“Anna Molly” – Incubus.
I need to start doing this again – title posts coincidentally with a good song.

Anyways – a better title would be “When there is smoke, there is fire.”  I should have written about this a while ago: rates.

Who out here in this blogosphere, or anywhere mind you, shop a little for interest rates for your savings/money market/CD accounts (maybe even checking if you dig deep)?  I know you can pretty easily with bankrate.com.  I even knew a [[smart]] guy that would shop for higher rates constantly, and would always find a rate higher than his student loans in order to pay for the interest.  I wonder how he’s doing now…

Anyways, I wanted to write about how published rate offerings for different banks may suggest how they are fairing this tumultuous economy going on here.  Please direct yourself here for a second - it’s HSBC’s published rates, frequently changing.  Scroll down to the various CDs they offer, from 3 month duration up to 2 years.  

Anything pop out at you that’s a bit off?  It seems logical for higher rates for the longer term, as it’s considered more risky the longer you lock in your money in a CD, and the bank should pay for that.  The shorter the term, the more liquid it is, the lower the theoretical risk.  HSBC’s rates pretty much follows that, except for their 2 year term CD at 1.60%.  It’s below the 1 year at 2.00%.

This is a micro banking definition of an inverted yield curve.  A normal yield curve would have interest rates increase as the duration of the CD increases.  This represents the risk for reward theory mentioned a second ago. 

When looking at irregularities like HSBC’s rates, it can give you some insight to how the bank currently managing itself.  Looking at these rates, I would have the initial thought that HSBC doesn’t really need immediate, short term funding (shown with the very low rates for 3 & 4 month CDs), nor do they need much longer term funding (shown with the lower rate in the 2 year term).  Where the bank is willing to pay for money is the intermediate terms that they offer, the 1 year, 13 months and 15 months.  Perhaps they are having some difficulty gauging themselves through that 12 -18 month cycle, or maybe they are quite weak in that ‘bucket’ of time.  Whatever it is, they are willing to pay up for these terms for some reason.

When I’ve rate surfed in the past, I’ve noticed huge differences in immediate short-term (less that 6 months) rates versus long term.  These banks were begging for short term funding, perhaps couldn’t get it anywhere else (might have no one willing to lend to them).  Anomalies, for sure (hey! back to the song of the post!).  But should be taken into consideration while rate shopping for your money.

Why?  Well, if there is a huge discrepancy within their short term versus long term funding (i.e. 2% for 3 month CD versus 1% for 3 year…I wouldn’t think that’d be out there though, at least for the major banks), this screams “we need money! now!”

I want to drive home that if a bank overall is paying significantly higher rates compared to those around them during a time like this, it should be highly questioned.   I’d currently be wary of smaller, community banks doing this.  Their troubles are less publicized, and therefore issues may not be immediately apparent other than published rates to the general public (although you can pull up public FDIC call report filings -10Qs for banks- and dig in yourself if you’re so inclined).   It’s a decent gauge on how a bank is doing – to see what they are willing to pay for.

Granted, this may not apply in a better rate/economic environment.

Dear Timothy Geithner,

It’s tough to say how well you will do as Treasury Secretary for the Obama administration.  Clearly you are qualified.  Yet it’s quite “coincidental” how you misinterpreted your tax obligations (and you even worked for the Treasury, come on…).

But that’s beside the point.

Read this article »

Finally – sorry – the last pillar of the basel II agreement.

The third pillar – it’s pretty simply – it requires banks to be more translucent with their reporting, allowing markets to get a better grasp of what’s going on inside the bank.

Let’s take a step back on the topic – why do I care?  Not just because banking is a rather important topic of conversation lately.  This is an international document that lacks the ability to be enforced.  Different cultures, different government regulations that affect banking more directly rather than an elusive, global document.  It’s worth talking about, getting familiar with, just as international accounting standards are being adapted to global companies. 

But overall – this is pertinent to current times.  I’d like a clearer definition of what a bank considers its assets before I invest.  I’d like to know how Lehman Brothers developed its CDOs and derivative products. Or how banks managed their risks, what they were exposed to, what to expect for risk in the future and how it’s pieced together.  

Smart people can develop complicated financial models to outsmart the market, to dissipate risk and create a win-win situation.  But let’s have regulations that piece together all of these, to understand CDOs and what-if situations of unwinding them.  Of conceiving irresponsible rating agencies inflating MBSs or plain company bonds.  Well, I guess I’m getting a little ahead of myself.

But a clearer presentation to the market of internal activities would allow the possibility of smart people to conceive these possibilities of failing banks, poor loan practices and the overall ripple effect on others.

I don’t think it’s too much to ask for a free market with free information.

I got this petite book for Christmas, requested out of curiosity - The Case Against the Fed.

My advice – don’t bother.

I’ve read the first 30 or 40 pages this morning, and one term comes to mind: ridiculous.  Let me make the point that it is geared towards people that do not know anything about banking.  The author takes that point of view in order to point out how inefficient and poorly managed the Federal Reserve is ran.  If you did not know much about banking, it would be easy to be sucked into this book.

It alarms me that the author dwells on counterfeit money, and then uses the act of counterfeiting money to compare to what the Treasury is doing on the Fed’s request – printing money.  The book says printing money is legal counterfeit. Um, alright.  Oxymoronic at first – just plain dumb when the thought actually sets in.  It speaks of inflation as a bad thing, that the current supply of money is optimum and no additional money is needed.  That price deflation, essentially, is positive. (Mind you – the author bases price deflation on purely technological advances.  Of course the TV I bought last year will be cheaper this year after new technology replaces it.  That is not price deflation).  

It’s one of the Fed’s tools – to control inflation.  But control inflation to be moderate and expected.  If we did not have inflation, the economy would not grow, would not evolve, would remain stagnant.  

The author fails to explain how counterfeiting (the illegal kind) is actually handled.  It is assumed that counterfeit money is not ever controlled.  It is said that the criminals make the money, and buy goods, making the supply of money artificially increase.  And that people down the chain of exchanging goods for the counterfeit money will lose purchasing power, not because the counterfeit money is detected and withdrawn from the people’s hands, but because at the beginning, the criminals were able to buy goods, artificially buying up the demand for the product, while the people later down the chain will have to pay more for that same product.  The author uses this image to poorly construct what goes on with inflation.

Right.

Has this person taken an econ class?  

Inflation is not the timing of money changing hands, where people at the end of the ladder lose out compared to the people who touch the money first.  Inflation is the increase of general prices of goods & services over time.  There isn’t a person that loses out because he or she is the last to receive a dollar in a chain of buying and selling goods/services.  It is where everyone will be paying more overtime for products or services that once were cheaper in the past.  The author uses the government fiscal spending as a poor example to illustrate the point again – that one aspect of fiscal spending is for government projects, then those projects are undertaken by contracts with private sector, where the direct families of those benefiting from the contracts are the ones that get the opportunity to spend the money first, and so the ladder continues down.  Supply & demand does not react that fast, where someone buying a product today will affect the price of it tomorrow.  It is plain not possible.  

At least I know which school I know not to go to for my PhD.

*shaking head in shame*

Something I’ve been curious about – and I think deserves more attention – are the Basel accords.  

From what I know up front, there are two and provide guidelines for capital requirements for banks.  And that Basel is in Switzerland.

The second Basel agreement is more pertinent, yet still only recommendations.  It provides recommendations for capital adequacy…sound relevant?  

-side note – banks in Europe have more of a liberal accounting system, with the ability to write off non-performing assets to look like they’re profitable (e.g. Deutsche Bank in 4Q07 I believe, maybe 1Q08).  

Sparing myself from reading 350 pages, there are three pillars of the agreement: capital allocation is more risk sensitive, separating operational risk from credit risk, and align economic and regulatory capital to reduce the possibility of regulatory arbitrage.

Let’s look at the first pillar for now (as I don’t have the focus after work for all three at once!) – capital allocation being more risk sensitive – it outlines capital adequacy for credit, operational and market risk.  It also aligns itself with a minimum capital requirement.  When banks take deposits and turn it around for investments, they can choose investments or loans, and the Basel accord rates this on a scale from least to most risky, starting with government bonds at 0%, OECD countries at 20%, mortgages at 50%, commercial loans at 100% and now something new – subprime borrowers at 150%.  The minimum capital requirement that the Basel accord lays out is 8% with the risk weighted assets.  I believe this is to encourage banks to even out their risk – but I wonder why there isn’t a maximum.  Perhaps I’m not understanding this fully.  Lastly – the first pillar says that banks basically can evaluate credit risk by their own means: the “Standard Approach”, or the foundation/advance “Internal Ratings Based Approach.” 

So returning to that side note – the IRB approach? huh? so you have the power to rate your own credit risk, even right it down so much that you create the illusion to have a profit?  I hope this approach is moderated…or at least looked after.

next to come: pillar 2 of the 2nd Basel accord.

The new year brings hope for bigger and better things, and I am no different!

My new years resolution is to write everyday.  Well, at least 6 of the 7 days a week.  Decent enough, right?  Also – I’m attempting to get a domain name for this, as I’d like to have more control over the look and feel of my presentation.

Let’s start off - 

Some ideas I would like to explore: 

• Basel accord (I & II)
• Keynes vs Friedman
• Pegging fed funds to an index

Anyone else have any suggestions? 

Also – a little FYI for my reader(s), another personal new years resolution is to get into a PhD program (or, the very least, a master’s) in economics.  I’ve signed up for the GRE exam for the end of February, as well as linear algebra (beyond calculus) at Harvard (extension school, mind you) to firm up my application.  I plan on refreshing my stats and calculus as well, and hopefully do another research project, like that of the FHLB exploration.  Schools I’m looking at are University of Washington, Suffolk University, Goethe University in Frankfurt, CERGE in Prague, University of Chicago (a reach, I know), and maybe UC San Diego, MIT (streeeetttcchhh) and another safety and/or international school.  Anyone know of any other good schools for economics?  

Cheers!

~house of cards ~ radiohead ~

I spend a lot of time watching the news, both at work and at home.  We all know what’s going on with our economy, how the fed and treasury are trying to help the financial system out, trying to help consumers out.  And then we see retailers increasing discounts during this time of looming depression to lure customers into relaxing their white knuckles on their cash.

But how has this economy really affected consumers?

Here’s how I see it so far – the banking system has crashed and is evolving into something never seen before.  The financial system is wiping out.  No longer do 150 year old companies exist.  More and more the sector is becoming an oligarchy.

And the news is reporting that it’s all about the credit markets.  Yes – well, it’s what caused it.  But it’s the banks’ problem.  I don’t really see it affecting consumers.  Their reaction to save more may be because of a perceived personal credit crunch.  But how many have you actually experienced a bank withdrawing your credit line on your card? 

I realize two separate points that go against this argument: 1) people are being denied new credit and loans, which cultivate growth in our economy and 2) people are losing jobs.

But for those not employed by the financial sector (about 94% I believe) – there’s still income.  Propensity to save is due to the fact that we see 6% of the job force is losing their jobs.  That we see foreclosures increasing.  That we hear banks not lending anymore.

Maybe I’m not making my point clear – consumers have money.  They have income.  They may not be able to move into a home – but they can still spend.  We still have credit, just not new credit.

Am I insane? I just saw someone on CNN saying they are choosing to use cash over their credit card.  But that means they have the ability to use credit.  I just think that the propensity to save and to spend shouldn’t be affected if you have a job.  You just can’t buy a house right now.

This point is not very refined – I just had to get it out there.

Traffic is picking up – I should write more!  Anyone got ideas?

My current thought is (and it seems to be popular with the econ blogs out there…I had this idea two weeks ago!) – Keynesian versus Monetarism, their schools of thought argued against each other, especially pertaining to today.  This will take some research though, so it will take a while.

Any other banking/monetary policy ideas out there?

For the econ geeks out there – you know that the fed can do more than adjust short term rates with the FOMC.  And, with many previous discussions before, they’ve enacted a new tool – interest on reserves.

But in an article on the WSJ over the weekend, another tool was discovered, and I should have thought of – long term rate manipulation.  hmm, go figure.  Well since treasury now owns freddie & fannie, that seems logical to be able to do.  Purchase long term freddie/fannie bonds to manipulate long term rates.

Let’s think about that – yes that would normalize the yield curve a bit.  Yes that would increase liquidity on the market.  But would it really help?  In pushing the long term rates down – the fed’s goal ultimately would be to lower mortgage rates for the consumer.  Supply-side economics to stimulate demand.  I can see how that would work, but would it really work?  

Tell me, who wants to lend right now?  The best borrowers are still continuing to be lined up next to low grade borrowers.  The banks are hoarding cash due to increase loan losses.  More liquidity would just be more cash to hoard.  A good point was brought up to me – if a bank can buy high grade commercial paper yielding 7%+, why lend at 6%?  Residential and commercial loans have become an unwanted asset.  The banking model is developing – no longer is it borrow short to lend long.  It’s borrow short to lend even shorter.  It’s asking the question ‘how much can we ring out for our NIM’ rather than ‘how can we fund this ninja loan.’

Hmm perhaps the government should buy more commercial paper to loosen up that market.  Perhaps we should just let capitalism hobble along without the government’s crutches.  Let live and let go.