From Another Credit Crunch
Posted by Eddy Elfenbein on June 24th, 2008 at 11:54 am

The New York Times from November 1991:

Is the credit crunch real? Are banks denying creditworthy businesses the loans they need to invest the economy out of the recession?
The idea certainly appeals to the White House, which is in hot pursuit of a villain or three to explain why the stalled recovery is not the President’s fault. But many economists remain skeptical. The fall in the volume of bank loans, they point out, could be explained equally well by a recession-induced decline in the demand for credit.
Or at least it could until now. Minds are bound to be changed by the release of the first serious analysis of the crunch hypothesis, by Ben Bernanke of Princeton University and Cara Lown of the New York Federal Reserve Bank. The study, to be published in the January issue of the Brookings Papers on Economic Activity, confirms that a scarcity of bank capital has indeed affected the supply of loans. But the two economists believe that the full weight has been felt only in the Northeast. And they say the impact on jobs and incomes may be smaller than anecdotes of businesses’ drying up for want of liquidity would suggest.

Have Lunch With Warren Buffett
Posted by Eddy Elfenbein on June 24th, 2008 at 11:42 am

For charity, you can have lunch with Warren Buffett. The current bid on eBay is $77,100.
That’s less than two-thirds of one Berkshire share.

Junk Default Recoveries Maybe Lower Than Usual
Posted by Eddy Elfenbein on June 24th, 2008 at 10:31 am

I’ve been surprised by the wide yield spread between low-risk bonds and high-risk bonds. Just look at the downward drift of Vanguard’s High-Yield Corporate Bond Fund (VWEHX).

I called Vanguard and the fund pays a dividend yield of 8.61%. Wow, that creams just about anything else you can find today.
Of course, they’re called junk for a reason. High-yield bonds have a greater risk of defaulting than investment grade debt. In today’s Wall Street Journal, Liz Rappaport says that if defaults do happen, the amount recovered could be less than it has been in the past.

A report to be published Tuesday by Moody’s Investors Service argues that the explosion of loans issued by junk-rated companies in the past few years means that if they default, the recoveries on these loans might be less than in the past.
The highest-priority loans, called first-lien senior secured bank loans, will likely recover on average 68 cents on the dollar upon default in this downturn, compared with a historical average of 87 cents, Moody’s said.

Here’s the money quote:

Now, Moody’s expects loan investors to fare almost as badly as investors in riskier junk bonds have done in previous busts. “It doesn’t matter what you call something,” says Kenneth Emery, author of the report. “What matters is where you sit in the liability structure.”

Historically, it’s fairly rare for a bond, even a junk bond, to default. The long-term rate for junk is about 2.6%, but for investment grade bonds, the default rate is just 0.1%. However, defaults can often spike dramatically higher. There have been times when the junk default rate has hit 15%, while it’s never gone above 1.6% for the highest-grade bonds.
Reuters reports today:

The U.S. default rate on junk bonds, high-yield debt that is below investment grade, rose to 1.89 percent in May, a 26-month high, from 1.64 percent in April. The rate is expected to rise to 4.7 percent within a year and there is a 20 percent chance it could go as high as 8.5 percent, S&P said.

Goldman Admits It Goofed
Posted by Eddy Elfenbein on June 24th, 2008 at 9:34 am

You don’t find the word “goofed” in many financial headlines, especially ones dealing with Goldman Sachs, but Reuters has the goods:

Goldman cuts financials, admits goofed on upgrade
Goldman Sachs & Co strategists urged stock investors on Monday to “underweight” U.S. financial and consumer shares, admitting it was wrong when it upgraded both sectors just seven weeks ago.
The downgrades sparked selling in the two sectors as investors feared that weakening consumer demand and deterioration in the credit markets will weigh on profitability.
“We boosted our consumer discretionary and financials weights in May on the belief the sectors would benefit from bank recapitalizations and fiscal stimulus,” Goldman strategists led by David Kostin wrote. “Our thesis was clearly wrong in hindsight.”

Good for them for reversing their call. One of the biggest mistakes investors make is refusing to admit defeat on an investment. People will hang on to the worst sorts of stocks just so because they don’t “want to take a loss.” Stocks don’t have egos. Sometimes it’s best just to let it go.
Here’s a look at how the S&P 500 Financials and Consumer Discretionary Indexes have done since the beginning of last year.

This chart reminds me of another big mistake investors make: “It’s already down so much, it can’t possibly go any lower?”

UNH Under $27
Posted by Eddy Elfenbein on June 23rd, 2008 at 3:07 pm

Unitedhealth Group (UNH) got down to $26.35 today. That’s the lowest price in over four years. The company said that it expects earnings this year of $3.55 to $3.60 per share.
I’m going go out on a limb here and say, I don’t think the market believes that.

Aussie Power Crisis Leads to Flat Beer
Posted by Eddy Elfenbein on June 23rd, 2008 at 2:40 pm

Talk about globalization. Thanks to demand from China, a town in Australia is booming. That is, until an explosion cut off natural gas supplies.

Hotels are turning off heaters, dirty laundry is piling up and restaurants and bars expect shortages of beef and draught beer. The crisis may shave a quarter point off Australia’s gross domestic product as mines and processing plants cut production, slowing the state’s commodities-driven boom, estimates Brian Redican, a senior economist at Macquarie Group Ltd. in Sydney.

It’s a nightmare deciding what stays on and what stays off. My favorite quote:

”When it gets to the stage where you can’t pour a beer in a pub, you know this crisis has the potential to affect every aspect of business,” says Bradley Woods, CEO of the Australian Hotels Association’s West Australian branch.

Buy! Buy! Buy! Wait, I Never Said Buy.
Posted by Eddy Elfenbein on June 23rd, 2008 at 2:11 pm

Oh Jim.

(Via Felix via the tireless Don Harrold)

Market Failure Versus Government Failure
Posted by Eddy Elfenbein on June 23rd, 2008 at 1:57 pm

Here’s an interesting article from the Washington Post looking at the government’s ability to handle market failures.

“How well does government do in helping the market to improve what it does?” asked Clifford Winston, an economist at the Brookings Institution and the author of the 2006 book “Market Failure Versus Government Failure.” “The research consistently finds that, in fact, government efforts to correct market failures have little effect, or actually make things worse.”
“There is a tendency for people to say, ‘If things are safer, then I will take more risk,’ ” he added. “It does not have to involve government interventions: Drugs are developed to reduce blood pressure, so people say, ‘Okay, I can eat more, and it does not matter if I gain weight, because I can take this pill.'”

I think people are inherently poor judges of risk.

Previous research has shown that people drive faster in vehicles that feel safer, attempt to bike on more dangerous terrain when they wear helmets and pay less attention to infants being bathed when the children are in seats that are said to reduce the risk of drowning.
Winston does not believe in one-size-fits-all solutions — whether interventionist approaches that liberals favor, or the hands-off strategies that conservatives prefer. Rather, he argues that solutions need to be tailored to produce measurably successful outcomes.
He once studied the effect of installing air bags in cars at a time when automakers were offering customers the option of buying cars with and without the safety devices. Winston found that people who bought cars with air bags tended to be the safest drivers to begin with. And now, lulled into a sense of security, they tended to drive faster, effectively canceling out the safety benefits.
The wrong lesson to draw from this is that air bags are useless. The right lesson is that air bags can improve safety when they are targeted at the riskiest drivers. As the safety devices become standard issue, for example, risky drivers are automatically protected. And as the safest drivers stop feeling they are extra safe, they may take their foot off the gas.

RIP: George Carlin
Posted by Eddy Elfenbein on June 23rd, 2008 at 1:38 am

Nasdaq Composite and Long-Term Support
Posted by Eddy Elfenbein on June 20th, 2008 at 11:03 am

I’m not much of a market technician, but I’m passing along this chart because the time period is so long.

In March, the Nasdaq came within 10% of hitting the long-term support line. Even though it looks close, the black line is around 2050 today, which is far below where the Nasdaq (^IXIC).