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| Wed May 28 23:05:03 2008 Seizing Up Explained |
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| Mon May 19 23:06:50 2008 More Bad Gas |
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| Thu May 8 21:37:23 2008 Bad Gas |
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| Wed May 28 23:05:03 2008 Seizing Up Explained What seizing up really means, and why you should be afraid... |
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| There was a good story in today's
Wall Street Journal. It covered the last few days of
Bear Stearns' life as a solvent company. It was fascinating reading!
One thing really struck home: the speed of the collapse. Once investors realized Bear Stearns had problems, they rushed to pull out their investments, and banks who were lending them money notified them that their loans wouldn't be renewed. The result? As you'd expect, Bear Stearns ran out of money fast. They couldn't raise the capital necessary to return investor funds, especially since banks were refusing to lend them any more. All they could do was sell their existing securities at fire sale prices to try to pay back investors. This is the classic description of bank runs, even though this was a investment bank rather than a commercial bank. I've written before about the rampant use of the term "seizing up" to describe the post-subprime collapse (see Carpe Seize! or Seizing Up). I was curious, what can they (reporters and financial pontificators) mean by "seizing up?" The WSJ Bear Stearns story is pretty clear: the entire investment bank community was primed to collapse. Investors everywhere would realize "hey, these investments aren't safe at all!", and they would all try to pull their money out at once. Investment firms would not be able to return the funds, because they don't have any. All of your invested money has been used as collateral on loans for the investment banks to make other, bigger investments in an attempt to make high returns. If everyone demanded their money, the firms would be forced to terminate their positions, probably at a loss, in order to close out the loans and return funds. Because all of the investment banks would be selling their securities at the same time in order to raise cash to return to investors, prices would plummet, and the result would be that most of the firms would go under (massive losses amplified by leverage) and most investors would get back only a fraction of what they'd put in. That's what I think "seizing up" means. The house of cards would really collapse. Rather than let that happen, the Federal Reserve moved to keep investment banks solvent. In an unprecendented move, the Fed helped broker a deal whereby JP Morgan would buy Bear Stearns at a huge discount, with the Fed promising to cover all Bear Stearns losses with taxpayer money (see the stories at MSNBC and CNN). I think that is a bad idea. The Fed is trying to cover investment banks with the same guarantees as commercial banks. But that is bound to fail. Why is the Fed's move to protect investment banks ultimately doomed to fail? Because investment banks are competing for the highest rate of returns. The way to achieve high returns is to take on high risk. And that means taking leveraged positions in the market. By attempting to guarantee investment banks, the Fed is putting billions of taxpayer dollars at risk. I say billions, because although the Fed is putting trillions of taxpayer dollars at risk, that is only on paper. A bad crash would bankrupt the country well before we reached the trillion-dollar mark. So what should the Fed do? The Fed should continue to cover and regulate commercial banks. Also, it should only protect commercial banks. Since the 80's, the Fed has let commercial banks take on investment bank responsibilities, especially with the Gramm-Leach-Billey Act, which I'd never heard of before but now looks very suspicious. Once the Fed is back to protecting commercial banks, it should be clear with investors: "If you choose to invest with investment banks, be aware that your deposits are NOT insured, and you could lose all your money." Right now, even a conservative investor is a fool not to invest in risky investment banks. There is no downside. If the bank does well, you make money. If the bank collapses catastrophically, the government will bail you out. So why not take a lot of risk, and let other taxpayers bail you out if needed? If the Fed persists in attempting to cover the risky behavior of investment banks, we'll be fine until the next market crash. Then the result will either be collapse of the economy (unlikely) or the currency (very likely). The currency will collapse as the government realizes it needs to print more money to cover all of the investment bank losses. Comments |
Related: > economics < Unrelated: books energy environment geopolitics lists mathematics predictions science |
| Mon May 19 23:06:50 2008 More Bad Gas Congress and the President pass a bad law. |
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| Today President Bush
signed into law a dubious bill submitted by the US Congress. It was another attempt
to reduce oil prices, and it may have serious consequences. (See
High Oil and Gas Prices for another even less effective Congressional attempt).
Senators had noticed that the US Strategic Petroleum Reserves were buying 70 thousand barrels of oil a day. Their thinking was that stopping these purchases would help reduce demand and therefore prices. Don't get me wrong, I hate high gas prices. I just filled my tank today and I was stunned (prices here are now well over $4 per gallon). I'd like prices to come down. However, the Congressional bill was ill-advised for two reasons: First, the strategic reserve purchases are a miniscule part of total demand. The United States consumes over 20 million barrels of oil a day. The 70 thousand barrels amounts to 0.3% of total US demand. Not 3%, 0.3%. Furthermore, oil is a global commodity, so the impact has to be judged relative to global consumption. The world consumes over 80 million barrels of oil a day. So the US Congress has removed less than 0.1% of global demand for oil. It is unlikely that the global markets will even notice that tiny drop in demand. But let's say the markets do notice, and the price drops by 0.3% (I've generously multiplied the demand drop by 3 since oil is after all an inelastic supply). In the best, most generous case, Congress may have reduced gas prices by one penny. Hey, maybe that's worth it, right? Wrong. That brings me to my Second reason that the Congressional bill was ill-advised: Congress is assuming that we are in a temporary period of high oil prices. Halting strategic purchases would help ameliorate the high prices, and then the purchases can resume when prices come down a bit. (The bill--now a law--stipulates that purchases can resume again at the end of 2008). However, there is a very good chance that prices will keep rising for the foreseeable future. Why would prices drop, after all? Demand won't drop very quickly, since a demand drop will require that large numbers of American consumers and industries replace their inefficient cars and factories with more efficient models, which will take a long time. (Based on the 1970's oil shock, it takes several years for demand to come down). But even if US demand is dropping, other world demand (China, India, others) continues to accelerate. A drop in US demand would help a lot, but this isn't the 1970's anymore. There are a lot more industrialized countries to buy that oil. And oil production is peaking. Russian oil production peaked in 2007, leaving only OPEC countries to keep up with production. However, only Saudi Arabia has significant reserves, and they are running out of easy-to-extract oil. Oil industry observers know all this. They expect prices to rise, not decline. Goldman Sachs recently predicted that oil prices would reach over $140 per barrel in 2008, up from close to $130 today. And they predict prices in the $150-200 range in the longer-term (6 months to 2 years). That would mean gas prices well over $6 per gallon. So what did Congress actually accomplish? We've saved a penny per gallon now (maybe), and then the strategic reserve will have to start buying again later when gas is even more expensive. And if you believe that stopping the purchases helped prices now, then you have to agree that starting the purchases later will hurt prices then. Comments |
Related: > economics < energy Unrelated: books environment geopolitics lists mathematics predictions science |
| Thu May 8 21:37:23 2008 Bad Gas A bad idea that will likely make the problem worse. |
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| I've been reading a lot lately about the supply and demand of oil, and the
impact on gas prices. (See
High Oil and Gas Prices and
Peak Oil, for instance). In the 1970's, high gas prices made
consumers buy more energy-efficient cars, or back off on buying new cars
altogether. And the same thing is happening now.
Chrysler has gotten worried about that (not surprising, given their double-digit sales declines). In response, they are now offering a guaranteed price of 2.99 per gallon for 3 years. That way, you can buy a car with low gas mileage, but not worry about your fuel costs exploding in the future. They have a few caveats. They don't let you buy more than a certain amount each year. Premium gas costs a bit more. And they have attempted to limit their own exposure by "using a hedging strategy." Practically, that can only mean they are placing orders for options to buy gas in the future at limited prices. The idea is that consumers don't have to worry about gas prices anymore, so people can go on buying cars again as if gas was still cheap! And as the article notes, "...other carmakers will be watching the program closely as everyone grapples with the negative effect of fuel costs on sales." Chrysler may make some money in the short term, especially if they are the first and only to market for a while. It could be a way to shore up sales while they update their product line with more gas-efficient models. But in the long term, this is a bad idea for everyone. The high cost of oil doesn't go away. Chrysler can hide it behind slightly higher auto costs, or pass it on to other speculators via their hedging strategy. But if oil costs keep climbing--and they probably will--then eventually Chrysler won't be able to buy the options necessary to fund the program. Given the uncertainties in supply, I suspect 3-year gasoline options will become expensive very fast, especially if multiple automakers want to buy them in volume. So as a gimmick, this could work in the short term. But it just means more people will buy less efficient vehicles for a while longer, and that will ultimately push gas prices up even more. Comments |
Related: > economics < energy Unrelated: books environment geopolitics lists mathematics predictions science |
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