The Next Bubble?

Is it possible that the next stock market bubble is stock trading itself? Of late some press has been given to practices like flash trading and high frequency trading. Both these mechanisms are dependent on high tech hardware and software and are therefore only available to the larger players – for now at least.

In flash trading, the trader tries to maximize the rebates offered by exchanges by freezing his trade for a fraction of a second by offering to trade rather than responding to the trade. Additionally a flash trader may seek interest in his security from “dark-pools” or electronic exchanges outside the traditional exchanges.

High frequency trading as the name suggests involves the conducting of really fast trades using sophisticated computers and algorithms. Enormous volumes of stock are traded and even minimal swings in the values of these stocks can lead to gains. Some observers say that high frequency trades account for over half the trading volumes in markets these days. Flash trading combined with high frequency trading can lead to even greater profits. A flash trader may for instance see the interest in a stock and use this information to buy the stock to re-sell at high frequency to people who want to buy it. The spreads sometimes are less than a cent. While some have compared this to front running – the illegal practice of using advance knowledge to trade in a stock – loopholes in the regulations in some markets allow this practice.

Both these practices take advantage of the momentum in a stock’s price. Large volume trades can capitalize on even a 1c movement in stock price and eke out substantial profits. In a way this is an extension of day trading and the end goal is to make profits in fractions of a second and get in and get out of a stock making money in as short a time as possible.

In recent months these practices have led to an explosion in the volumes of shares traded. Many companies see many times the volume of the total shares listed which implies a high frequency or flash trading of the shares. These shares are held for fractions of a second only to be re-sold.

This feeble mind wonders how an ordinary investor can capitalize on high frequency trading.
Currently of course a small investor will not have access to these markets. The only way to play this is to be a high net worth individual, one who has money in the accounts of brokers who use these tactics. Chances are though that these mechanisms will be democratized over time allowing smaller players to participate or to pool their resources in order to participate….at their peril.

Obviously the accelerated trading of large volumes for profits may result in the formation of a bubble until some large companies bet too much and lose too much. On the plus side however, the government is already taking steps to investigate this.

One wonders if this is the continuation of the new paradigm for making money. It started in the dot com boom and bust and continued in the real estate bubble. Inherently these bubbles pushed the envelope on making money from nothing but trading be it in dot com stocks or derivatives and instruments tied to real estate. Flash or high frequency trading continues this by trading in micro momentum with scant regard to fundamentals or other historic measures of valuation.

This leads one to almost yearn for the quaint old days of stock swings on quarterly earnings and the maniacal focus of the top executives in meeting the quarterly figures. People complained that a quarterly focus prevented companies from strategizing long term. Now it appears that even a quarter is too far off the horizon and micro seconds are the new unit of measure.

Leno and other random thoughts

There is a lot of skepticism about Jay Leno's success in the 10pm (E) time slot. I am one of the naysayers - to the skeptics. I believe he will do exceedingly well. I am also one of the people who will watch him.

When I lived in the east coast in the pre-DVR days, I found the late night shows to be on too late (is that an oxymoron?). Also given the current nature of their jokes and the fact that they are on most weekdays, I do not tend to record them on my DVR these days unless there is an expectation of a really interesting guest.

The other reason I feel/hope he will be successful is because I am a sitcom aficionado. I do not particularly care for the serious drama/programming that otherwise occupies networks in this hour. I have never cared for crime or hospital dramas and lately my interest in news magazine shows have also declined. I was never a major reality TV fan either.

As a self admitted news junkie with a ear tuned throughout the day on the financial news especially, I am pretty much worn out by news by the end of the day. I prefer my prime time TV shows to consist of blah sit coms which are good for a laugh. In this environment I believe that Leno will be a welcome change. I am betting that there are many others in this country who feel the same way too and will make his program hugely popular. So popular that they will have to raise the ad rates on it very soon.

Let us see how this prediction pans out.

Either way, whether it succeeds or fails, this is a win-win for Leno. Success of course will give him a vehicle on NBC. Failure may result in him being courted by Fox or ABC for inclusion in their late night schedule. I wonder if ABC will slot Nightline in the 10 or 10:30 pm slot to make room for Leno should that happen.

Speaking of TV shows I watched quite a bit of CNBC during the night of 9-13. I caught the tail end of Maria Bartiromo's interview with Citibank CEO Vikram Pandit and later the town hall meeting with Tim Geithner the treasury secretary. From Pandit's speaking and his body language it appeared that Citi is well capitalized for the time being. I am a little anxious about my shares of C, but I will hold on to them for a little longer. As for Geithner, many of us fail to realize the complex and stupendous tasks that faced policy makers like him and Paulson. It is very easy to criticize them in hindsight but I wonder how many of us would take decisive action like they did during the most challenging times and under intense scrutiny.

Looking at major news today (and contrasting them with the headlines during the beginning of the year),

• Fed rate is still close to zero
• Fighting in Israel is no longer headline grabbing and the pirates seem to have mysteriously disappeared.
• The Dow is at 9592, the NASDAQ at 2083 and the S&P at 1043.
• Gas is around $2.30 locally
• There is a lot of debate on health care, some of it very ugly.
• Money, job and home worries still persist
• Conflicts continue in Afghanistan and less so in Iraq - at least from the US perspective.
• Gold has topped $1000.

In the U.S. at least health care and deficits seem to be getting the most press along with a growing wariness about the war in Afghanistan and an undercurrent of a "what are we doing there" attitude. While there is consensus in capturing or killing the planners of 9-11, there seems to be a growing unease on continued guerilla warware without any clear goals.

Lastly, since I started this post off about a TV show, I wonder how many people are out there who would welcome the introduction of a digital VCR? I mean a DVR for all intents and purposes but without programming fees. The only option these days appears to build one using the Windows Media Center software. DVR programming fees - to me at least - is another source of money dripping from my pocket book and I resent the charge. If I could happily record shows on my VCR for free, I don't see why I should have to pay for that privelege on my DVR.

New Cars

Taking advantage of the recently concluded Cash for Clunkers program, this feeble mind traded in a clunker for a sedate family sedan. The last time I purchased a new vehicle for the spouse, I backed into a parked truck within the first month which caused no end of embarassment.

As a result, I am being very careful especially while backing out avoiding garbage cans and the like. New cars these days are loaded with safety features. But what I realize is that bumpers have become very soft. This is partially to cause less damage to pedestrians should you come in contact but also to serve as crumple zones directing the force of a crash away from the occupants of the vehicle.

While that is a noble design aspiration, unfortunately it lends itself easily to scratches, breaks and tears. The bumpers of my old clunker was made of solid steel. When I was rear ended by a newer car and a very low speed, the front end of the latter pretty much disintegrated while my clunker only suffered a couple of scratches.

I have also been noticing new cars with bumps on their bumpers. And it appears that in addition to having plastic bumpers, new cars don't have very good visibility. To be more aerodynamic, cars have sharply sloping bodies and a typical driver cannot see where the car ends. Most people however get used to their vehicles and can judge distances fairly accurately but perhaps before they get that intuition, they end up having a small accident or two.

Entitlement Cycle

Are we entering another entitlement cycle? A broad look at the last hundred years suggests that in the early part of the 20th century it was pretty much every man for himself. The period following the Second World War resulted in a more active application of the Welfare State concept especially in the western world. This model appeared to deteriorate in attractiveness and soar in costs and in the 70s and 80s and some countries – notably the US – started dismantling some of the entitlements (e.g. unemployment benefits) or moving them to the private domain. Now another 20 years later increasing entitlements – especially universal health care - appear to be back in the forefront of the national spotlight.

It would appear that we move from entitlement to self reliance and back every 20 years. The movement is not stark or abrupt but a slow chipping away of the edifice in place resulting in the slow replacement of one system with the other.

The most obvious explanation to this is that the costing for the period of entitlement is inaccurate and the state cannot bear the burden of the costs these programs require. The fact that the citizenry get taxed punitively does not help the cause either. At some point therefore the state gives in. Over time reduction in entitlements lead to a loss in the general well being of the populace because though the people have more money in their hands, it is not enough to pay for the entitlements previously provided by the state. As the chorus of anger builds up over the lack of entitlements, the state is forced to take notice, reinstate some of the benefits and the whole cycle repeats.

The crucial aspect therefore is cost. And it is heartening to hear that in the current climate of healthcare reform considerable attention is being given to how to pay for the reform. Creating a feel good solution without considering the cost may be good for one or two presidential terms but not sustainable much longer.

JAHP (Just Another Healthcare Post)

So what are the private insurance companies whining about? Why aren't they providing affordable healthcare for the un-insured? Because it isn't profitable to do so!

So
1) The private insurers don't want to provide healthcare for all
2) The private insurers don't want the government to offer a plan since they fear that the plan will siphon off its profitable consumers too.

And Americans, instead of understanding how vulnerable they are to a financial catastrophe in the event of a job loss or serious health problem do not really think through the healthcare issue but just spout meaningless garbage about big government and taxes. Yes, the government can be overbearing and a nuisance at times but remember it is by the people and for the people!

All Americans should ask themselves these questions.
1) How secure are you in your job?
2) What will you do for healthcare if you and/or your spouse lose your job/s?
3) Can you seriously afford COBRA in its unsubsidized form and for how long?
4) Can you seriously afford to pay for healthcare? Do you know how much a couple of days of hospitalization costs? Or maybe a minor surgery? Or a battery of tests?
5) What will you do if you get laid off with a pre-existing condition or two in your mid fifties?
6) Honestly...how much have you saved? Do you have anywhere from $200,000 to over $1 million set aside purely for healthcare? If not, can you claim that you can take care of any healthcare emergency without insurance?
7) Even if you are healthy and young now, it is a matter of time that you will develop a long term issue be it back pain, diabetes, heart disease or the like. Do you think you will get individual coverage then should you lose your job and can't find one in a reasonable time frame and are forced to take involuntary retirement?
8) Can you afford the sparse options that exist like the state pools and variations on the group coverage which will end up costing you thousands in premium?

The fact is you can downsize to a smaller home or an older car or stop shopping for luxuries. But the lack of health insurance coverage exists as a significant, clear and present danger to the well being of most Americans.

Yes taxes suck. Yes the habitual freeloaders will get health coverage from our tax dollars (they already are). Yes there might be times when government healthcare will really suck. That is why for the last point at least, it is currently being offered as an option and not the sole choice. You can say why should I pay taxes for it when I plan to stick with the private plan. The truth is you don't have a choice. It is your companies that make the choice for you and trust me, they will offer you the cheapest plan possible. Also wouldn't if be great that you have an affordable option should you lose your job?

What about the oft cited cases of nationalized healthcare where care is not immediate?
I would rather be in a situation where I am waiting for an operation without the fear that it will bankrupt my family rather than foregoing one because I can't afford it though surgery is available immediately. No situation is perfect, but Canadians and Europeans have some of the highest life expectancies around. Surely something must be right in their systems.


Yes other reforms should happen simultaneously. Doctors shouldn’t charge the way they do, they shouldn't have to pay high premiums for malpractice insurance and insurance companies shouldn't cost the way they do. But come on, do you have time to wait for all those reforms or would you rather go with the one that affects you directly?

Do you really think options like Health Savings Accounts will make that much of a difference? How much will you contribute in these? $500 a month? How much healthcare will $6000 a year get you? HSA's might be viable if there is a ceiling after which it is covered by a catastrophic coverage. Tried finding the latter coverage lately or with an existing health condition?

Do you think shopping for health insurance is an answer? Do you think there will be an enlightened insurer somewhere in this country who will look at all your frailties with a kindly eye and yet offer you a decent affordable coverage when the same has been denied by other hard nosed insurers? Well you probably believe in the tooth fairy too.

It none of these arguments convince you, you are either or extremely well off, or you are in complete denial about your vulnerability to a health crisis or you are so taken in by party propaganda that nothing will shake you.

The fact is that ultimately the health insurance companies dug this hole by denying coverage to larger and larger numbers of people and simultaneousy colluding with others to making individual payments for healthcare totally un-affordable.

A public option (not sole choice) is the only answer out of this crisis. Let the private sector compete with the goverment because after all if the private sector is indeed so efficient and well run, they shouldn't have much trouble holding their own against the government.

The End Result

How much should one obsess over something - when the end result is the same?

There are two irritants which this feeble mind is trying to resolve.

One involves replacing an old computer and the second, replacing an old car. Both have put in honorable service, 8 years for the former and over 10 for the latter. As I attempt to replace these with the general economic woes in the background, I attempt to find a rationale for my choice. Should I buy a desktop or a laptop? Should it be low end or high end? Similarly for the car, should it be a reliable people carrier or a more luxurious vehicle? Should I go hybrid?

At the end of the day however, I look at what I do with these purchases. Chances are any long and exotic drives are unlikely. I will just travel to work and usual activities. With the computer, it will be browsing, preparing some documents or spreadsheets and an occasional (very occasional) game.

So my decision will gravitate towards the lower end or mid range product which I will inevitably buy and then regret I did not spend more. I have gone through this cycle enough times that I am comfortable with buyer's remorse and can deal with it.

One of the few game I do play is Sim City. My family doesn't understand my fascination with this slow moving game. I sometimes equate it to a sense of expectation that may or not fructify. For instance I have watched and observed people watching aimless videos. An example is a video shot from a travelling car.

We are so conditioned especially from watching TV to expect something that we will mindlessly watch an empty road rushing by for varying lengths of time until realization kicks into our brain that nothing is actually going to happen and we get bored. I am not saying that Sim City is like that but there is a similar hypnotic quality in a slower rate of speed in it as opposed to the faster more reactionary video games.

How long we watch boring things without getting bored is also a manifestation of how focused we are with an activity. The less concentration we have the more our mind interests itself with background thoughts letting the foreground banality to progress for longer than it should have.

Financial Recovery

So Treasury Secretary Timothy Geithner pitched his vision of ridding banks of their troubled assets on Monday (3-23-09).

In essence the Treasury will front some money, the FDIC will guarantee a whole lot more and the private sector partner will also provide a few percent of the total cost. This money will be used to bid for assets being shed by banks. If the trinity make successful bets, they will make a profit off their investments. Alternatively they will make a loss if their bets prove wrong. And since the federal government has fronted most of the cost, it will bear significant risk as well.

The problem assets are truly mind boggling especially for this feeble mind. You start off with homes Joe Schmoe's like us own which are packaged and re-packaged with a bunch of other homes and real estate investments into instuments that are sold and resold across the world. If this isn't a direct participation by Joe Schmoe in the global economy, nothing else is. So when a homeowner pays his mortgage, it trickles up into  the return on investment for a derivative.  It is no longer a bank holding a humble mortgage and using simple spreadsheets to track returns on a real asset.

But that apart, the whole notion of auctioning a banks bad assets leads to a few challenges. 

Firstly many banks are living in a state of denial not unlike us small shareholders who grimly hang on to some of our stocks that have declined precipitiously, hoping for an upswing. For banks, it is more than hope. By continuing to value assets at a higher price than they may fetch in the current market, they can show - on paper atleast - that they meet capital requirements.  So if they sell these assets via auction at reduced prices, they may need to shore up their capital using funds they may or may not have. This is another reason banks are fighting the mark to market rule because this rule forces institutions to value assets at current prices and not at the price of the transaction (buy or sell). By keeping inflated assets in their balance sheets banks can appear healthier than they are.

Secondly of course there has to be a market for the auction. The packaged derivatives may have prevented the Feds from attacking the problem from the bottom that is the individual homes. So they have approached the problem from the top in an all encompassing sweep including all asset classes including derivatives. But an opaque derivative means, the people bidding on the auctions are bidding blind using mathematical models. Remember these models were also used infamously to hike up the prices of the derivatives.

Thirdly, I am betting that the financial community will be happy about participating in the auctions. The financial institutions holding these assets may be more circumspect becauce it may lead to deterioration to their balance sheets, but the companies bidding on the assets are essentially betting on huge returns for an investment of only 6 cents to a dollar. Obviously the higher the bidding goes, the happier the banks will be. And we all know how Wall Street loves speculation.

Examined all together, we are talking of

1. Still a fundamental lack of knowledge of the assets being purchased
2. A potential for cleaning out balance sheets but conversely a hit to these.
3. Mathematical modeling
4. Large bets being placed  with little of one's own money.

Aren't at least three of these four factors what got us into this mess in the first place? Also, the government is hoping that once the assets are auctioned off, the successful bidder will keep these long term to enable stabilization of the assets, gradually expiring the derivatives and mortgages as people buy the assets and pay them off. However if the successful bidder resells the assets, they may further decline in value. Also, if the underlying asset fails to get new owners, they may deteriorate - e.g. a vacant home getting mold or getting vandalized. This would then further lower their value.

The feeble mind hopes that this strategy pays off. It wishes the government and participants all the luck. Otherwise the coming years will be very interesting and will make 2008 seem like a walk in the park.

The Law of the Jungle

David Roche in an article in the Wall Street Journal (1-22-09) says this:

It's natural for policy makers to say, "We know where the problem at the heart of the credit crisis is: it is a lack of lending and we must get credit flowing." If only it were that simple. What policy makers on both sides of the Atlantic desire is to sustain household leverage and consumption at any price, when the only exit from the credit crisis involves a return to thrift by the over leveraged. That cannot be achieved painlessly.


This paragraph succinctly captures the heart of the credit crisis and its aftermath for this feeble mind. Essentially governments want their citizens to splurge again and continue to rack up debt. They are operating under the mistaken belief that this is the only way to keep their economies healthy. They appear not to have learnt that poorly regulated and over abundant credit led to the problem in the first place, and, as the article points out - thrift - and a return to sanity in terms of personal consumption is the only way out.

The governments are caught in a vice. Through a series of developments spanning multiple decades, the share of manufacturing in the GDP has declined and services especially financial services have gained share.

At its very core, even the most sophisticated economy today is not very dissimilar to a primitive system of bartering. There exists a symbiotic relationship between the extractors (e.g. miners) to the producers (i.e. factories) to the consumers (i.e. us) to the providers (i.e. banks, retail etc.).
There is a give and take between these sectors and there is an intermingling of roles. In a global economy, these roles are not all represented equally in all economies as some (U.S.) consume more and take a hyper consumer/provider role, while some (China) take on the producer role. Granted this is an oversimplification, but this is all this feeble mind can grasp and it provides a framework for the money flow in societies.

A miner may sell his ore to a factory and buy a car from a dealer after taking a loan from a bank. When the extractor/producer sector is in decline in an economy, the provide/consumer sector races in to fill the void. However in the absence of the former, the latter turns to cannibalizing itself trying to create prosperity without offering any tangible goods or service but merely by manipulating its instruments - be they stocks or real estate or derivatives. This results in a bubble that inevitably bursts.

When we disturb the equilibrium by focusing one sector - finance - at the cost of another, a period of turmoil inevitably follows. This is not dissimilar to the law of the jungle. There exists an equilibrium between the predator and the hunted. However if due to some reason, the predators get an advantage that makes them multiply, they will exhaust the forest of its food and will be forced to dwindle to a more sustainable level.

As stated in the article, consumers have splurged. The predators have hunted and decimated the forest. To nurse the forest back to health, you do not send in helicopters to drop food to the predators to sustain their numbers, but you let the chips fall as they will so that the predators slowly dwindle and other animals make a comeback.

However as a developed and humane society, we help the citizens affected so that the recovery as it happens does not end up making them destitute and they emerge stronger in the future.

And the recovery has to bring about some sanity in sectors. If post recovery, the financial sector continues to dominate other sectors, the relief will only prove to be temporary and the precursor to a longer famine.

How the global economy recovers is anyone's guess. A painful scenario would be that a combination of lowered standard of living, fuel prices and credit tightening would result in manufacturing making a comeback. Another, more plausible scenario would be the recently talked about separation of toxic assets that would free up the good economy to return to business as usual. However, the toxic assets will cast a shadow and its effects may touch us all in terms of taxes and currency fluctuations. It would be a successful resolution however, if the private sector is allowed to thrive again without too much government intrusion because in the ultimate analysis, they are the only sector that has shown that it can consistently build wealth.

2009

So what will 2009 hold for us? In these early days we have

1. Fed interest rates at close to zero.
2. Fighting in Gaza/Israel.
3. Somalian pirates still holding a tanker and a few ships.
4. The DJIA around 8600, the S&P around 900 and the Nasdaq around 1600.
5. Scandals that are still brewing from Madoff to the Illinois senate seat controversy.
6. Gas at around $1.60.
7. Anticipation on Obama's inauguration.
8. Money, job and home value worries.
9. Uncertainty about the economy - will it get worse or will it get better?
10. Ongoing conflicts in Iraq and Afghanistan.

A lot depends on whether a person is an optimist or a pessimist.
And a person's optimism or pessimism really depends on whether he has an income coming in and if he/she can make ends meet.

This feeble mind this that, that is the key to success in 2009. It includes

• Live within your means.
• Pay off all your debts including mortgage.
• Save a year's worth of living expenses. This should include estimated Cobra payments, home, car, flood, umbrella insurance, car and mortgage payments, school/activity fees for children, any estimated co-payments, food and clothing allowances and up to $10K as an emergency reserve on top of the other estimates. This is a tough goal and may not be achieved in one year but we need to get realistic on what a year's living expense really means.
• Hold on to you job in any way possible.
• Don't cave in to impulses small ( a new cellphone) or large ( a car or a pool).
• Stop looking at ads. You are not helping the economy by spending, you are only hurting yourself. The economy will find ways to adapt.

I guess the above proves that I have a pessimistic view, and to be honest I suppose I do. I am not overly so but just like companies tighten their fiscal policies and curtail spending in tough times, so should you.

I am however hoping that the year turns for the better

• That the economy stabilizes after the job losses and contraction.
• The middle class get some safety net that prevents them from going destitute after a illness or job loss.
• The government goes after hedge funds and regulates them better rather than imposing more burden on a regular business a-la Sarbanes-Oxley.
• The big 3 automakers produce vehicles that people buy for their mechanical merits rather than for patriotic reasons.
• We get some closure of a successful nature in our overseas military undertakings.
• We end the year with cautious optimism.

So...happy new year!