility. Yes, we
all love volatility in stocks, but for once this may be more than we
In forex things are a little different. True, there are many inexperienced traders. But somehow- and I don't understand the psychology of this but it's true- watching one's actual cash disappear in forex trade after forex trade over a few days is far more discouraging than losing it in stocks in even bigger chunks over several months. So novice forexers tend to come in and get the message and go away. This phenomenon will be especially true during a hard crash because novices tend to hold on longer than they should- and as the hours tick by they're sooner or later caught in a deadly spike.
Meanwhile, the forex de facto market makers (governments and institutionals) will be constantly looking for an edge. It will be the war of the titans, so I expect hours of range-bound trading at a time, punctuated by unbelievable spikes. A one-way crash ends in stability, with no one willing to take the other side of the trade; price can only move again after protracted periods of range-bound consolidation. It might be a fairly big range, but it's still a trading range.
Another reason to expect range-bound forex trading is that, although there may be profoundly disparate rates of adverse effect on each currency (dollar crashing faster than the yen, for example), these rates of effect will tend to continue for extended periods of time. This is because internal legal, economic, and political elements of each country will cause each currency to suffer at different rates. This would seem to make for extreme volatility, contrary to my earlier comment. But that's just not the case.
It's equivalent to turning around a battleship; each fresh regulation or economic initiative requires broad support and meets substantial opposition along the way. So nations can make changes but slowly. Since currencies are traded in pairs (eur/usd, gbp/jpy, for example), this differential in rate of effect on single currencies, and the relatively long term nature of that differential, should produce a strong trend in the pair, but one that is range bound and with limited relative volatility- after the initial shakeout, of course.
Another piece of forex advice during the crash: always print a hard stop, not a trailer. Trailing stops will often be worse than useless because they will give you the false belief that they will save you- and they won't, not during a giant spike. Limit stop is the way to go, for both stoploss and takeprofit. And one more item: Ignore the lousy "experts" that forex sites offer you. They are usually wrong anyway, even now. And they may have agendas you can't see.
|Where to keep your money in a crash?
To be honest, I've struggled with this question for years and have yet to form a firm opinion. You'll have to decide, but here is some of my thinking.
Emergency government restrictions will almost certainly be in effect, preventing you from withdrawing more than a certain amount from any bank account. (As an aside, governments are notorious for fighting new economic wars based on models of the past, which in this case was 77 years ago; they really ought to come up with a new strategy.)
The first remedy most people propose is metals, i.e., gold and silver. But who knows, the government may even restrict that somehow- even to the point of limiting the amount you can buy or sell at any one time, or how much the bank will permit you to lug out of your safe deposit box. Further, there's really no guarantee that metals will have true intrinsic value in a modern crash. One nation might flood the market with its metallic reserves, depressing the price; another nation with huge in-the-ground reserves might limit mining and exports, causing other nations to take countermeasures. We just don't know for sure. And gemstones? That's very much a dubious strategy for many of the same reasons as mentioned concerning metals. Under-the-mattress cash is too risky. Still, a modest cash stash someplace is probably a good idea.
It occurs to me that converting cash to postal money orders is a good partial strategy. Get them in reasonable denominations- maybe no more than $500 each- make them out to yourself and sock them away someplace safe (not in a bank). Stay updated on postal regs to be sure they don't expire on you; renew as needed. The beauty is, if they're lost or stolen, they're government backed and can readily be replaced.
strategy? This will sound a little weird, considering that all
been talking about is market crashes. But I'm thinking to keep
my cash assets in the markets, of
all places. Of course, this would only apply if you
know how to trade the markets, especially how to short. And
notice, I didn't say in stocks-
by in the markets I mean in
brokerage accounts as cash, and only briefly as stocks or in forex
I figure like this... the last thing the government wants to do is suspend trading for a significant period of time (they'll undoubtedly halt trading at certain crisis points, however, but only for a short time). They may also restrict the size of withdrawals from brokerage accounts, though this would be politically very risky. In any case, trading continues, and I continue to have a ready means of accumulating wealth, even if I can't touch most of it until the economy settles down, which is perfect timing anyway. If inflation takes over, my trading profits will also inflate. If deflation hits, I'm usually at cash anyway so I'll still be ahead.
Funds in forex may be even less vulnerable to government restriction than funds in stocks. Forex involves international banks and it's tough for any government to regulate their behavior, so my forex funds should continue to be easily accessible.
|And of course I'll be looking around for
some real estate and other opportunites as time goes by.
have little capital, and don't own property, and don't want to get in
the markets, but you can stand a little
bit of risk, consider watching what happens as the crash begins-
you can even watch this now as we hit little bumps on our way in.
Remember my story about real estate signs in my neighborhood right
after the China crash? Well...
With the first hard dip there'll likely be a brief bounce. On the dip, you'll notice people selling their extra cars for cheap. Price your local car market and be careful. Get it cheap. Get it old, since old cheap ones will be easier to resell. Get some spray paint and some wax. Clean it up, do a basic backyard paint job on it in a bright color. Flip it fast, then do it again. And again, if you have the chance. Just don't get caught holding in the next dip- there may be no looking back. So what's with the bright color thing? In times of economic fear, you want to convey hope because that attracts people. Yellows and reds would be my colors of choice, and definitely not purple or black.
Another idea? When you see those for sale signs popping up, be ready with a paintbrush, a broom, a rake, a hammer, a lawnmower, some hedging shears, a mop- whatever it takes. Those folks want to sell and you can help them. Tell them so, and give them a price. Have a written agreement ready for anything major, like painting- and in some places you may need a license for painting, in which case you're not necessarily out of luck; check with your lawyer, but my experience is that even where states require a painter's license and bonding, the only "penalty" is that your contract may not be legally enforceable, so make sure you can trust the people you deal with.
Think! What else do people want in hard or fearful times? They want cheap laughs. They also want someone to blame. Now, you don't want to get sued or get anybody lynched, but if you have even the slightest artistic talent, consider putting it to profitable use. Do a few cartoons about how tough things are and about who's to blame. Print them out as teeshirt iron-ons from your computer and sell them at flea markets. Make a couple teeshirts advertising this and wear them around. No artistic talent at all? Then yours will have to be the strictly text variety of humor and sarcasm. Personally, unless I could get them very cheap, I wouldn't bother selling the teeshirts- just the iron-ons.
|Another thing people want in tough times
is to look good.
second most glamorous and glitzy times in American history were the
1930s, in terms of people being flashy, topped only by the Roaring
20s. Cheap, flashy but classy
jewelry should do well. Go to your hobby shop, get a kit and
learn how. Consider (carefully) signing up with one of the
cheapest multilevel cosmetic companies you can find. You may not
be able to own the nightclubs, but you can sure decorate the people in
Folks will also be looking to save money any way they can. If you can come up with ways for them to do that, with little of your own investment, you'll have a winner. Along these same lines, good collection agents will be at a premium. Scout around- you may find a new and profitable career, one you can operate from home. Hint: I know one very successful phone collector; he says the secret to his success is the soft and easy touch- no threats, just easy persuasion, tiny payments.
toys. This may raise some serious liability issues (and
you certainly want to be
careful not to cause injury to any kids), so talk first to your
lawyer. Can you cheaply come
up with some interesting toys or science kits? Review the toy
with an eye to how it might cause injury to a child because if it "can"
cause harm, it most assuredly "will" cause harm. In hard times,
parents still want to do the best they can by their kids. This
could be profitable for you. Or, can you find a really cheap closeout on some
computer games? Buy them
and sell them.
In a crash, people start seriously reflecting on their educational
shortcomings. They also think about how not to let their kids
have educational deficiencies. So if you can tutor something for
Business needs. Focus on anything a business needs and sell it to them cheaper than anybody else because their focus in a crash will be on cost, not quality. Refill their inkjets or whatever.
|So you want to learn to trade the markets?
Let me shock you with a few absolute facts about newcomers to trading. First, anybody new should expect to lose money- at least half of their initial portfolio value. Second, very few people have the discipline to really learn how to trade. Third, too many newbies waste 'way too much money on useless trading tools.
I'll get to remedies for some of this in a moment, but let's explore why these things are true. The main reasons new traders lose money at first are: they hang onto a losing trade far beyond the time they should exit; like lemmings, they follow the crowd on a "hot" stock right over the cliff; they lack technical skills necessary to trading. Amazingly, the lack of skill is the least of their enemies, mainly preventing them from making regular profits. Even the most skilled traders sometimes act like lemmings or hang on too long.
One part of the discipline factor- or lack of it- is the failure to adopt a working trading strategy and stick with it. Another part of it is an unwillingness to hit the books and learn how to create a working strategy. Becoming a good trader takes months of study and practice. It takes hard work to achieve competence and great personal discipline to consistently apply that knowledge. Some people just learn the mechanics of one style of trading and briefly apply them, then another and they try that for awhile, and on and on really getting nowhere.
|Newcomers who buy useless trading tools
and services continue to amaze me. Let's start with overpriced
brokerages. Why on earth would you prefer to pay a broker's fee
of $9.95 each way, $19.90 roundtrip, when you can get exactly the same
thing at another brokerage for only $4.95, $9.90 roundtrip, or
more recently, for free?
Would you do that?
It's the lemming thing: half
the peole you talk to are with this big broker who advertises all over
television, so you follow them.
Another way these expensive brokers entice you is with their so-called trading tools- specialized automated charts, stock screening systems, alert notices, and charting systems you can program yourself. Now, I have nothing against having a full suite of trading tools- after all, I'm a quant- but most new people simply don't have the fundamental skills to make best use of these gizmos anyway. And once they do have the fundamental skills, they can use the abundance of free tools on the web with equally profitable accuracy.
So what, exactly, is the point of their doing this to themselves? The point is that the glitzy tools make them feel confident, like they know what they're doing and nothing bad can happen to them in the middle of all this fine technology. They are made to feel, quite literally, like jet pilots. But it's a jet that steadily drains their resources; I've seen them at last come away shaking their heads, as if they'd been in a dream, a bad one.
|The same is true of most of the fancy
standalone trading programs out there. Most new traders lack the
skill to get any real profit out of them, in comparison to using the
free stuff. Worse, there are usually monthly fees with these
programs, and it just isn't worth it. Added costs create added pressure on you the trader to
perform. You start taking pointless risks, you start holding on
to losers too long. In years of trading, I've only seen two standalone programs that I
would even consider buying,
and I haven't bought either of them yet because I want the price to
come down. Maybe that's my common sense or just my bottomfeeder mentality or maybe I'm
just plain cheap. But
even at my level of trading, I don't need the extra pressure on my
If you're going to become a trader, I do strongly recommend certain costly items, among them broadband, dsl, or cable. Cable is a bit insecure, but what isn't these days? You also want a fairly new computer, a desktop in preference to a laptop. Why? Because you need a big screen to keep track of what you're doing, especially at the beginning, and you want a pleasant view that doesn't strain your eyes. Later, you can get a laptop. The fast connection isn't essential, however. Plenty of good traders are on dialup.
yourself to become a trader. There are two basic ways to
trade the markets, with fundamentals,
or with technicals.
Fundamentals traders tend to be more long-term traders, while
technicals traders tend to be more short-term traders.
Distinctions do blur, however, in actual practice. Fundamentals are those things you
generally see in the news, e.g., the identities and backgrounds of
those who run the company, the financial aspects of the company, the
overall relationships of the company to the news, the nature and
strength of the sector which defines the company, and other matters of
a "reasoning" nature. Technicals,
on the other hand, and this includes the related fields of technical and quantitative analysis ("TA" and
"Quant", respectively), are concerned only with charts and mathematical
Technicians believe that all information affecting stock price is already reflected in the price, and feel no particular need to look beyond their charts to examine fundamentals in any great detail, if at all. In my experience I don't think I've ever seen a pure fundies trader- nearly everyone at some point in the trading decision seems to avail themselves of technicals. Unless you're planning to buy and hold for years, you want to become most expert at technicals- in my opinion, fundamentals are mostly for the Warren Buffet's of the world, in which case you won't be a trader, but an investor. And in the scenario we've already painted, you can see how disastrous being an investor might be. And while Mr. Buffet can afford the risk, can you?
|TA uses indicators
and you want to learn what they mean and how to read them. Chiefly, you
want to learn about the MACD, OBV,
RSI, stochastic, and Bollingers.
Here's where to learn for free: stockcharts.com, and investopedia.com.
|Quant also uses indicators but they
aren't the standard TA indicators normally available to you with most
charting tools. Quant indicators are mainly those which you
devise yourself (see also my
earlier description of quant). You really must learn TA to be effective;
after that, you can choose to learn quant to enhance your effectiveness
dramatically. I trained myself in TA and got fairly good at it
before moving on to quant.
If you decide to learn quant, you don't have to be a mathematician. A spreadsheet does all the hard work for you, and I include a comprehensive spreadsheet tutorial in my OrangeQuant video cd, available at orangequant.com. Current (July 2007) pricing ranges from $49- $119.95, depending on whether you just want the .pdf version or the video cd's. There's also a section on optical quant, which involves placing geometric overlays onto a stock or forex chart to forecast price movement (you can do this in any paint program or use a drop of water to literally stick a transparency you've made onto your monitor). Several of my tested geometries are included, as well as instructions for creating your own. Optical quant is a very lazy and fast way to see price breaks coming a mile away. A free demo version of OrangeQuant is at the site too, so you can try it out to see if you like it. Quant is very powerful.
|Trading the markets is not for
everyone. If you're risk-averse, this is not the place for
you. If you're greedy to the point of recklessness, this is not
the place for you. If you're a wishing
and hoping person,
you'll be bankrupt in two weeks.
If you can't focus and be consistent, you'll lose. If you feel
safe following the crowd, you'll be donating your money to those of us
What it really takes is a mature thinker, possessed of a modest mixture of greed, caution, determination, and innovative reasoning, along with a willingness to acquire a powerful set of market skills and strong self-discipline. You have to be willing to accept a loss and try again. You have to be able to set gain and loss parameters and stick to them. You have to be able to make a plan and execute that plan, while gingerly knowing if and when the plan needs changing. If all that describes you, then you're a trader. If not, save yourself some grief and stay away. Put your money in a cd or something.
|Speaking of money, you may wonder how
much you'll need to start. In stocks, I recommend starting with
no less than $500, and no more than $1000. Anything less than
$500 makes it hard to make a significant profit. Starting out
with more than $1000 is just too much risk- wait 'til you're very
skilled and confident before trading with more. Expect to lose
about half your starting bank. By all means, papertrade a lot before using
actual cash. There are many websites that will give you a free
"play money" account, such as investopedia.com. Papertrading helps you learn from
your mistakes, painlessly. Papertrading has its shortcomings: it
lacks the emotional component
of using real cash, and you aren't getting a feel of the vagaries of
the bid/ask system used in real-time trading. But it's better
In forex, a starting bank of no more than $200-$400 is probably best, depending on your chosen leverage. Again, expect to lose half before you really wake up and achieve competence. Papertrading is available through most forex sites; you can typically get $50,000 or $100,000 to open. Practice a lot. The TA aspect of forex is similar to TA in stocks, but because forex routinely makes faster, bigger moves than stocks, you are tested emotionally much more, and the speed often makes TA more difficult to read. I find quant essential to good forex trading.
Available forex leverages vary; some brokers allow as much as 200:1, which means you can lose money really fast, or make it really fast. Lately, I'm comfortable with only 50:1. Rather than explain leverage per se, a complicated concept in forex, along with the concepts of units, lots, and minilots, let me give you a straightforward example of how this works. (Please note that most experts suggest risking no more than 1% of your margin on any single trade, a rule which I routinely ignore, as in the example below, but one which you should assiduously follow until you're very, very good)...
Let's say you're running 50:1 leverage on $2000 margin (your actual cash balance). If you use $1700 in margin to make a trade (leaving $300 in available margin to cover moves against you), this will mean you can make about $10 per pip (the last tradable integer to the right of the decimal). But there's something called the spread, the difference between the buying and selling prices (ask-bid). Let's assume the spread to be 2 pips. So in a 3-pip move in your direction you'll make about $10. In a 5-pip move your way you'd make about $30. Normally, if you went to a currency exchange with USD and bought $1700 in euros and then five minutes later sold the euros back for dollars on the same 5-pip move, you'd get only about 60 cents in profit. But with 50:1 leverage, you get 50 times that much. Conversely, had the trade gone against you 5 pips, you would lose about $30 with 50:1 leverage, but at a walk-in currency dealer you'd only lose about 60 cents. So that's what leverage is all about; without it, smaller traders wouldn't find forex trading worth the trouble.
Note: The OrangeQuant package goes into great detail on using forex platforms and forex quant.
|Some Related Links
PA Governor Offers Foreclosure Help, Warns Residents
Chinese Gold Rush- Citizens Ignore Warnings
Housing Market Softening
Signs of the Economic Apocalypse
Venture-Backed IPOs rising
USA Living on Borrowed Time- and Money
Wikipedia's Version of the Crash of 1929
Debt Relief for Companies Indebted to China
Mortgage Branch Meltdown
Private Equity Fundraising Jumps 42% in 1st Half of 2007
KKR Files for $1.25-Billion IPO
NSS Article- Start Spreading the News
OSTK Sues Market Makers for NSS Damages
USXP (Universal Express) Sues Market Makers for Damages
Naked Shorting- Darkside of the Looking Glass (video)
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We are headed for some tough times, and giving others a heads-up can make strong friends for you later. People need to know what's coming, how to protect themselves, and how to profit from it- you are rendering a public service.
If you have doubts about the dire warnings here, just start reading between the lines of publications like Barron's, Technical Analysis of Stocks & Commodities, or Futures. These folks really do present you with the information; they just aren't yet willing to say out loud what that information really means. They are offering a word to the wise, and all you have to do is listen. Outfits like the Wall Street Journal and network television are much more circumspect, but the warning tones are even beginning to creep into their reportage as well. So just read and listen between the lines.
Thank you for joining me here for this discussion. I hope it prospers you.
----- Dennis Hudson
copyright 2007 Dennis Hudson, orangequant.com
all rights reserved except as expressly granted herein
Banks Setting Up 'Superconduit'?-
Monday, Oct. 15, 2007
'Superconduit', or just another fast track to hell?
Info Source- Wall Street Journal, Sat. 10/13/07 and this WSJ blog:
I'm calling this "the superconduit to hell". In between laughing my butt off and pounding my keyboard in disbelief, this is about as close as I've ever come to some serious profanity during this pending crash. Details will be out sometime today and, likely as not, the market will at first react favorably to this latest version of 'pass-the-sausage' economic strategy. But watch out later in the day or Tuesday as serious money starts to come back off the table, as word gets around about what a crock this really is.
Alright, buckle up- the explanation of this is so twisted and dizzying you may fall off your chair. Turns out that three weeks ago the U.S. Treasury Department convened talks with major banks to deal with (mainly) subprime fallout. The superconduit (Master Liquidity Enhancement Conduit, 'MLEC') is the result. The idea, in a nutshell, is to get a bunch of big banks to buy the bad debt of some of the worst-off or stupidest banks, mainly Citigroup, who holds about $100 billion in so-called structured investment vehicles (SIVs). JP Morgan and Bank of America are said to be prime candidates for this bailout of Citigroup, and one must wonder what that might do to their balance sheets.
The big problems are several. First, the fact that since nobody wants to buy this bad paper, how do you set a price for it that makes sense? I mean, if nobody would buy it on the open market, why in the hell are BofA and JPM even thinking about buying it in the first place? Once you digest that lump of coal, you realize that this is just a shell game-- in order for healthier institutions to be willing to buy the crap, there's got to be a guarantee or payoff somewhere down the line, right? We'll find out later today what that payoff is, I guess, but it'll probably be that the buyers will agree to hold the smelly bag for awhile in exchange for some serious interest and a buyback guarantee at some fixed price. But ultimately, somebody will have to pay, probably the taxpayers.
|Dow Breaks Record- Monday,
Oct. 1, 2007
Good news? Or just one last gasp?
The DOW set a new record high today of 14,115.51. Imagine that. In the midst of banks forecasting major Q3 losses, the DOW goes up. In the midst of the largest closure of a U.S. bank in 14 years (see Netbank article below), the DOW screams to a new record. In the midst of the DX (Dollar Index) crashing to almost 79, the DOW goes zoom as if everything is just peachy. Right smack in the middle of a massive run on England's fifth largest bank (see Northern Rock story below), the DOW pulls up its socks and heads for the heights. Flying in the face of all the subprime-overleveraged-CDO crap and everything else, the DOW goes north.
So I guess all us crashmongers are just dead wrong, eh? So the lemmings can now go back to business as usual, right? But hold on a minute. There's a big difference between volatility and trending. Go back, study the Great Depression, you'll see some key similarities to today. The really sharp ups and downs began in March of 1929, and continued until the definitive start of the crash in late October. As Gallea and Patalon note in Contrarian Investing:
"One symptom of a mania is that, as prices rise vertically, the aggressiveness of investors keeps pace. Near a market's top, many people expect the party to go on forever."
They also point out:
"Every mania has a defining moment, a point when a public figure (or figures) assures the crowd that the good times can go on and on- in essence, that 'things are different this time'."
There's an article today on yahoo (Jeremy Siegel article), in my opinion worth reading only to demonstrate the second point mentioned above from Gallea and Patalon. Gushing with praise for the Fed and other central banks, Siegel goes to great lengths to tell us how everything is just fine: "The Fed stanched a contagion," he tells us, referring to the subprime catastrophe, and thereby has prevented it from spreading into the general economy. He goes on:
"The world's other central banks have also acted accordingly by supplying all the liquidity needed to keep credit costs under control and assure the stability of their banking systems. Thanks to their concerted actions, the sub-prime crisis should not turn into a recession."
There's no point to singling Dr. Siegel out- there are plenty of similar bullish speakers around- but it's obvious that these folks are all about propping the market up just awhile longer, obvious economic facts to the contrary. Why? Because big money is hurting-- and the way out is not through an immediate crash. An immediate crash would capture some profits for them, through shorts and puts, but not nearly enough to cover for all that subprime debt. So they need to milk the markets-- up then down then up, etc.... they are desperate to restore confidence in the markets. Then, once they have sufficient volume back in for a sufficient length of time, that's when they'll let the whole thing finally crash and not before. Just take a look at recent volumes in your favorite stocks and compare to their volatility-- it's all been out of whack for several months.
Now ask youself if you really see a trend in the DOW that's matched by volume. You don't. It's a false trend. It's a manipulated market. All I can say is, if you keep playing long, be careful. When they finally pull the plug, it won't be pretty.
ADDENDUM: Wednesday, Oct. 3, 2007.
See what i mean? The pumpmonkeys are at it again.... today, as the market slid slowly south, we got this from briefing.com ....
"...What happened today, then, was nothing more than a move to take profits from an overextended market....
"The materials sector (-1.3%) was the worst-performing sector. Its weakness is apt to generate some chatter about it being a sign the market is worried about a recession. Don't pay attention to that...."
And this was in the face of today's yahoo.com survey question on where people think the DOW is headed, showing, as of 7:00 pm ET...
"With the Dow hitting the 14,000 mark what target will we see next?"
Results: 61,937 (57%) said DOW next goes to 15,000
47,943 (44%) said DOW next goes to 13,000
Total Votes: 108,662 (figures slightly off due to rounding)
Folks, that mix of market sentiment is not a resounding vote of confidence in the market, as you can see. It implies continued strong volatility as the bears and bulls fight this out. It implies significant fear and hope. If you think like a quant or technical analyst, you can see a big long-legged doji coming as the composite of the next few days. At a bullish top like this, that usually means one thing--- a hard crash or the start of a long downtrend. Be careful.
Netbank Shutdown- Monday, Oct. 1, 2007
ING Bank to Preside Over Wreckage
Netbank Closed by U.S. Office of Thrift Supervision
In the largest U.S. bank closure in 14 years, regulators shut down Netbank last Friday-- waiting, of course, until after market close to make the announcement. Depositor accounts were handed off to ING (another online bank) for administration. Make what you will of this, but coming hot on the heels of the Northern Rock bank run (see further below), it does seem ominous. What's puzzling some market watchers is the handover to ING, who is believed to have substantial stakes in bad subprime debt, which is mainly what clobbered Netbank in the first place, bankrupting its parent company. Keep watching, in a credit crisis and crash, the weak die first, shortly followed by the strong...
CFC Bailouts? My Latest Theory
Why Biggie Banking Institutions Are Helping CFC- Thurs. Sept. 27, 2007
Ever since BofA did that weird $2 billion CFC "investment" (bailout), i've been tormented by the mystery of it. BofA certainly had better ways to make money than rolling the dice on this turkey, even though they're getting 7.25% interest and an excellent shot at CFC's servicing business when CFC goes BK. But recent developments, i.e., CFC announcing it was in serious talks with other large financial institutions for yet more "investment" (bailout) billions, are helping me understand this a lot better--- or so i think. let's take it from the top-- first of all, we all know that the bodies of subprime loans are EVERYWHERE in the banking and financial sectors, right?
SO WHY WOULD JP MORGAN and others do this? it's financial suicide, UNLESS..... maybe, JUST MAYBE, these "good samaritans" are doing it to save their own fat skins. they are all most likely holding TONS of really bad CFC subprime paper. in other words, if CFC goes down, they ALL go down, hard. so "maybe" CFC points out the obvious to them and adds, "Look, not only will you guys take a big hit if we go down, but we can make it even worse by chewing up all our collections for operating costs in the meantime."
Just a theory. But in my opinion you'll want to be wary of financial stocks for a long time. If anything, SHORT 'em. The overall mortgage default and foreclosure curve will keep climbing and will peak around March 2008. Between now and then a lot can happen. The ability of banks and hedge funds to keep playing this shell game is limited-- when liquidity is gone they are all toast. And they are fast running out of liquidity. they are running out of capital and the Fed has said "no bailout" (bad news for them, if you believe the Fed). and even if the Fed does bail them out (the Bank of England has also said "no bailout"), it will produce a bout of runaway inflation that will make the deutschmark debacle of the 1930s look like a "minor correction". you'll be buying a loaf of bread with suitcases of cash. And if the Fed and BofE keep their word, it's still going to be ugly because you won't have any cash to buy anything anyway.
Rate Cut? It Doesn't Help
In Fact, It Makes Matters WORSE- Sept. 19, 2007
Now, you know how bearish i've been lately? well, i'm still the same. but my time horizon has shifted. the expected Fed move changed things. now i expect happy hour in the markets for at least a few days until everybody figures out that the rate cut was not good news for the markets. but why not?
Fact is, the cut has set in motion forces which will presently bite the markets very hard in the lower wherewithals. further, the cut will not help the housing market or housing prices- they'll still fall hard, well into double-digit losses (as Mr. Greenspan heroically noted recently). the mechanics of this are simple: true, the banks can take in more mortgages cheaper, but nobody wants to buy the paper because investors don't trust it anymore. so, either the banks have to offer better yields on CDOs to investors, which will cut deeply into banks' next quarterly reports and trash the markets, or, the banks just won't be doing much mortgage biz. i think it's the latter.
But just suppose they do manage to flog some more bad paper to investors....The net effect will be to set us up for an even harder crash down the road as new homeowners gradually find out they can't afford the loans and (gasp) just walk away from their mortgages, which is what's already happening and is what triggered the present mess that required the rate cut in the first place, only now the fallout will be much worse. Rate Cut No Help for RE
Now, there are also some other issues with this rate cut business. there are all these other places in the world called "countries", and they all have their own economies and currencies to worry about. stay with me. Rule #1- a rate cut trashes a country's currency, and that's exactly what's happened to the dollar. even against the highly dollar-biased Dollar Index currency basket, the USD has lost magnificently (now down to 79, the 80 danger threshold was crossed a couple weeks ago). [see DX- Dollar Index]. and the rate cut announcement didn't help. any halfway decent chartist can see exactly where we're headed. but what does this mean?
It means that our "friendly" creditor countries out there, who've been buying all our debt as U.S. Treasury notes, are now in the uncomfortable position of having to decide to either cut our throats, or let the USD cut theirs. and they seem to be choosing to survive. all those dollars they're holding are steadily decreasing in value, which is good for their exports but bad for their currency. and it's so bad that it's threatening to hurt their overall economies. so, even though Uncle Sam wants them to cut their interest rates to help stabilize the USD, such a move would devalue their currencies too. India and the rest of Southeast Asia are about ready to throw up their hands and let the USD twist in the wind. Asia Picture on Rate Cut
One major problem with the dollar devaluation (which is what the rate cut really is) is that oil is mainly denominated in USD (except for Venezuela and Iran, which will now only accept yen for oil). so here you sit in a developing economy, using googobs of oil per minute, and some guy comes along and raises oil prices by 10% in USD, what do you do? keep holding those ever-crashing dollars, or cash 'em in for some other more stable currency? right. and that starts a carry-trade unwind like never before seen, meaning heavy dollar dumping, which in turn devalues the dollar even more.
So, yeah, i'm temporarily bullish- but only 'til the bulk of market retailers (read, "knotheads") figure all this out. well, maybe i shouldn't call them names like that, but i find it highly perplexing that the markets- for two days- have taken all this as good news. so i take it back- they're not "knotheads", they're just folks like me but who haven't yet put in the time to study this complicated mess.
SuperFlash- Friday, Sept. 14, 2007
Bank Run! London-
Above: some of the thousands of Northern Rock's
depositors line up to cash out at England's 8th
largest bank... (capsule story below)
Comprehensive story at timesonline.com
Northern Rock, England's eighth largest bank, was outed this week as having had to turn to Bank of England (England's rough equivalent of the U.S. Federal Reserve) for emergency cash. Depositors instantly smelled a rat and lined up by the thousands to grab their savings, as well as crashing bank computer networks in attempts to move funds (the Rock was later accused of crashing the nets themselves, but denied it). The furor is indirectly linked to the continuing worldwide subprime disaster-- lenders who would normally have provided cash to the Rock are entangled in the subprime mess.
MAE BUYOUT DEAD IN WATER?
(sorry- no tidy formatting here- just getting it out to you fast)
SLM (nyse)-- Sally Mae student loan corp
the $25 billion LBO may be in trouble. one analyst says that pending legislation that would cut federal subsidies to student lenders could trash the deal.
"...The student lender in April accepted a leveraged buyout proposal worth $60 per share, from J.C. Flowers & Co, Friedman Fleischer & Lowe, Bank of America Corp. (NYSE:BAC - News) and JPMorgan Chase & Co (NYSE:JPM - News)..."
the deal totals $25 billion, but now the banks are threatening to roach, based on adverse impact of legislation. but if they default, it'll cost them $900 million, unless they can prove adverse impact. what's really behind this is the fact that about a dozen banks (including the above) are up to their eyeballs in LBO commitments- $300 billion worth. and they don't really want to complete these deals because the related companies may tank, given the present climate, leaving the banks as bagholders for all that debt. wiggle room, lol... so if you're playing this one, be careful...
SuperFlash- Thursday, Aug. 30, 2007
About those $1 bil SPY Calls Sold
Did Someone Bet Big on a September Crash??
A discussion brewing since Aug 22 has at last exploded into the open. I don't own this site or have any financial interest in it, but they started it and you should read the thread. http://www.tickerforum.org/cgi-ticker/akcs-www?post=4669. It's as if the world just discovered it last night and people are freaking out- traffic hitting heavy and owner scrambling to keep servers working. MARKET REACTION TO THIS COULD SERIOUSLY AFFECT YOUR POSITIONS. A more dispassionate article on this can be found at http://www.moneymorning.com/2007/08/29/this-900-million-bet, but by no means less ominous.
IN A NUTSHELL, on August 22, "someone" sold $1 billion in September SPY calls, spread across all prices. Options expiration is the third Saturday of each month, so one theory holds that this party has inside info that led them to make this bet that the market will crash by 30-60% by September 21. Other theories hold, variously, that this is a hedge against something else the seller is doing.
I posted the chart below on a forum and immediately got upstaged by someone posting a second chart, which I decline to steal (See chart & forum here). After that, it was firestorm city- the thread got so many hits I decided I should post mine here. Warning- if you're long, you should close this screen and tiptoe quietly away...
Opinion. Well, I just got my feelers hurt. Someone whom I highly regard on a forum commented (accurately) that part of Countrywide's problems stemmed from quants inputting the wrong data into their algorithms. Also, two weeks ago a couple of major quant funds crashed. Kinda makes quants look bad, huh? So I sense we're being set up to take the fall for this entire mess. No fair!
What this all came down to (as concerns quants), was office politics. And I'm talking about not just Countrywide and the quant funds, but the overall crisis. One of the first things you learn by experience in quant (course available orangequant.com) is to pack up and go home during extreme volatility. Stay at cash. Yes, you can stick around and scalp if you want, using technicals- but leave your statistical tools in the bag. Both statistical quant and indicator quant develop serious strains in high volatility, i.e., they crack and burn. Decay accelerates phenomenally- far worse than usual. So I'm sure that all the quants were telling their managers exactly that. But, at the outrageously high salaries the quants were getting, the managers couldn't afford to send them home. Instead, they kept yelling, "Give us something!" (and that mindset probably continues). So there you have it- it's the managers' faults, not the quants'.
Monday. A copyrighted Barron's Article reported today that keen LBO operators snookered major banks into more than $300 billion in LBO debt over the past few months. The story comes as no surprise to those familiar with the likes of KKR (Kohlberg, Kravis, Roberts), Carlyle Group, and Blackstone, to name a few private and public equity players of note (not all were named as involved in the story).
WHAT THIS MEANS... as an LBO "hobbyist", I love watching these people operate. What they did, as the merger-acquisition-LBO-takeover market was heating up, was strongarm major banks, including Citibank, JP Morgan, Goldman Sachs, Royal Bank of Scotland, and Merrill Lynch, into accepting below-par interest rates for $300 billion in LBO deals. Greedy, their eyes on the tremendous potential fees and interest, the banks caved to the pressure, relaxing their usual hard stance on interest rates and virtually giving away the store. But now, the market has turned and many of the once creditworthy targets are failing the smell test of the derivatives marketplace. In short, no pun intended, the banks no longer have anybody interested in buying such questionable paper. But they're still on the hook to provide all that funding at bargain-basement interest rates, to enterprises that may collapse any day like so many bad souffles in a thunderstorm.
Normally, the banks have an escape clause that lets them out of a deal if the target falls on hard times before the deal is consummated. But this time around, the LBO mechanics only let them have an escape clause that provided that the banks would have to prove that a downturn in the fortunes of the target was worse than in comparable companies in the same sector. I'm almost rolling out of the chair laughing as I write this... get it? ALL OF THE COMPARABLE COMPANIES ARE CRASHING. So the banks have no way out....
Stay tuned here and to your favorite market newsfeed- this could get verrryyy interesting verrryy soon...
It's Friday night. What a week! Wells Fargo's system shutdown Sunday nearly touched off a major panic and a run on all the banks. Bank of America and three other banks, apparently with the quiet help of the Fed, cobbled together a $2 billion deal to basically raid Countrywide Financial. Thursday, the four horsemen AAPL, GOOG, RIMM, and AMZN all fell off their high horses, leaving many traders wondering, "What next?", while others greedily snapped up what they hoped would be bargains. All week, politicians have been calling for homeowner bailouts against foreclosures. European bankers began the painful process of admitting that they too have drunk a lot of the subprime koolaid. And today after market close, the Fed finally released a memo from Monday that gives Bank of America (BofA) and Citibank (and possibly other banks) a license to risk 50% more of depositors' money than the law allowed.
What should we make of all this? Hard to say. Let's take it one at a time (and I might not finish before I have to doze off, but I promise to get back here ASAP to finish up).
Starting out with the most ridiculous item-- the homeowner bailout idea- it's absolutely ludicrous to imagine that there's enough money on five planets to bail out defaulting homeowners. While it's true that I have little sympathy for those who, with their eyes wide open, bought those $250k crackerboxes, signing off on the scary mortgage terms at the same time, the fact remains that there simply isn't enough cash around to bail them out. Even if it could be done, we'd only be bailing out the crooked and stupid mortgage bankers, hedge funds, mutual funds, and pension funds that greedily sucked up all those bad derivative notes, which will lead them all to expect another bailout next time, leading to an even worse catastrophe down the road. You don't cure a meth addict by giving them more meth.
Realizing this, and the public outrage that would result if the government even seriously tried such a bailout, the ever-creative U.S. Federal Reserve Monday devised its own fiendish solution to market meltdown, and indirectly a temporary fix to the foreclosure crisis. I say fiendish because it's a plan cooked up in hell, and it's very likely to turn an ordinary 1929-style crash into a full-blown economic firestorm. The lemmings don't yet understand the implications, and they probably won't until they wake up one day to find they can't access their bank accounts. For now, they think the Fed-Citibank-BofA thing is good news. But by late next week they may begin to smell the coffee- or not- after all, so far the lemmings have proved themselves impervious to real knowledge.
Waiting for release until after Friday close, the Fed's Monday memos to BofA and Citigroup
(see it here)
(and "possibly" to J.P. Morgan)
labors for a couple pages to explain the rule and Fed justification for
its action. The memos were in response to the banks' requests for the
exemption. The rule says a bank shall not lend out or encumber
its assets to its brokerage affiliates to any extent greater than 20%
of its total worth.
This is to prevent high-risk incestuous relations that could bankrupt a
bank and cost the FDIC a lot of money (up to $100k per individual
depositor). BUT, the rule has an "escape" provision that allows
the Fed to create an "exemption" for any bank if it deems the exemption
to be "in the public interest". And that's exactly what the Fed
did, taking a full page to explain why.
So now, BofA and Citibank can lend out up to 30% of their worth to their affiliates. This applies to mortgage transactions and securities transactions. So it becomes magically possible now for their mortgage bankers to make a lot more bad loans, and a lot more bad stock trades to prop up the markets yet awhile longer. In other words, they can now take us all exactly 50% deeper into the crap than they have already. And, they can set themselves up for a 50% deeper crash. But who cares?- as long as they're making money meanwhile.
If you've read this far, you can see why the lemmings don't get it... it's just too darn complicated. But, just in case they might have understood it, the Fed and the banks kept it secret until after Friday close. If the lemmings ever truly get it, they will start a run on the banks like never before seen. But knowledge is like a virus- it spreads- and it won't be long before the lemmings, in their own way, begin to figure it out. The first sign of that will be a sharp dip in the markets, then the lemmings will start in on the banks. Believe it.
The only arguably "good" thing about this Fed "exemption" may be that it requires the affected banks to daily mark to market all covered transactions. So the public will actually know from their books the true financial state of the banks with respect to these transactions. Of course, that could be a double-edged sword- any serious slippage down from originating value could trigger customer fear and panic withdrawals of cash. So why have that provision? Because the Fed isn't going to take the blame for the crash.
NOTE: Oddly, by late Saturday, I couldn't find direct Yahoo coverage.
But money.cnn sure covered it, with a pretty good analysis too.
If the story disappears, you know the fix is in.
on to the Wells Fargo shutdown.
In light of the above Fed "exemption", we have to wonder what it might
have had to do with the Sunday thru Tuesday banking "glitch" at
WF. Did WF perhaps know about the coming "exemption"and was maybe
afraid of a run on the bank by depositors? If true, that would
speak volumes about how WF
interprets the "exemption", i.e., basically the same as we did
WF phones, ATMs, and merchant acceptance lines were shut down; customers found themselves inexplicably limited to only $250 of cash from the ATM machines (when they worked at all). On Tuesday morning, WF told the media the problem had been fixed, though it persisted far into Tuesday night. A rumor started (but by whom?) that terrorists had struck WF at our weakest moment in order to cause a panic. WF said the whole thing was basically a glitch. But they have backups on top of backups. And what was the deal with the $250 limit? If you can get $250 in a "glitch", then you ought to be able to get your whole $400 or $500 normally allowed per day, right? In short, this was 'way fishy.
Now, as for that $2 billion BofA "liquidity" injection into teetering Countrywide Financial, I wrote a lengthy email to some friends on this which I'm going to offer here "as is", if you don't mind....
"...you know abt countrywide (CFC)- they're THE subprime poster child right now. this week BAC (bank of america) injected some cap into CFC in exchange for some preferred shares (exercise price $18). now on the face of it everybody knows that's a stupid $2 bil trade, since they can't exercise it for a long long time, based on the deal BAC made with the SEC to allow them to make the purchase. BAC does, however get 7.25% interest on the shares and, while that's not a bad rate BAC could've done a lot better with its cash elsewhere. so duhhh?
"what BAC is really hoping for is either of two things... either CFC defaults on the interest payments, or CFC goes bankrupt and defaults. either of these scenarios would make BAC, as a preferred stockholder, first in line of the creditors. they could then cherry pick all the good paper out to satisfy the debt, along with seizing CFC's servicing contracts. in popular terms, i think this would be called a RAID. LOLOLOL..... :-P
"and now it gets really funny... what most of us expect is that BAC will now begin shorting CFC to death. but, they can't actually use the shares they hold to do it. so that means a lot more capital, highly leveraged, in order to crash CFC into the ground and force the default, with BAC making a ton of cash on the short meanwhile. to avoid scandal--- BAC will blame it all on the hedge funds, who are notorious for shorting distressed companies. (as it's happening, it will be impossible to tell who's doing what, since all trades are made in street names, i.e., in the names of the brokers who place the trades, not in the names of the actual outfits, unless a trade is bigger than 10% of the outstanding shares).
"when the dust settles, CFC will be trading in the pennies but not bankrupt because that would panic the market-- and probably part of the deal with the Fed and the SEC was that BAC would try not to let this happen. in other words, "kill 'em boys, but leave the corpse standing." meanwhile, CFC's crash will likely take a ton of other subprime players down with it, as well as a bunch of banks. but BAC is playing with fire-- the deeper in they get the more likely they'll start getting some of the liability involved because CFC has some very nasty obligations to mortgagors (homeowners), like refinance promises etc... bottom line, BAC could end up going down with CFC if they aren't verrrryy careful."
Have a nice weekend.
Well, last friday they fiddled the system to prop it up awhile longer. I call this a pure PROP JOB. By an impromptu cutting of the discount rate, the U.S. Fed has again forestalled the inevitable. But it looks like the market ain't buying it!
The discount rate is the rate at which banks can borrow money from the Federal Reserve. It isn't the prime rate, which is what controls consumer interest rates. The overall effect of cutting the discount rate was pure flash- smoke and mirrors- to confuse the retail traders (like you and I) into thinking everything is just peachy. But it was a serious misstep. After Friday's bounce the market wised up. Wiser heads spread the word that this won't ease the credit crunch, and may make it worse. In fact, banks generally didn't come racing to the discount window to borrow any of that freshly minted green for one simple reason: it makes them look bad and could cause a run on their reserves by customers. So all the cut did was give a few fat investors and hedge funds yet another chance to escape the consequences of a vengeful market, which was obviously the whole idea of the Prop Job in the first place.
Another reason for the PROP JOB was the Thursday night thru Friday morning slaughter of the dollar by the yen. The Fed had to do something, even if it was the wrong thing to do.
Now, there's still some euphoria out there- the lemmings will always be with us- so be careful. Seriously consider some of the defensive ideas in the ebook. This sucker is still highly likely to crash totally. Someone noted today (Karl Denninger) that currency markets rarely move in lockstep with stocks, but that's exactly what's been happening with the usd/yen pair lately. I won't steal his thunder as to why this is so ominous, but I think he has a point and it's well worth reading.
Lately I've been watching RIMM (Research In Motion, maker of the Blackberry). I don't trade it- doing only Forex right now- but I find its behavior very revealing of what's really going on with the movers and shakers. Goldman-Sachs, already in deep doodoo over its hedge funds, has been steadily "upgrading" its analysis of RIMM and the market lemmings have been dutifully following along and, yes, making money. But don't forget what happened to RIMM last Tuesday, Wednesday, and Thursday when it crashed about 30 bucks, just before the 3/1 Friday split.
So what does this RIMM volatility say about the movers and shakers? Well, like Goldman-Sachs, they are all still in deep doodoo. RIMM and certain other stocks are their answer to covering margin calls so they can stay liquid, i.e., avoid bankruptcy. So with RIMM, they played it long early last week, then shorted it and crashed the pps, then went long again and pumped it up thru the media. And right about now, they're probably shorting again- or maybe they won't start shorting 'til about Thursday- and then RIMM will crash once more. They'll keep this up as long as the market will stand it and then they'll constantly short it all the way down. And these are highly leveraged shorts- so when reversal starts again, look out below! Much of the shorting is also done thru option puts, another variety of shorting that's even more deadly to stock price.
So any stock you see behaving strangely right now, going up in the face of all this economic fear, watch out! If you get green, take the money and run!
The Crash seems to be approaching at warp speed, with the system unraveling far faster than even I expected. So, as with the "news flash" at the top of this page, i haven't yet included this info in the downloadable file, which takes time, thought, and organization. But I put this stuff here as news occurs or as I happen to think about it. Yeah, I have opinions, strong ones, so let's start with some of that...
With the general media now admitting Crash spillover from the mortgage business into the general economy, more of the public is becoming aware and justifiably alarmed about the consequences. And, many people will soon be blaming the "big rich guys" for causing all this mess, which in fact they did, but they sure didn't do it alone...
So while we're busy blaming the fatcats, let us remember that we, the retail public, made our own contributions to this disaster. We're the ones who just couldn't do without home ownership at any price. We're the ones who just couldn't do without that new car at any price. We're the ones who just couldn't do without that new furniture, stereo system, apartment rental, refrigerator, television, or home improvement at any price. We're the ones who just couldn't bear to live unless we absolutely maxed out all six of those pieces of plastic in our wallets. We're the ones who just had to have that ridiculous cell phone that does everything but make coffee.
We're the ones who bought those $250,000 cracker boxes on outrageous terms when we knew full well that the only way we could pay for them was if they went up in value by at least 10% per year. We're the ones who bought those $50,000 Humvees and armored-looking SUVs because it was the "hip" thing to do. Geez, fifty grand for a box on wheels? How stupid is that? Can you live in that thing? And those expensive cracker boxes in manicured gated neighborhoods? With the sewage systems that don't work? With the improperly set foundations already setting up wall cracks? What the hell were we thinking??
I say "we" only so you wouldn't feel so alone. But in fact by sheer grace I was preserved from all of the above economic crimes and misdemeanors. I didn't want a credit card, and I sure as hell wasn't going to pay a quarter million dollars for four walls and a toilet. I grew up in a house my parents bought for five grand and I never forgot that. I got over my taste for fancy cars in 1975 when engine repairs to my Porsche 911t cost me as much as a year's rent, even though I was then earning in excess of $36k. In recent years, I've been tempted to get a nice "entertainment center", and I may do that soon, but so far my ancient cranky used color tv's have done the job. Most of my spare cash since 2005 has gone into the markets- to learn and to make money. And that helped me to see what was coming.
We will survive this crash. But what's important is what lessons we take from it. The hazards of consumerist gluttony is one such lesson. In future, we need to get real about the true value of things and pay not one dime more than that. We need to get over our fascination with shiny stuff that glitters. We need to grow up about wanting stuff now and being too childishly impatient to save up for stuff. In short, we need to grow up.
Friday, Aug. 17, 2007
S.E.C. kills FTDs Grandfather Clause!!
Major Crunch coming to a market maker near you!!
This info is not yet included in the above download but i wanted
YOU to have it now...
In a move that could be seen by some as an effort to cover up
its partial responsibility for the current crash, the S.E.C. on
Tuesday, August 14, 2007 issued a rule declaring a key part of
Regulation SHO null and void. The nullified portion had allowed
brokers and market makers (mm's) to skip out on fails to deliver
("FTD's") positions which had accumulated prior to Reg SHO.
Now, under the new rule effective October 15, 2007, mm's must
cover these "grandfathered" FTD's...
S.E.C. Website Statement in Detail
Analysis: WHAT DOES THIS MEAN?
First of all, given the deteriorating state of the markets, one could argue that this is an SEC move to cover itself against later criticism for having allowed all these FTD's in the first place. (FTD's explained below). FTD's are basically counterfeit stocks, and there's tons of them in the market, time bombs waiting to destroy the economy. The SEC is trying to distance itself from the explosion soon to come.
It's really a good move but very late in coming. Two countervailing effects are now on tap. First, as mm's are forced to cover these criminal "naked shorts", there will be an upward effect on stock prices, though this upward effect is now dampened by other economic crises. The second effect, however, will profoundly amplify downward momentum already underway due to the subprime mortgage disasters, hedge fund failures, and imminent bank failures. The amplification is due to the fact that covering their criminal shorts means brokers and mm's have to dig very deep into already disappearing cash reserves. This in turn will mean an even meaner liquidity crunch, exacerbating the overall economic chaos... well, you can read between the lines-- some mm's and brokers are about to have to close their doors, and that is going to trigger more and worse in the banking industry and the economy in general...