On the age-old question, where did the money go... Here is one idea:
Market meltdown: Where did all the money go?: "Charles Biderman, chief executive of TrimTabs Investment Research in Sausalito, has a different explanation.
He says that from the market's bottom in 2003 until its peak in 2007, the market value of all publicly traded stocks worldwide grew from about $20 trillion to $45 trillion.
During this period, only about $1.5 trillion in cash went into the market. Debt accounted for some of the remaining increase in market capitalization, but most of it existed only on paper."
Thursday, January 01, 2009
Wednesday, December 31, 2008
Robbing banks is illegal?
"'As it stands now, they've turned [banks] into virtual cash machines,' New York
Police Commissioner Raymond Kelly said."
Golly, who's he talking about? Real estate agents? Mortgage brokers? Cash-back-at-close, zero-doc, no down borrowers? Naw, plain old bank robbers.
"In fact, bank robbers have simply handed tellers a note in a vast majority of
hold-ups in New York."
So, remember kids, its better to rob a bank with a mortgage (note) than with a hand-scrawled note. If you rob a bank with a real estate license, that's okay. If you rob a bank with a hood over your head, that's illegal. If you rob a bank by promising (via a "promissory note") to pay back money you have no intention or capability of repaying, you get a bailout. If you rob a bank by authorizing garbage loans that have slim chances of repayment, you get a fat bonus check and stock options. Confusing, ain't it?
Quotes are from: Is recession behind spike in bank robberies? - CNN.com
Happy New Year!
Friday, December 26, 2008
Health Care Flex Spending Account: Use it or lose it
If you have a balance remaining in a use-it-or-lose-it flex spending account, there is less than one week left in 2008. With over-the-counter drugs and first aid supplies now flex-spending eligible, there's no need to "lose it." Depending on how much you have left, you can clean out your medicine cabinet (replacing old, expired cold medicines and the like), pick up a first aid kit, even get a home defibrillator. Personally, I have been browsing drugstore.com's FSA store, seeing what is FSA eligible and gathering up receipts for things we bought earlier without realizing they were eligible. I've whittled our balance down to $26, which I'll use to restock the first aid kit before Dec. 1.
We've made a point of submitting receipts before year-end, allowing sufficient time for the administrator to process them and hopefully notify us of any non-approved claims while there's still time for us to use up our funds.
Hope you're all enjoying the holidays in good health and good cheer.
We've made a point of submitting receipts before year-end, allowing sufficient time for the administrator to process them and hopefully notify us of any non-approved claims while there's still time for us to use up our funds.
Hope you're all enjoying the holidays in good health and good cheer.
Saturday, December 20, 2008
My Property IQ is 68: Zip Realty's new feature
Zip Realty has rolled out a new feature called Property IQ. This feature allows zip users to enter their best guess about what a property will ultimately sell for. In the absence of any other guesses, the list price is used as the "Community" prediction. Thus, if I guesstimate that an overpriced property will sell for less than asking - and there is not a community of other users agreeing with my guesstimate - then the algorithm deems me a nit wit. Even if I just entered the price that the agent told me the house actually went into contract for. The only "accurate" guess right now is the asking price.
The goal here seems to be to encourage, persuade, and peer-pressure buyers into the practice of thinking that homes will sell close to asking price, even when asking price is a pie-in-the-sky pipe dream. In our competitive society, we are well socialized to strive for high performance - high score, high net worth, low lap times, high status, rich networks. Games have power - pro racers play video games of unfamiliar tracks to gain familiarity, and even small-craft pilots have been known to fly three states over to pick up a good flight simulator. In striving for a win, an A, a certificate, an Attaboy, we learn over multiple attempts to perform to the grading scale rather than strive for real knowledge. Here, the grading scale is set-up out of the box to gently nudge users towards asking-price-is-the-real-value, despite launching the game in the midst of the worst real estate crisis since the Great Depression. Considering how many properties in Sacramento MSA are languishing on the market for a year and longer, the asking price is rarely ever the real value. But answering anything other than asking price, right now, is gently reprimanded through the insulting "Your Property IQ is 0!"
Yes, that's right, my property IQ was zero, because I guessed well-below-asking on a seriously overpriced property. But I was able to salvage my Property IQ by guessing well-above-asking on another property. So now I have a system - if a house sells, I bet at or above asking; otherwise, I only enter a Guess where the guess is well below asking price. I hate lazy programming and lazy algorithms as much as I hate the pervasive manipulation and bull$#!7 of the real estate industrial complex.
The goal here seems to be to encourage, persuade, and peer-pressure buyers into the practice of thinking that homes will sell close to asking price, even when asking price is a pie-in-the-sky pipe dream. In our competitive society, we are well socialized to strive for high performance - high score, high net worth, low lap times, high status, rich networks. Games have power - pro racers play video games of unfamiliar tracks to gain familiarity, and even small-craft pilots have been known to fly three states over to pick up a good flight simulator. In striving for a win, an A, a certificate, an Attaboy, we learn over multiple attempts to perform to the grading scale rather than strive for real knowledge. Here, the grading scale is set-up out of the box to gently nudge users towards asking-price-is-the-real-value, despite launching the game in the midst of the worst real estate crisis since the Great Depression. Considering how many properties in Sacramento MSA are languishing on the market for a year and longer, the asking price is rarely ever the real value. But answering anything other than asking price, right now, is gently reprimanded through the insulting "Your Property IQ is 0!"
Yes, that's right, my property IQ was zero, because I guessed well-below-asking on a seriously overpriced property. But I was able to salvage my Property IQ by guessing well-above-asking on another property. So now I have a system - if a house sells, I bet at or above asking; otherwise, I only enter a Guess where the guess is well below asking price. I hate lazy programming and lazy algorithms as much as I hate the pervasive manipulation and bull$#!7 of the real estate industrial complex.
Tuesday, December 09, 2008
The End of Wall Street's Boom - What REALLY Happened?
The End of Wall Street's Boom - National Business News - Portfolio.com: "The era that defined Wall Street is finally, officially over. Michael Lewis, who chronicled its excess in Liar’s Poker, returns to his old haunt to figure out what went wrong."
This is a lengthy article, but quite an interesting read. If you don't know Michael Lewis, he wrote Liar's Poker, about his experience working on Wall Street in the 1980s. Liar's Poker is also the game the fellows at Long Term Capital Management played - the founder of LTCM worked at Salomon Bros. in the 1980s, too. Lewis also wrote a book about baseball, and one about the dot-com era before it became the dot-bomb era, and he writes an amusing column for Slate called Dad Again.
The article reaches some very interesting conclusions, which I won't spoil here. But one of them seems to be the same one I keep coming back to - Wall Street is run by idiots. Traders don't know anything about economics, and economists regularly admit that they're terrible traders.
I suspect that the art/science of economics is something of a crystal ball on Wall Street - yet, like all mystical sciences, the economic tarot can tell you what will happen, but not when. Trading is all about the when. If you get out too early, you'll never make enough gains to retire; if you get in too early, you'll drive yourself to an early stress-related death and won't get to retire, anyway (hey, maybe that's a good retirement plan - cheaper than the $200k they recommend you put away for retirement health costs alone!). Traders use the technicals (charts and pure market data) to try to get ahead of a curve - but charts, alone, don't warn you when an enormous wrecking ball like the housing implosion is heading your way. Which is why my broker laughed at me when I said I didn't want to touch anything housing related - not even funds holding Fannie/Freddie bonds. My theory is that good traders are neither traders nor economists - they are sufficiently detached to take the signals of both disciplines with a boulder-sized grain of salt. Throw in a healthy dose of market historian and psychologist, and you might actually have a trader who can turn the odds in his own favor.
Short of that (plus a lot of luck), Mr. John Q. Public is facing some looonnnggg odds. The SEC lets banks and brokerages hold off-balance sheet risks that an average investor doesn't know about until it sinks his share price. Even the on-balance-sheet holdings are sometimes sliced and diced and innovated to a point that finance professionals can't understand what they really are, let alone what they're worth, or how quickly they can sink the company. Index funds came about specifically because fund managers aren't superior traders - managed funds and index funds have roughly equal odds of outperforming various benchmarks. The market moves on rumors that can create the sorts of problems that were rumored to be a risk. And when Mr. John Q. Public throws his hands in the air, says the heck with it, and plows his money into the age-old safe haven - banks and big, stable Blue Chips, he finds out later that the banks aren't safe and the Blue Chips are dallying in risk loans. Even Money Market funds were "breaking the buck" and losing principal value, because the professional financiers invested in bonds that - despite being triple-A rated short-term bonds - went poof. Oh, yeah, that's because the ratings agencies are either inept, corrupt, or both. But what choice does a fellow have - Social Security is bankrupt, pensions are a privilege only the government-employee class can count on, and his 401k has to make up the difference. Good luck, Mr. Public. You'll need it.
This is a lengthy article, but quite an interesting read. If you don't know Michael Lewis, he wrote Liar's Poker, about his experience working on Wall Street in the 1980s. Liar's Poker is also the game the fellows at Long Term Capital Management played - the founder of LTCM worked at Salomon Bros. in the 1980s, too. Lewis also wrote a book about baseball, and one about the dot-com era before it became the dot-bomb era, and he writes an amusing column for Slate called Dad Again.
The article reaches some very interesting conclusions, which I won't spoil here. But one of them seems to be the same one I keep coming back to - Wall Street is run by idiots. Traders don't know anything about economics, and economists regularly admit that they're terrible traders.
I suspect that the art/science of economics is something of a crystal ball on Wall Street - yet, like all mystical sciences, the economic tarot can tell you what will happen, but not when. Trading is all about the when. If you get out too early, you'll never make enough gains to retire; if you get in too early, you'll drive yourself to an early stress-related death and won't get to retire, anyway (hey, maybe that's a good retirement plan - cheaper than the $200k they recommend you put away for retirement health costs alone!). Traders use the technicals (charts and pure market data) to try to get ahead of a curve - but charts, alone, don't warn you when an enormous wrecking ball like the housing implosion is heading your way. Which is why my broker laughed at me when I said I didn't want to touch anything housing related - not even funds holding Fannie/Freddie bonds. My theory is that good traders are neither traders nor economists - they are sufficiently detached to take the signals of both disciplines with a boulder-sized grain of salt. Throw in a healthy dose of market historian and psychologist, and you might actually have a trader who can turn the odds in his own favor.
Short of that (plus a lot of luck), Mr. John Q. Public is facing some looonnnggg odds. The SEC lets banks and brokerages hold off-balance sheet risks that an average investor doesn't know about until it sinks his share price. Even the on-balance-sheet holdings are sometimes sliced and diced and innovated to a point that finance professionals can't understand what they really are, let alone what they're worth, or how quickly they can sink the company. Index funds came about specifically because fund managers aren't superior traders - managed funds and index funds have roughly equal odds of outperforming various benchmarks. The market moves on rumors that can create the sorts of problems that were rumored to be a risk. And when Mr. John Q. Public throws his hands in the air, says the heck with it, and plows his money into the age-old safe haven - banks and big, stable Blue Chips, he finds out later that the banks aren't safe and the Blue Chips are dallying in risk loans. Even Money Market funds were "breaking the buck" and losing principal value, because the professional financiers invested in bonds that - despite being triple-A rated short-term bonds - went poof. Oh, yeah, that's because the ratings agencies are either inept, corrupt, or both. But what choice does a fellow have - Social Security is bankrupt, pensions are a privilege only the government-employee class can count on, and his 401k has to make up the difference. Good luck, Mr. Public. You'll need it.
Tuesday, December 02, 2008
Where's the Money?
jaycee commented on an earlier post:
"I am trying to understand what is going on and I found your post really interesting. But I still have a question: we are not making bets with Martians, so surely the money is staying in the system? If I make a bet with a sucker who says: Sorry, I don't have the means to pay you, it will not make me bankrupt, just a bit peeved."
It's an excellent question, and one I've been trying to figure out. I don't have an authoritative answer to jaycee's question, but I humbly offer an educated guess....
The net losses are primarily in defaults. Suppose I'm a hedge fund trader, leveraged at 10-to-1, when I make a bad bet. I either have to eat the losses out of other gains/equity, or I'll default on the margin loan. The brokerage has to eat the defaults, and they can only eat so much. Banks are losing in mortgage defaults, and we're seeing increasing bankruptcy filings. Those are net dollars lost. As much as possible, the banks and brokerages dump the losses on shareholders.
Generally, a consumer invests the dollars that he or she perceives are "excess", above their basic needs. An investment dollar typically flows from investment to investment to investment; a consumption dollar flows from consumer to producer to employee/consumer to producer many times before possibly making its way back to investment markets. We are seeing net outflows from asset investments (stocks, bonds, real estate). Some of that outflow is from consumers just trying to pay the bills - some, for instance, flows to oil-producing nations, and much of that outflow won't come back. It's still in the system, but it's in the global system, essentially unavailable for domestic use. Other asset withdrawals are going to domestic producers, but as people lose their jobs, face income stagnation and cost inflation, fewer dollars are perceived as "excess" dollars to be saved/invested. Although that money is still in the system, it's a long way away from the investment assets whose valuations were based on how many dollars were invested.
Then there's the issue of the "velocity" of money. Middle class money is the best for stimulating economies, because middle class earners typically spend, spend, and spend some more, often spending a disproportionate amount on services. Services are almost entirely wages, which provides a second producer/consumer with money to spend - largely, on services, which provides a 3rd producer/consumer with money to spend. And so on. The exact same dollar changes hands many, many times - and each time, it counts as taxable income, it counts as GDP, it counts as someone employed, and it counts as another employee/consumer feeling a little more confident about the economy. I think of middle class money as slutty money - it gets around - well, that's velocity - the more a dollar gets around, the greater "velocity" it has. Poor folk don't have much money and rich folk keep a larger portion of their money than middle class folks do (that's why they're rich, and why an awful lot of rich folk got rich saving and investing off mere middle class income).
So if we go back to that Citibank transaction - if I buy a share for $45, the seller has the $45; it's still in the system. But I started with $45 of spendable money, $45 worth of earnings, $45 worth of wealth effect, $45 worth of net worth. If the share price drops to $7, well, there goes my spendable asset, my net worth, my wealth effect. There's a very, very good chance that my "velocity" of spending will decrease by the $38 the share dropped in value. If I was investing for a down payment on a house, that's $38 less house I can buy. If I was investing for a wedding, there goes the open bar. If I was investing for peace of mind and the satisfaction of securing my future - zoiks. Chances are, I'll pull $90 of spending velocity out of my budget to make up for the loss, and it still may not replace the lost peace of mind.
That's my best guess - we aren't suffering a mere shifting of assets, but a genuine implosion in some assets. Other assets are lost on the wrong side of the tracks, while others are dragging themselves sickly across the floor crying piteously, "help me, I'm hung over."
"I am trying to understand what is going on and I found your post really interesting. But I still have a question: we are not making bets with Martians, so surely the money is staying in the system? If I make a bet with a sucker who says: Sorry, I don't have the means to pay you, it will not make me bankrupt, just a bit peeved."
It's an excellent question, and one I've been trying to figure out. I don't have an authoritative answer to jaycee's question, but I humbly offer an educated guess....
Winners and Losers, The Money's still there
For most trades, there's a winner for every loser, so the money is still in the system somewhere. If I buy Citibank at $45, the seller gets $45. When Citibank drops to $6, the $45 I gave the seller still exists. Ditto for a house - if I buy a house for $200k and it drops to $100k, the money still exists in the seller's bank account. Unless the money never existed - with fractional reserve banking, banks can lend more money than they have - basically "printing" vapor dollars. If the bank lends me money to buy a house or a stock, and I don't pay them back, the bank has to eat the loss. They lose real dollars.
Defaults suck the Vapor Dollars Out of Grandma's savings
The net losses are primarily in defaults. Suppose I'm a hedge fund trader, leveraged at 10-to-1, when I make a bad bet. I either have to eat the losses out of other gains/equity, or I'll default on the margin loan. The brokerage has to eat the defaults, and they can only eat so much. Banks are losing in mortgage defaults, and we're seeing increasing bankruptcy filings. Those are net dollars lost. As much as possible, the banks and brokerages dump the losses on shareholders.
Paper Losses Become Real Losses
Houses, stocks, and even business inventories are showing paper losses. To the extent that people have to pull cash, they are converting paper losses into real losses. That's why there's so much griping about 401k withdrawal requirements this year. Businesses have to sell inventories, even at a loss (due to tax rules, cash flow, inventory staleness/freshness, and cost of commercial real estate for storing inventory). Those losses take money out of the system permanently.
The risk is that leverage let us inflate asset values quite rapidly - doubling home values, for instance. As credit dries up and net losses on defaults accumulate, it creates a leveraged pop - that's why the government has pumped some $7 Trillion in liquidity into a $13 Trillion economy this year, and yet we're still in a recession.
Not Lost, Just Wandered Off
There's also the issue of money still in the system, but removed from investment assets. This is a little out there, but it does impact valuations. The money available to invest is not static. Every day, each consumer/investor decides whether to save/invest current income, or whether to withdraw/spend invested income.
Generally, a consumer invests the dollars that he or she perceives are "excess", above their basic needs. An investment dollar typically flows from investment to investment to investment; a consumption dollar flows from consumer to producer to employee/consumer to producer many times before possibly making its way back to investment markets. We are seeing net outflows from asset investments (stocks, bonds, real estate). Some of that outflow is from consumers just trying to pay the bills - some, for instance, flows to oil-producing nations, and much of that outflow won't come back. It's still in the system, but it's in the global system, essentially unavailable for domestic use. Other asset withdrawals are going to domestic producers, but as people lose their jobs, face income stagnation and cost inflation, fewer dollars are perceived as "excess" dollars to be saved/invested. Although that money is still in the system, it's a long way away from the investment assets whose valuations were based on how many dollars were invested.
Fast Money: Whoosh! It's Gone
Then there's the issue of the "velocity" of money. Middle class money is the best for stimulating economies, because middle class earners typically spend, spend, and spend some more, often spending a disproportionate amount on services. Services are almost entirely wages, which provides a second producer/consumer with money to spend - largely, on services, which provides a 3rd producer/consumer with money to spend. And so on. The exact same dollar changes hands many, many times - and each time, it counts as taxable income, it counts as GDP, it counts as someone employed, and it counts as another employee/consumer feeling a little more confident about the economy. I think of middle class money as slutty money - it gets around - well, that's velocity - the more a dollar gets around, the greater "velocity" it has. Poor folk don't have much money and rich folk keep a larger portion of their money than middle class folks do (that's why they're rich, and why an awful lot of rich folk got rich saving and investing off mere middle class income).
So if we go back to that Citibank transaction - if I buy a share for $45, the seller has the $45; it's still in the system. But I started with $45 of spendable money, $45 worth of earnings, $45 worth of wealth effect, $45 worth of net worth. If the share price drops to $7, well, there goes my spendable asset, my net worth, my wealth effect. There's a very, very good chance that my "velocity" of spending will decrease by the $38 the share dropped in value. If I was investing for a down payment on a house, that's $38 less house I can buy. If I was investing for a wedding, there goes the open bar. If I was investing for peace of mind and the satisfaction of securing my future - zoiks. Chances are, I'll pull $90 of spending velocity out of my budget to make up for the loss, and it still may not replace the lost peace of mind.
That's my best guess - we aren't suffering a mere shifting of assets, but a genuine implosion in some assets. Other assets are lost on the wrong side of the tracks, while others are dragging themselves sickly across the floor crying piteously, "help me, I'm hung over."
Monday, December 01, 2008
EcoWorld - Guest Commentary » Blog Archive » Sundown for California
EcoWorld - Guest Commentary » Blog Archive » Sundown for California: "The educational system, closely aligned with the Democrats in the legislature, accelerated its secular decline. Once full of highly skilled workers, California has become increasingly less so. For example, California ranks second in the percentage of its 65-year-olds holding an associate degree or higher and fifth in those with a bachelor’s degree. But when you look at the 25-to-34 age group, those rankings fade to 30th and 24th."
Rather lengthy, but interesting reading. I'm not sure why it's on EcoWorld, as the article isn't really about ecology at all.
Rather lengthy, but interesting reading. I'm not sure why it's on EcoWorld, as the article isn't really about ecology at all.
Sunday, November 30, 2008
Universal Default: Credit's Grim Reaper
Years ago, I was in the middle of a major project when AT&T Cingular shut off my cell phone. They had changed my account number when I upgraded service, never mentioning the change in account number OR the credit balance building up under the old account number as the new account became delinquent. Eventually, we straightened it out. They got the credit balance transferred to the new account, and AT&T Cingular even "generously" agreed to waive the $25 re-connect fee and all of the late fees.
For that project I mentioned, I charged many thousands of dollars of equipment to my personal credit card. I had worked with my particular client long enough to know, without a doubt, that they would pay on time once the project was complete.
Around the same time, Chase, the company that owned my credit card, notified me that I was in Universal Default and my interest rate would now be 29%. I called to ask why, and they said I had made a late payment to someone. They would not tell me who was reporting the late payment. They would not reconsider their decision, and no one at the company would tell me, specifically, why I was in Universal Default. Now, many years later, I realize that the AT&T Cingular snafu was right around the same time - but, back then, I didn't know what Chase was talking about. So I had no choice but to pay the usurious interest rate until I could pay off the account. If Chase had simply raised my interest rate (absent the declaration of Universal Default), I could refuse to accept the higher rate, close my account, and pay the balance at the prior interest rate. In Universal Default, I had no such right of refusal. My interest rate climbed 19% immediately, retroactively (on balances charged at the lower rate), and with no recourse.
Meanwhile, Universal Default can be invoked by other creditors (that's why it's Universal - if one company says you're in default, any other company with Universal Default can apply Universal Default terms to your account). So my backup line of credit was pulled. I ended up selling my second car to get through the pinch, and, of course, I cancelled my Chase account. I will never do business with them again. Ever.
I was very, very fortunate that my Universal Default nightmare only lasted a few months before I was able to tell Chase to shove my full and final payment up their, um, closed accounts file. In the meantime, I got an ugly glimpse of Universal Default. I learned one of the unanticipated risks of carrying a balance on credit cards, and I changed how I manage money.
If you carry a balance on your credit cards, it might benefit you to become positively paranoid about avoiding Universal Default. Make sure that every bill is paid on time. Check your credit limit online in between billing periods. And pay off that balance as quick as you can, because banks are looking for new sources of revenue right now.
I should have fought back.
In retrospect, I accepted Chase's actions far too easily. I should have combed through the original contract terms to find out what rights I had to protest Universal Default. I should have gotten a copy of my credit report, so I could fight the Universal Default designation with hard evidence. I should have contacted the local legal clinic for advice and a strongly worded letter. But, at the time, I had no clue how I could prove that I hadn't missed payments on anything. (Running a new business, I didn't have a lot of money to hire a lawyer).
If I had gone into Universal Default because of an unknown credit line reduction, I would fight it with every resource available to me. It's one thing to invoke Universal Default for an action the consumer should have known about (a late payment); it's quite a different and dirty and sleazy and most-likely-illegal thing to invoke Universal Default for an action the bank took, which the consumer wouldn't have known about until after exceeding a lowered credit limit.
If I went into Universal Default for exceeding a lowered credit line before receiving notice that the credit line was lowered, I would become the squeakiest wheel the bank ever heard. I would make a complaint with http://www.consumer-action.org/ and http://www.consumersunion.org/. I would be willing to testify to Congress and/or tell my story to the media. And you bet your buttons I would contact every one of my elected representatives, state and federal, asking for help. Now that we taxpayers are direct investors in the credit card companies, our government reps are sort of like the banks' unofficial, unwanted Board of Inept Directors. I think that's a bad thing, but if some good can come of that bad thing, then I'd use it. Banks want continuing help from the government, so they are probably a little more responsive to Congresspeoples' inquiries right now - and it wouldn't hurt for our reps to better understand how these banks really do business.
Interesting reading: http://www.consumer-action.org/news/articles/2008_credit_card_survey/ Note that these are survey responses by banks. I can tell you right now that some of the answers - from my own card issuer(s) and those I've read junk mail from recently - are flat-out wrong. Citibank's response to "Would you ever reduce my credit limit?" was No. But it's interesting what the banks will admit (like charging a late fee if the due date is a weekend or holiday when they are closed).
For that project I mentioned, I charged many thousands of dollars of equipment to my personal credit card. I had worked with my particular client long enough to know, without a doubt, that they would pay on time once the project was complete.
Around the same time, Chase, the company that owned my credit card, notified me that I was in Universal Default and my interest rate would now be 29%. I called to ask why, and they said I had made a late payment to someone. They would not tell me who was reporting the late payment. They would not reconsider their decision, and no one at the company would tell me, specifically, why I was in Universal Default. Now, many years later, I realize that the AT&T Cingular snafu was right around the same time - but, back then, I didn't know what Chase was talking about. So I had no choice but to pay the usurious interest rate until I could pay off the account. If Chase had simply raised my interest rate (absent the declaration of Universal Default), I could refuse to accept the higher rate, close my account, and pay the balance at the prior interest rate. In Universal Default, I had no such right of refusal. My interest rate climbed 19% immediately, retroactively (on balances charged at the lower rate), and with no recourse.
Meanwhile, Universal Default can be invoked by other creditors (that's why it's Universal - if one company says you're in default, any other company with Universal Default can apply Universal Default terms to your account). So my backup line of credit was pulled. I ended up selling my second car to get through the pinch, and, of course, I cancelled my Chase account. I will never do business with them again. Ever.
I was very, very fortunate that my Universal Default nightmare only lasted a few months before I was able to tell Chase to shove my full and final payment up their, um, closed accounts file. In the meantime, I got an ugly glimpse of Universal Default. I learned one of the unanticipated risks of carrying a balance on credit cards, and I changed how I manage money.
If you carry a balance on your credit cards, it might benefit you to become positively paranoid about avoiding Universal Default. Make sure that every bill is paid on time. Check your credit limit online in between billing periods. And pay off that balance as quick as you can, because banks are looking for new sources of revenue right now.
I should have fought back.
In retrospect, I accepted Chase's actions far too easily. I should have combed through the original contract terms to find out what rights I had to protest Universal Default. I should have gotten a copy of my credit report, so I could fight the Universal Default designation with hard evidence. I should have contacted the local legal clinic for advice and a strongly worded letter. But, at the time, I had no clue how I could prove that I hadn't missed payments on anything. (Running a new business, I didn't have a lot of money to hire a lawyer).
If I had gone into Universal Default because of an unknown credit line reduction, I would fight it with every resource available to me. It's one thing to invoke Universal Default for an action the consumer should have known about (a late payment); it's quite a different and dirty and sleazy and most-likely-illegal thing to invoke Universal Default for an action the bank took, which the consumer wouldn't have known about until after exceeding a lowered credit limit.
If I went into Universal Default for exceeding a lowered credit line before receiving notice that the credit line was lowered, I would become the squeakiest wheel the bank ever heard. I would make a complaint with http://www.consumer-action.org/ and http://www.consumersunion.org/. I would be willing to testify to Congress and/or tell my story to the media. And you bet your buttons I would contact every one of my elected representatives, state and federal, asking for help. Now that we taxpayers are direct investors in the credit card companies, our government reps are sort of like the banks' unofficial, unwanted Board of Inept Directors. I think that's a bad thing, but if some good can come of that bad thing, then I'd use it. Banks want continuing help from the government, so they are probably a little more responsive to Congresspeoples' inquiries right now - and it wouldn't hurt for our reps to better understand how these banks really do business.
Interesting reading: http://www.consumer-action.org/news/articles/2008_credit_card_survey/ Note that these are survey responses by banks. I can tell you right now that some of the answers - from my own card issuer(s) and those I've read junk mail from recently - are flat-out wrong. Citibank's response to "Would you ever reduce my credit limit?" was No. But it's interesting what the banks will admit (like charging a late fee if the due date is a weekend or holiday when they are closed).
Friday, November 28, 2008
Reduced credit limits; Big Deal
After Citibank lowered my credit limit, I got to thinking. Citibank claims they mailed (the undated) notification on November 5th, but I received it on Nov. 26th, the day before Thanksgiving. Citibank e-mails me balance transfer offers, but they didn't e-mail me about changing my account terms. If I were a different consumer, this could have been disastrous. I had 3 weeks to unknowingly exceed my new, lower credit limit - racking up over-the-limit fees and falling into Universal Default. Most of my mail arrives within 3 days - why Citibank's notice took 21 days is sheer mystery. But that 21 day delay in notification effectively made the credit limit reduction retroactive - I found out about it on Nov. 26th, but it took effect 3 weeks before I knew anything about it.
Consider a consumer carrying a moderate $2,000 balance out of a $6,000 credit limit. If Citibank lowered his limit to $4,000 on November 5th and he bought 4 plane tickets on November 10th for a Thanksgiving trip, he could easily max out his card long before coming home to notification of the credit line decrease. Buying $2,000 plane tickets at 10% interest - suddenly becomes a major offense. By exceeding the new and unknown lower credit limit, he gets hit with $30 fees every month he's over his new credit line, and 29% interest rates eating up $100 a month before he can pay the balance down.
For some consumers, especially ones carrying a lot more than a $2,000 balance, going into Universal Default can push them over the edge, from struggling-but-making-it to "f- it, why bother paying my credit card when I cannot possibly get ahead of it at 30% interest?" A credit card holder who didn't buy a McMansion, who is trying to do the right thing, trying to pay down debt and build up savings and work up to a better spot in life, reads every day about homebuyers and bankers and brokers and insurance companies getting bailed out. No bailout for the credit card debtor, but she keeps making her payments, trying to whittle it down, and then WHOMP! Out of nowhere, the bank changes the rules and she's suddenly over her head without doing a damned thing to fall into the abyss. Why should she keep making payments anymore? Her share of the financial bailout - counting all the cash the Fed is pumping into liquidity along with the direct bailouts of financial institutions - is over $20k++ and suddenly the bank needs to cheat her out of an extra $100 a month by telling her extra slowly that her credit line has been cut right before the holidays.
Maybe our imaginary consumers shouldn't carry a balance at all. It would be good for our economy, in the long run, if people consumed a little less than they produce. We should all carry a balance - in our savings accounts. But we don't, and the path from here to that economic utopia will be painful for everyone. And if the banks' greed and stupidity pushes people into Universal Default and that causes some of them to go into genuine, not-making-payments default, well, gosh darn it, those bastards will be back for more bailout money next year. I don't object to lowering credit limits, and I only object to tightening credit in the sense that "hey, that's not why the government is giving you bailout money!" I object to the sleazy way the banks are doing this, trying to wrest a couple more nickels out of people through downright unethical behavior.
The government is trying to loosen credit and persuade consumers to go out and stimulate the economy. The banks receiving bailout money are doing the exact opposite - they're restricting credit availability to everyone, even great credit risks, and then they're whomping innocent consumers with changes that can push them over the edge. Are the credit card companies trying to push default rates up, to justify yet another round of bailout payments? What other justification could they possibly have for virtually retroactive account changes?
Consider a consumer carrying a moderate $2,000 balance out of a $6,000 credit limit. If Citibank lowered his limit to $4,000 on November 5th and he bought 4 plane tickets on November 10th for a Thanksgiving trip, he could easily max out his card long before coming home to notification of the credit line decrease. Buying $2,000 plane tickets at 10% interest - suddenly becomes a major offense. By exceeding the new and unknown lower credit limit, he gets hit with $30 fees every month he's over his new credit line, and 29% interest rates eating up $100 a month before he can pay the balance down.
For some consumers, especially ones carrying a lot more than a $2,000 balance, going into Universal Default can push them over the edge, from struggling-but-making-it to "f- it, why bother paying my credit card when I cannot possibly get ahead of it at 30% interest?" A credit card holder who didn't buy a McMansion, who is trying to do the right thing, trying to pay down debt and build up savings and work up to a better spot in life, reads every day about homebuyers and bankers and brokers and insurance companies getting bailed out. No bailout for the credit card debtor, but she keeps making her payments, trying to whittle it down, and then WHOMP! Out of nowhere, the bank changes the rules and she's suddenly over her head without doing a damned thing to fall into the abyss. Why should she keep making payments anymore? Her share of the financial bailout - counting all the cash the Fed is pumping into liquidity along with the direct bailouts of financial institutions - is over $20k++ and suddenly the bank needs to cheat her out of an extra $100 a month by telling her extra slowly that her credit line has been cut right before the holidays.
Maybe our imaginary consumers shouldn't carry a balance at all. It would be good for our economy, in the long run, if people consumed a little less than they produce. We should all carry a balance - in our savings accounts. But we don't, and the path from here to that economic utopia will be painful for everyone. And if the banks' greed and stupidity pushes people into Universal Default and that causes some of them to go into genuine, not-making-payments default, well, gosh darn it, those bastards will be back for more bailout money next year. I don't object to lowering credit limits, and I only object to tightening credit in the sense that "hey, that's not why the government is giving you bailout money!" I object to the sleazy way the banks are doing this, trying to wrest a couple more nickels out of people through downright unethical behavior.
The government is trying to loosen credit and persuade consumers to go out and stimulate the economy. The banks receiving bailout money are doing the exact opposite - they're restricting credit availability to everyone, even great credit risks, and then they're whomping innocent consumers with changes that can push them over the edge. Are the credit card companies trying to push default rates up, to justify yet another round of bailout payments? What other justification could they possibly have for virtually retroactive account changes?
Will this reduce my credit score?
A couple of things that go into our credit scores include how much of our credit lines we have ever used. The credit report details our current balance, high balance, and credit limit. If a consumer runs their credit card up to the limit and then goes over the limit, it looks - to the facile programming logic of a credit-scoring computer - like that person is financially irresponsible. It's not good to exceed your credit limit. But if your credit limit gets lowered to less than your highest balance, it can look like you have been irresponsible in keeping track of your spending.
When Citibank cut my credit limit, it may have reduced my credit score. I don't remember if I've ever used the full credit line. But, in any event, the proportion of my high balance to my new credit limit will be less favorable. Closing my oldest charge account won't help, either - FICO takes into account the age of accounts, with older accounts showing a longer history of responsible payment. Since I don't have other revolving debt, the proportional hit will be bigger.
If this lowers my credit score - especially since I still live in Sacramento metro, one of the areas hardest hit by the housing downturn - my other credit cards could potentially reduce my credit limits or close my account. No big deal; if all of my credit cards were terminated, I could still use my rewards ATM/visa card, but it wouldn't give me the consumer protections that credit cards provide.
When Citibank cut my credit limit, it may have reduced my credit score. I don't remember if I've ever used the full credit line. But, in any event, the proportion of my high balance to my new credit limit will be less favorable. Closing my oldest charge account won't help, either - FICO takes into account the age of accounts, with older accounts showing a longer history of responsible payment. Since I don't have other revolving debt, the proportional hit will be bigger.
If this lowers my credit score - especially since I still live in Sacramento metro, one of the areas hardest hit by the housing downturn - my other credit cards could potentially reduce my credit limits or close my account. No big deal; if all of my credit cards were terminated, I could still use my rewards ATM/visa card, but it wouldn't give me the consumer protections that credit cards provide.
Citibank: The Grinch Who Stole my Credit Limit
I'm in a real-estate-meltdown zip code. I've read about credit card companies terminating and reducing credit lines for folks in declining industries, folks who charge at rent-to-own stores, and even folks in the wrong zip code. But I continue to receive credit card solicitations. I thought my over-800 credit score made me immune to credit cutbacks. I was wrong.
Wednesday's mail contained a note from Citibank (and another pre-approved Gold card from American Express). I almost shredded Wednesday's letter, unread, since it looked just like all the balance transfer offers they send me every couple of months. I've been a Citibank customer for more than 15 years, and I've never missed a payment. I don't carry any debt outside of a small mortgage, but I do use my rewards cards for everything from purchases to monthly utility bills. I get hundreds of dollars in rewards checks this way.
My Citibank card doesn't offer rewards, and the interest rate is several points higher than my other cards (except AmEx). So I rarely use it. They do offer have a Virtual account number tool that lets me create one-time-use virtual credit cards for online transactions, so I do use my Citibank card a couple times a month. For a while there, they gave me a rebate on hardware store purchases, and I used the card a LOT more until the offer expired.
Now Citibank has cut my credit line - because I don't use their card enough. I know I'm not a super-profitable customer, since I don't carry a balance at 10%. But then, too, they'll never have to write off a penny on me. A couple percent in (ATM) transaction fees makes my bank plenty happy - wouldn't Citibank benefit from transaction fees on low-risk transactions, too?
If you ran a credit card company, wouldn't you try to keep long-term, never-missed-a-payment, no-debt customers happy? If they weren't using my card anywhere near as much as they used other cards, I would try to make my card more valuable to them. But Citibank decided to punish me for not charging a lot to their card nor carrying a balance with them. So I closed my account.
Perhaps I overreacted, since the reduction was minimal. They still left me with enough credit to buy a small car, but 1) I'm tired of the junk mail asking me to transfer my (non-existent) loans to my Citibank card, every flipping month; 2) I'm still a little burned on my Citibank stock losses (brilliant recommendation from Morgan Stanley, eh?); and 3) that's just bad business and I don't like to do business with companies that don't get it. So that's one less stack of unsolicited balance transfer checks to shred every month. Yippee!
Wednesday's mail contained a note from Citibank (and another pre-approved Gold card from American Express). I almost shredded Wednesday's letter, unread, since it looked just like all the balance transfer offers they send me every couple of months. I've been a Citibank customer for more than 15 years, and I've never missed a payment. I don't carry any debt outside of a small mortgage, but I do use my rewards cards for everything from purchases to monthly utility bills. I get hundreds of dollars in rewards checks this way.
My Citibank card doesn't offer rewards, and the interest rate is several points higher than my other cards (except AmEx). So I rarely use it. They do offer have a Virtual account number tool that lets me create one-time-use virtual credit cards for online transactions, so I do use my Citibank card a couple times a month. For a while there, they gave me a rebate on hardware store purchases, and I used the card a LOT more until the offer expired.
Now Citibank has cut my credit line - because I don't use their card enough. I know I'm not a super-profitable customer, since I don't carry a balance at 10%. But then, too, they'll never have to write off a penny on me. A couple percent in (ATM) transaction fees makes my bank plenty happy - wouldn't Citibank benefit from transaction fees on low-risk transactions, too?
If you ran a credit card company, wouldn't you try to keep long-term, never-missed-a-payment, no-debt customers happy? If they weren't using my card anywhere near as much as they used other cards, I would try to make my card more valuable to them. But Citibank decided to punish me for not charging a lot to their card nor carrying a balance with them. So I closed my account.
Perhaps I overreacted, since the reduction was minimal. They still left me with enough credit to buy a small car, but 1) I'm tired of the junk mail asking me to transfer my (non-existent) loans to my Citibank card, every flipping month; 2) I'm still a little burned on my Citibank stock losses (brilliant recommendation from Morgan Stanley, eh?); and 3) that's just bad business and I don't like to do business with companies that don't get it. So that's one less stack of unsolicited balance transfer checks to shred every month. Yippee!
Thursday, November 27, 2008
Friday, November 14, 2008
Treasury Draws Fire for Shift in Rescue - WSJ.com
Treasury Draws Fire for Shift in Rescue - WSJ.com: "Another problem: If the government purchased securities from banks, they [the banks] would likely have to record further losses on the markdown price, which many could ill afford."
You have gotta be kidding. I know I'm just a podunk hicktown Sacramento county nobody, but this was obvious from day one. The brain trust leading us throught the greatest financial crisis of our generation didn't realize that you can 1) buy securities from the banks at a price that is fair to the taxpayer; 2) buy securities from banks at a price that shores up their net assets (pick one). In the midst of a financial crisis, it might be nice and generous to pay banks the highest justifiable price for the securities, but, if the securities were really worth that price, the banks could sell them for that price on the open market.
You have gotta be kidding. I know I'm just a podunk hicktown Sacramento county nobody, but this was obvious from day one. The brain trust leading us throught the greatest financial crisis of our generation didn't realize that you can 1) buy securities from the banks at a price that is fair to the taxpayer; 2) buy securities from banks at a price that shores up their net assets (pick one). In the midst of a financial crisis, it might be nice and generous to pay banks the highest justifiable price for the securities, but, if the securities were really worth that price, the banks could sell them for that price on the open market.
Wednesday, November 12, 2008
What's next, inflation or deflation?
What's next? If deflation is coming, I'm staying in cash. If inflation is coming, I'm buying all the rental properties I can afford. There's an argument for both.
The government can't afford deflation. Deflation would reduce their tax income while the government debt remains the same. The debt as a percentage of GDP or as a multiple of tax revenues would become even more enormous than it is now. So I would expect the government to do everything they can to avoid deflation - even at the risk of creating rampant inflation.
Although we're all breathing a huge sigh of relief over falling oil prices, gas is still over $2 a gallon at my corner station. In 2003, gas was $1.68 a gallon, and, in 2001, it was closer to $1.35. Opec wants to keep gas prices high, and who can blame them? We all want to keep our incomes as high as we can. Consumers have shown their price elasticity for gas, and, the bottom line is, we'll pay $3 a gallon and complain about it but keep buying it. Now that oil producers know we'll pay that much, they would be bad business people for accepting less. That's inflationary, because oil goes into everything - we burn it for heat, we produce electricity with it, we make everything from plastic grocery bags to medical implants from it, and we use it to transport every product we make from source to sale. Gas prices have a huge influence on consumer prices, because everything has to be trucked, shipped, flown, railroaded, or some combination thereof.
The declining value of the dollar - thanks, in large part, to our government and consumer debt - is inflationary. Everything we import is costs more when paid in deflating dollars.
On the other hand, we could be facing deflation.
As Americans worry about the future, they save more and spend less. People with products and services to sell, have to lower their prices to induce consumers to spend. Every newspaper has ads with massive rebates, incentives, and discounts on American cars. If you've been on the fence about remodeling, try getting some fresh quotes. Contractors are on sale. Lowes' price tags all say "new low price." And the Going-Out-Of-Business sales start at least 20% off. That's deflationary.
Unemployed Americans now number over a million. New layoffs are counted in the hundreds of thousands. Unemployed people don't tend to spend a lot, and they don't earn a lot. That's deflationary. Retail - the old "well, if I don't find anything else, I can go work at the mall" backstop for the unemployed, is struggling. People scraping by on savings is a deflationary force.
The Visa/Mastercard/HELOC printing press has virtually shut down. People are afraid to borrow, and that's okay, because banks are afraid to lend. Given the exponential effect lending and borrowing have on money supply, a reduction in borrowing is extremely deflationary. But, don't worry, the government is still borrowing.
An anonymous Internet user commented several years ago that we were heading for inflation in necessities and deflation in luxuries. Maybe, but a latte still costs $4.
The government can't afford deflation. Deflation would reduce their tax income while the government debt remains the same. The debt as a percentage of GDP or as a multiple of tax revenues would become even more enormous than it is now. So I would expect the government to do everything they can to avoid deflation - even at the risk of creating rampant inflation.
Although we're all breathing a huge sigh of relief over falling oil prices, gas is still over $2 a gallon at my corner station. In 2003, gas was $1.68 a gallon, and, in 2001, it was closer to $1.35. Opec wants to keep gas prices high, and who can blame them? We all want to keep our incomes as high as we can. Consumers have shown their price elasticity for gas, and, the bottom line is, we'll pay $3 a gallon and complain about it but keep buying it. Now that oil producers know we'll pay that much, they would be bad business people for accepting less. That's inflationary, because oil goes into everything - we burn it for heat, we produce electricity with it, we make everything from plastic grocery bags to medical implants from it, and we use it to transport every product we make from source to sale. Gas prices have a huge influence on consumer prices, because everything has to be trucked, shipped, flown, railroaded, or some combination thereof.
The declining value of the dollar - thanks, in large part, to our government and consumer debt - is inflationary. Everything we import is costs more when paid in deflating dollars.
On the other hand, we could be facing deflation.
As Americans worry about the future, they save more and spend less. People with products and services to sell, have to lower their prices to induce consumers to spend. Every newspaper has ads with massive rebates, incentives, and discounts on American cars. If you've been on the fence about remodeling, try getting some fresh quotes. Contractors are on sale. Lowes' price tags all say "new low price." And the Going-Out-Of-Business sales start at least 20% off. That's deflationary.
Unemployed Americans now number over a million. New layoffs are counted in the hundreds of thousands. Unemployed people don't tend to spend a lot, and they don't earn a lot. That's deflationary. Retail - the old "well, if I don't find anything else, I can go work at the mall" backstop for the unemployed, is struggling. People scraping by on savings is a deflationary force.
The Visa/Mastercard/HELOC printing press has virtually shut down. People are afraid to borrow, and that's okay, because banks are afraid to lend. Given the exponential effect lending and borrowing have on money supply, a reduction in borrowing is extremely deflationary. But, don't worry, the government is still borrowing.
An anonymous Internet user commented several years ago that we were heading for inflation in necessities and deflation in luxuries. Maybe, but a latte still costs $4.
A currency printing press in your wallet: Fractional Reserve banking
Bank regulations require banks to keep enough money "in reserve" to meet customers' withdrawal needs and generally remain in business. Fractional reserve banking allows a bank to keep only a fraction of its deposits in reserve. That fraction varies, but howstuffworks reports that it is currently 3% to 10%. Wikipedia does a nice job of illustrating how a $100 deposit, through loans that are then deposited at other banks, can become $457 in currency. (Note that they are using a 20% reserve requirement in their scenario - actual reserve requirements are much lower.)
If I sell my house for a $100,000 profit and then deposit that money with my bank, the bank only has to keep a portion of the cash in reserve, say, $10,000. They can then lend my neighbor $90,000. If he uses it to buy an RV from the lady down the street, and she deposits the money in the bank, then the bank credits $90,000 to her account, puts $9,000 in reserve, and looks for someone to borrow the remaining $81,000. From that original $100k, we have my $100,000 checking balance and the RV seller's $90k in the bank. We just printed money, without bothering the government's mint. The "created" money expands exponentially.
So, if you wondered where all that money was coming from to fund home purchases at double 2001 prices, now you know. The banks, essentially, printed it out of thin air. Yippee, we're all rich, everyone can afford a Mercedes and a Humvee and a pair of jet skis. My Visa card is a pocket-sized mint.
So what happens if somebody defaults after borrowing money the bank never had? Hopefully, the bank can make up the difference out of profits. If a lot of people default on their loans, the bank can still hope to make the money back by the time I withdraw my $100k. But with stock income gone, prices climbing, and job losses mounting, more people are withdrawing from their savings.
Leverage=risk. So banks prefer to make their money originating loans, and then sell the loan to investors who can afford the risk. But investors left a clause in there that the banks have to buy back certain types of bad loans - early default, fraudulent loans, etc. Banks didn't plan to have to buy those loans back. Banks planned to keep making money.
A $10,000 cash loss is a $100,000 loss in lending ability. If Ocrenter kept a tally of losses, just on the houses he features, how much would you guesstimate that would be? A couple hundred million in losses? A couple hundred million in losses is a couple hundred billion in loans the bank can't afford to make anymore. Fractional reserve requirements create exponential growth in money supply - but when the pendulum swings the other way, it's an exponential contraction in money supply.
Ruh-roh.
If I sell my house for a $100,000 profit and then deposit that money with my bank, the bank only has to keep a portion of the cash in reserve, say, $10,000. They can then lend my neighbor $90,000. If he uses it to buy an RV from the lady down the street, and she deposits the money in the bank, then the bank credits $90,000 to her account, puts $9,000 in reserve, and looks for someone to borrow the remaining $81,000. From that original $100k, we have my $100,000 checking balance and the RV seller's $90k in the bank. We just printed money, without bothering the government's mint. The "created" money expands exponentially.
So, if you wondered where all that money was coming from to fund home purchases at double 2001 prices, now you know. The banks, essentially, printed it out of thin air. Yippee, we're all rich, everyone can afford a Mercedes and a Humvee and a pair of jet skis. My Visa card is a pocket-sized mint.
So what happens if somebody defaults after borrowing money the bank never had? Hopefully, the bank can make up the difference out of profits. If a lot of people default on their loans, the bank can still hope to make the money back by the time I withdraw my $100k. But with stock income gone, prices climbing, and job losses mounting, more people are withdrawing from their savings.
Leverage=risk. So banks prefer to make their money originating loans, and then sell the loan to investors who can afford the risk. But investors left a clause in there that the banks have to buy back certain types of bad loans - early default, fraudulent loans, etc. Banks didn't plan to have to buy those loans back. Banks planned to keep making money.
A $10,000 cash loss is a $100,000 loss in lending ability. If Ocrenter kept a tally of losses, just on the houses he features, how much would you guesstimate that would be? A couple hundred million in losses? A couple hundred million in losses is a couple hundred billion in loans the bank can't afford to make anymore. Fractional reserve requirements create exponential growth in money supply - but when the pendulum swings the other way, it's an exponential contraction in money supply.
Ruh-roh.
Monday, November 10, 2008
365 Days on Market, and then an Above-Market sale
Here's a recent example:
6848 MELLODORA DR, Orangevale, CA 95662
List Date: 05/31/07
List Price: $245,000
MLS status is now "inactive"; zillow shows a sale for $255,000.
I am hard-pressed to believe that the market value was anything near $245k. Yet now it has sold for more than asking price; surely there was some cash, renovation money, or exceptional closing cost assistance kicked back.
With a price in the mid-200s, the buyer could take out an FHA 203k loan for remodeling. Most closing costs in this market are typically paid by the seller. Nehemiah type down payment "assistance" are supposed to be gifts - if the selling price is raised by the amount of the downpayment assistance, it is not a gift. And the property tax in California is determined by the selling price - a buyer saves money by minimizing the selling price, thus minimizing property taxes for as long as they own the property. So a reasonably intelligent buyer would roll closing costs into the loan rather than the purchase price. In other words, there aren't many reasonable explanations for paying more than asking price on a home, except cash-back-at-close or horrible credit.
Buyer beware. Ask your agent to specify exactly what concessions are included in the selling price of comparables.
6848 MELLODORA DR, Orangevale, CA 95662
List Date: 05/31/07
List Price: $245,000
MLS status is now "inactive"; zillow shows a sale for $255,000.
I am hard-pressed to believe that the market value was anything near $245k. Yet now it has sold for more than asking price; surely there was some cash, renovation money, or exceptional closing cost assistance kicked back.
With a price in the mid-200s, the buyer could take out an FHA 203k loan for remodeling. Most closing costs in this market are typically paid by the seller. Nehemiah type down payment "assistance" are supposed to be gifts - if the selling price is raised by the amount of the downpayment assistance, it is not a gift. And the property tax in California is determined by the selling price - a buyer saves money by minimizing the selling price, thus minimizing property taxes for as long as they own the property. So a reasonably intelligent buyer would roll closing costs into the loan rather than the purchase price. In other words, there aren't many reasonable explanations for paying more than asking price on a home, except cash-back-at-close or horrible credit.
Buyer beware. Ask your agent to specify exactly what concessions are included in the selling price of comparables.
Thursday, October 23, 2008
How big is $600 Trillion? Scary big.
The derivatives market is complex and largely fairy-tale finance. The vast supra-majority of people (presidents, presidential candidates, and Congress included) do not understand the derivatives market, and most barely even know the market exists. If you are unfamiliar with derivatives, please refer to my first post yesterday, which attempts to explain derivatives in layman's terms (and I am a layperson, I have not even traded in puts and calls on stocks).
The derivatives market has a face value of $600 Trillion. While the entire $600 Trillion is not at risk (see "What the heck is a derivative"), I have an enormous problem with the notional value of the derivatives market. The world's GDP is $65 Trillion - outstanding derivatives have a face value ~10 x the entire World's annual income. Warren Buffet is the world's wealthiest person, with a net worth of $62 Billion - about 1/10,000th. In fact, the net worth of the 25 wealthiest people, worldwide, combined, is just over $750 Billion - about 1/1,000th of the face value of the derivatives market. The net worth figures do not necessarily reflect the 30%+ decline in the stock market. The world's 100 richest people have a combined net worth of about $1.7 Trillion.
The 25 wealthiest people's net worth represents the value of everything they own - derivatives, real estate, stocks, bonds, businesses, precious metals, everything. Generally, the wealthiest 1% of people own about 1/3rd of all financial assets. The world's 100 richest people have a combined net worth of about $1.7 Trillion. The derivatives market has a notional value of about $600 Trillion.
There are approximately 1,000 Billionaires in the world - the "poorest" person out of the 100 richest was George Soros, with an estimated net worth of $9 Billion. If we assume that the other 900 Billionaires have an average net worth of $5 Billion, their combined net worth is about $4.5 Trillion. The derivatives market has a notional value of about $600 Trillion.
The world's population is about 7 Billion people. The derivatives market has a notional value of about $600 Trillion. That is about $100,000 for every man, woman, and child in every city, village, prison, slum, and palace in the world.
There are about 10 Million millionaires. From Market Watch: "The high-net-worth population swelled 6% last year to more than 10.1 million people who own assets totaling an eye-popping $40.7 trillion, according to the CapGemini/Merrill Lynch World Wealth Report." The derivatives market has a notional value of about $600 Trillion.
From Slate: "By contrast, the value of the world's financial assets—including all stock, bonds, and bank deposits—was pegged at $167 trillion last year by McKinsey. "
Most financial assets are held long-term. $167 Trillion in net worth of financial assets does not equal anywhere near $167 Trillion in transactions. And derivatives are a very narrow slice of markets. The relatively enormous size of the derivatives market in comparison to the world's assets is enervating.
Okay, but it's not $600 Trillion at risk. First off, we can assume that about half of the derivatives contracts are, say, betting that the market will go up, while the other half are betting that the market will go down. The market can only go up or down, so assume that roughly half of the derivatives bets cancel each other out. Furthermore, derivatives contracts tend to be time sensitive, so many will expire without paying out a dime. The purchase price is the dollar amount that actually trades hands when a contract is created - the purchase prices are a relatively sane $17 Trillion or so. But going back to my insurance policy analogy - if you pay $800 to buy a one-year homeowner's insurance policy worth $100k, only $800 changes hands until something happens to the house. Then, the insurance company could pay out up to $100k. So the money in play in derivatives is somewhere between the $17 Trillion purchase price and the $600 Trillion notional value.
Worse, the other side of the derivative trade may not have any money at all to back up his promises.
Remember, a stock option contract is a type of derivative. If I bought a put contract for $2 that guarantees me the right to sell Intel stock at $20 a share, I would be exercising that contract now that Intel is down around $14. The person who sold me the contract - the counter party - would be out $4 (the $20 face value minus the $2 contract minus the $14 share price today). The loss, in that case, would be twice the contract purchase price and 1/5th of the notional value. If I had been trading in financial stocks, the loss could be nearly the entire notional value; even Exxon is down 29%.
One of the early links in this post is to an article that says that only about $3 Trillion dollars is actually at risk, because most derivatives contracts will cancel each other out. I take issue with that claim - prove it. Because most traders are rational. If I bet you $5 that the sky is blue, would you find someone else to bet $5, with the same odds, that the sky is not blue? Probably not. Even if you found someone willing to bet that the sky is not blue, because they want to hedge a bet they made with me that the sky is blue, you wouldn't give them the same terms - you would charge a lot more to make a bet you are likely to lose, and you would charge very little to make a bet you're certain you'll win. But then a storm comes along, the sky turns purple, and you're out your lunch money because you never thought you'd lose that bet.
As financial markets go crazy, a lot more contracts are paying out than usual. Because there are essentially no reserve requirements for derivatives issuers, this is somewhat akin to Hurricanes Katrina, Andrew, and Iniki all hitting at the same time as major Midwestern flooding, tornadoes throughout the Southeast, and earthquakes up and down the West coast. The "insurance" companies can't pay out on massive and unexpected losses - they are designed to pay out on reasonably expected losses. You can reasonably expect 1 Cat 5 hurricane in a year; 2 would be bad but not shocking, three would probably bankrupt some insurance companies. I'll take any bet if I'm certain I won't pay out - and I bet a lot of Wall Street types, especially the ones betting with someone else's money, felt the same way. Only a very few people expected the Dow to drop from 14,000 to 8,400. Few people expected oil to rise to $140, and fewer still expected it to rise to $140 and then fall to $64. Unprecedented circumstances give rise to unprecedented profits and losses, and it's easy to be on the wrong side of a bet.
Bottom line: Who can afford a $17 Trillion loss? How about $4 Trillion? $50 Trillion? In a global economy where the value of everything produced and sold in the entire world is just $65 Trillion a year, I don't think anyone can afford to back $600 Trillion bets, even if the losses are mere tens of Trillions.
Notes: Trade in derivatives data comes from the Bureau of International Settlements. $600 Trillion is rounded. World GDP is likely understated somewhat, because there is no official tracking of grey market, black market, contraband, and under-the-table income. All figures in U.S. dollars are subject to exchange rate fluctuations.
The derivatives market has a face value of $600 Trillion. While the entire $600 Trillion is not at risk (see "What the heck is a derivative"), I have an enormous problem with the notional value of the derivatives market. The world's GDP is $65 Trillion - outstanding derivatives have a face value ~10 x the entire World's annual income. Warren Buffet is the world's wealthiest person, with a net worth of $62 Billion - about 1/10,000th. In fact, the net worth of the 25 wealthiest people, worldwide, combined, is just over $750 Billion - about 1/1,000th of the face value of the derivatives market. The net worth figures do not necessarily reflect the 30%+ decline in the stock market. The world's 100 richest people have a combined net worth of about $1.7 Trillion.
The 25 wealthiest people's net worth represents the value of everything they own - derivatives, real estate, stocks, bonds, businesses, precious metals, everything. Generally, the wealthiest 1% of people own about 1/3rd of all financial assets. The world's 100 richest people have a combined net worth of about $1.7 Trillion. The derivatives market has a notional value of about $600 Trillion.
There are approximately 1,000 Billionaires in the world - the "poorest" person out of the 100 richest was George Soros, with an estimated net worth of $9 Billion. If we assume that the other 900 Billionaires have an average net worth of $5 Billion, their combined net worth is about $4.5 Trillion. The derivatives market has a notional value of about $600 Trillion.
The world's population is about 7 Billion people. The derivatives market has a notional value of about $600 Trillion. That is about $100,000 for every man, woman, and child in every city, village, prison, slum, and palace in the world.
There are about 10 Million millionaires. From Market Watch: "The high-net-worth population swelled 6% last year to more than 10.1 million people who own assets totaling an eye-popping $40.7 trillion, according to the CapGemini/Merrill Lynch World Wealth Report." The derivatives market has a notional value of about $600 Trillion.
From Slate: "By contrast, the value of the world's financial assets—including all stock, bonds, and bank deposits—was pegged at $167 trillion last year by McKinsey. "
Most financial assets are held long-term. $167 Trillion in net worth of financial assets does not equal anywhere near $167 Trillion in transactions. And derivatives are a very narrow slice of markets. The relatively enormous size of the derivatives market in comparison to the world's assets is enervating.
Okay, but it's not $600 Trillion at risk. First off, we can assume that about half of the derivatives contracts are, say, betting that the market will go up, while the other half are betting that the market will go down. The market can only go up or down, so assume that roughly half of the derivatives bets cancel each other out. Furthermore, derivatives contracts tend to be time sensitive, so many will expire without paying out a dime. The purchase price is the dollar amount that actually trades hands when a contract is created - the purchase prices are a relatively sane $17 Trillion or so. But going back to my insurance policy analogy - if you pay $800 to buy a one-year homeowner's insurance policy worth $100k, only $800 changes hands until something happens to the house. Then, the insurance company could pay out up to $100k. So the money in play in derivatives is somewhere between the $17 Trillion purchase price and the $600 Trillion notional value.
Worse, the other side of the derivative trade may not have any money at all to back up his promises.
Remember, a stock option contract is a type of derivative. If I bought a put contract for $2 that guarantees me the right to sell Intel stock at $20 a share, I would be exercising that contract now that Intel is down around $14. The person who sold me the contract - the counter party - would be out $4 (the $20 face value minus the $2 contract minus the $14 share price today). The loss, in that case, would be twice the contract purchase price and 1/5th of the notional value. If I had been trading in financial stocks, the loss could be nearly the entire notional value; even Exxon is down 29%.
One of the early links in this post is to an article that says that only about $3 Trillion dollars is actually at risk, because most derivatives contracts will cancel each other out. I take issue with that claim - prove it. Because most traders are rational. If I bet you $5 that the sky is blue, would you find someone else to bet $5, with the same odds, that the sky is not blue? Probably not. Even if you found someone willing to bet that the sky is not blue, because they want to hedge a bet they made with me that the sky is blue, you wouldn't give them the same terms - you would charge a lot more to make a bet you are likely to lose, and you would charge very little to make a bet you're certain you'll win. But then a storm comes along, the sky turns purple, and you're out your lunch money because you never thought you'd lose that bet.
As financial markets go crazy, a lot more contracts are paying out than usual. Because there are essentially no reserve requirements for derivatives issuers, this is somewhat akin to Hurricanes Katrina, Andrew, and Iniki all hitting at the same time as major Midwestern flooding, tornadoes throughout the Southeast, and earthquakes up and down the West coast. The "insurance" companies can't pay out on massive and unexpected losses - they are designed to pay out on reasonably expected losses. You can reasonably expect 1 Cat 5 hurricane in a year; 2 would be bad but not shocking, three would probably bankrupt some insurance companies. I'll take any bet if I'm certain I won't pay out - and I bet a lot of Wall Street types, especially the ones betting with someone else's money, felt the same way. Only a very few people expected the Dow to drop from 14,000 to 8,400. Few people expected oil to rise to $140, and fewer still expected it to rise to $140 and then fall to $64. Unprecedented circumstances give rise to unprecedented profits and losses, and it's easy to be on the wrong side of a bet.
"3. Unregulated, over-the-counter derivatives. There are scary numbers floated
out there (in the hundreds of trillions of dollars or more) of “notional value” outstanding. The problem with these numbers is that they don’t represent
actual amount-at-risk, and in fact nobody seems to know what that figure actually is. The lack of a regulated exchange and central clearing means that there is no margin supervision of any sort; ergo, you have no way to know if your contract is in fact good (that is, the other guy has the money.) AIG, as an example, had $500 billion dollars of exposure outstanding in these contracts, and while this sounds somewhat reasonable when one considers they have a $1 trillion dollar balance sheet in fact
it is not because most of AIG’s balance sheet assets are committed to cover liabilities
(e.g. insurance policies, annuities and the like.) The lack of margin and regulatory supervision is directly responsible for this. These derivatives have become nothing more than a fancy game of “pick pocket”, where Broker “A” sells protection to Client “A” for $X, and then tries to find someone to buy that same protection from for “$X – something.” While speculation in the marketplace is fine, speculation without being able to prove capital adequacy to back up your bets is not." ... from http://www.denninger.net/letters/paulson-bernanke-senate.pdf
Bottom line: Who can afford a $17 Trillion loss? How about $4 Trillion? $50 Trillion? In a global economy where the value of everything produced and sold in the entire world is just $65 Trillion a year, I don't think anyone can afford to back $600 Trillion bets, even if the losses are mere tens of Trillions.
Notes: Trade in derivatives data comes from the Bureau of International Settlements. $600 Trillion is rounded. World GDP is likely understated somewhat, because there is no official tracking of grey market, black market, contraband, and under-the-table income. All figures in U.S. dollars are subject to exchange rate fluctuations.
Wednesday, October 22, 2008
How Big is the Derivatives Crisis?
My last post discussed the general concept of Derivatives. Now, let me give you some wild conjecture about the scope of the derivatives crisis.
The Bureau of International Settlements (BIS) estimates the derivatives market at about $600 Trillion. But that's the notional value - the face value. That's like saying that the face value of insurance policies is $600 Trillion - the actual amount paid out by insurance companies is a fraction of the total of all the face values of all the policies in the world combined.
So what's the real risk level?
Well, derivatives can be mere side bets - and, like the Super Bowl, the bets for and against any particular outcome should roughly even out. The BIS tries to estimate
But how much money is really going to be lost? Here's some guesses.
The derivatives market "insures" the value of assets, typically financial assets like stocks, bonds, and real estate. Financial assets are under pressure right now. The majority of real estate loans issued in the last few years borrowed against property in Florida, California, and Nevada. The once-hottest markets are now the icy-est, with property-value declines of 40% in the Sacramento market, and, conservatively, 20% in the majority of really-hot (and widely invested-in) markets. The stock market is down from a Dow of 14,000 to less than 9,000 (about a 35% decline). Oil is down from a high around $140 to today's value around $70 - a 50% decline.
So the assets that underlie the derivatives contracts have declined by about 30% (a very, very rough average of the declines in major asset categories). A homeowners' insurance contract doesn't pay out unless the house is damaged - an awful lot of our financial houses are on fire right now. This is an economic Hurricane Katrina, 1906 Earthquake, and Midwestern flood all in one.
If an insured car is totalled, the insurance company will try to sell the car for scrap and parts, while paying the car's owner to replace the car. The insurance company is out the difference between the market value of the car and the scrap value of the car. Well, with an options contract, you don't actually lose the full notional value of the contract, you merely lose (or win) the difference between today's market value and the notional value. If I buy a put contract on Corning stock at $20, the counter party doesn't lose $20 - they lose the difference between today's stock price (~$11) and the $20 contract price. So instead of losing $20, they lose $9.
So BIS says the total derivatives market is about $600 Trillion in notional value. That's like saying the Corning derivatives market is $20 - it doesn't mean anyone is losing $20 (or $600 Trillion). What they'll lose is the difference between today's value and the contract value.
Let's try a wild guess. If the major assets (real estate, stocks, oil) are down, that's the economic equivalent of a house fire. The "insurance companies" (derivatives counter parties) will have to pay out. The house isn't a total loss. Suppose that 10% of the derivatives market has to pay out - 10% of a $600 Trillion market is $60 Trillion. Now, stocks, bonds, real estate, and oil aren't total losses - they're just down.
So suppose the payout on the insurance policies (derivatives market) is the difference between face value and current value - that's about a 20% decline, on average, conservatively. That's $60 Trillion of derivatives (10% of the total derivatives market) paying out a 20% loss. That's $12 Trillion. That is, roughly, the equivalent of a full year's income for the United States as a whole. That is about 1/6th of the entire world's annual income.
Let's put this in perspective. Would you be okay with a salary reduction of 1/6th of your income? Would you be okay with your taxes increasing by 1/6th of your income? Would you lose weight if you ate 1/6th less than you eat today? 1/6th of the entire world's GDP is a lot.
I really think that assuming only 10% of the derivatives market will have to pay out, and that their losses will only be 20% of the total notional value at risk, is incredibly conservative. But, at least, having a reasonable floor gives us a basis for guesstimating the ceiling.
The Bureau of International Settlements (BIS) estimates the derivatives market at about $600 Trillion. But that's the notional value - the face value. That's like saying that the face value of insurance policies is $600 Trillion - the actual amount paid out by insurance companies is a fraction of the total of all the face values of all the policies in the world combined.
So what's the real risk level?
Well, derivatives can be mere side bets - and, like the Super Bowl, the bets for and against any particular outcome should roughly even out. The BIS tries to estimate
But how much money is really going to be lost? Here's some guesses.
The derivatives market "insures" the value of assets, typically financial assets like stocks, bonds, and real estate. Financial assets are under pressure right now. The majority of real estate loans issued in the last few years borrowed against property in Florida, California, and Nevada. The once-hottest markets are now the icy-est, with property-value declines of 40% in the Sacramento market, and, conservatively, 20% in the majority of really-hot (and widely invested-in) markets. The stock market is down from a Dow of 14,000 to less than 9,000 (about a 35% decline). Oil is down from a high around $140 to today's value around $70 - a 50% decline.
So the assets that underlie the derivatives contracts have declined by about 30% (a very, very rough average of the declines in major asset categories). A homeowners' insurance contract doesn't pay out unless the house is damaged - an awful lot of our financial houses are on fire right now. This is an economic Hurricane Katrina, 1906 Earthquake, and Midwestern flood all in one.
If an insured car is totalled, the insurance company will try to sell the car for scrap and parts, while paying the car's owner to replace the car. The insurance company is out the difference between the market value of the car and the scrap value of the car. Well, with an options contract, you don't actually lose the full notional value of the contract, you merely lose (or win) the difference between today's market value and the notional value. If I buy a put contract on Corning stock at $20, the counter party doesn't lose $20 - they lose the difference between today's stock price (~$11) and the $20 contract price. So instead of losing $20, they lose $9.
So BIS says the total derivatives market is about $600 Trillion in notional value. That's like saying the Corning derivatives market is $20 - it doesn't mean anyone is losing $20 (or $600 Trillion). What they'll lose is the difference between today's value and the contract value.
Let's try a wild guess. If the major assets (real estate, stocks, oil) are down, that's the economic equivalent of a house fire. The "insurance companies" (derivatives counter parties) will have to pay out. The house isn't a total loss. Suppose that 10% of the derivatives market has to pay out - 10% of a $600 Trillion market is $60 Trillion. Now, stocks, bonds, real estate, and oil aren't total losses - they're just down.
So suppose the payout on the insurance policies (derivatives market) is the difference between face value and current value - that's about a 20% decline, on average, conservatively. That's $60 Trillion of derivatives (10% of the total derivatives market) paying out a 20% loss. That's $12 Trillion. That is, roughly, the equivalent of a full year's income for the United States as a whole. That is about 1/6th of the entire world's annual income.
Let's put this in perspective. Would you be okay with a salary reduction of 1/6th of your income? Would you be okay with your taxes increasing by 1/6th of your income? Would you lose weight if you ate 1/6th less than you eat today? 1/6th of the entire world's GDP is a lot.
I really think that assuming only 10% of the derivatives market will have to pay out, and that their losses will only be 20% of the total notional value at risk, is incredibly conservative. But, at least, having a reasonable floor gives us a basis for guesstimating the ceiling.
What the Heck is a Derivative?
A derivative is a contract that derives its value from something else. The notional value of a derivative is its face value. It might be simpler to think of it like your homeowners' insurance policy; the policy can pay out up to the stated replacement cost of your house - that is the face value (or notional value) of the insurance policy. If it costs $100,000 to rebuild your house, then the market in homeowners' insurance on your house is $100,000 in notional value. The insurance company doesn't pay $100k, they're simply at risk for up to $100k. The premium you pay to the insurance company each year is the part that gets added to GDP, the part the insurance company can save, spend, or invest, the part that matters in any year that you don't have losses.
But, Hurricane Katrinas can happen. So the insurance company has to set aside enough money to pay out the claims it can reasonably expect. Insurance companies are heavily regulated by State and Federal government agencies, and they are required to use reasonable assumptions to decide how many claims to reasonably expect, and they are required to keep enough money on hand to cover those claims.
Derivatives, on the other hand, are not heavily regulated. In many ways, a derivative is like an insurance policy. If I am worried that my Corning stock might decline in value right when I want to cash it in for a down payment on a house, I can buy a put option contract (one of many types of derivatives) that gives me a right to sell the stock at an agreed-upon price within a specific time period. Effectively, I am insuring against a decline in the value of an important asset (much like you insure against a fire destroying the value of your home).
There are many other types of derivatives contracts, and they cover a wide variety of possible losses. One type of loss they cover is "credit default" - if I lend money to my brother-in-law, I know the odds aren't very good that he'll pay me back. A credit-default "swap" lets me pay somebody else to take on the risk (the other guy pays me if my BIL flakes) - we "swap" a little money in exchange for trading who bears the risk.
You'll note that my Brother-in-Law isn't very likely to pay me back, and I knew that when I lent him money. That's one of the problems with credit-default swaps. Banks made crazy mortgages, and they didn't have any good reason to believe that, say, the Target cashier buying a half-million-dollar house would actually pay the mortgage back. Since the derivatives market is essentially unregulated, you can actually buy the equivalent of a credit-default swap on your deadbeat Brother-in-Law. In real insurance, you can't do that - you can only insure against a risk that neither side could reasonably predict. Letting someone buy insurance after, say, the house burns down, would mean that the only people buying insurance are people whose houses are on fire.
Given the loosey-goosey rules around derivatives contracts, people can use options contracts responsibly and irresponsibly. The only limit is whether you can find someone to trade risk with you. And, mostly, you can - it's like having a group of dumb, fun-loving friends who will actually sell you fire insurance even after finding out you store kerosene next to your woodstove, and you're fixin' to build a fire.
And derivatives traders have something else in common with dumb frat boys. They'll bet on pretty much anything. If you've ever looked at a friend across a bar table and said "I'll bet you $10 she shoots him down," you're qualified to be a derivatives trader. Because derivatives contracts don't require that either side be directly involved in the transaction that the contract derives its value from. I don't have to own Corning stock to buy a put option on Corning, and you don't have to own Corning stock to sell me a put contract. So derivatives contracts can work as side bets - just like that bar bet about whether some guy you don't even know gets a date with some woman you don't even know.
So, that's a very rough description of these derivatives things people are talking about. My next post will provide some wild conjecture about how big the risk is in derivatives trading.
But, Hurricane Katrinas can happen. So the insurance company has to set aside enough money to pay out the claims it can reasonably expect. Insurance companies are heavily regulated by State and Federal government agencies, and they are required to use reasonable assumptions to decide how many claims to reasonably expect, and they are required to keep enough money on hand to cover those claims.
Derivatives, on the other hand, are not heavily regulated. In many ways, a derivative is like an insurance policy. If I am worried that my Corning stock might decline in value right when I want to cash it in for a down payment on a house, I can buy a put option contract (one of many types of derivatives) that gives me a right to sell the stock at an agreed-upon price within a specific time period. Effectively, I am insuring against a decline in the value of an important asset (much like you insure against a fire destroying the value of your home).
There are many other types of derivatives contracts, and they cover a wide variety of possible losses. One type of loss they cover is "credit default" - if I lend money to my brother-in-law, I know the odds aren't very good that he'll pay me back. A credit-default "swap" lets me pay somebody else to take on the risk (the other guy pays me if my BIL flakes) - we "swap" a little money in exchange for trading who bears the risk.
You'll note that my Brother-in-Law isn't very likely to pay me back, and I knew that when I lent him money. That's one of the problems with credit-default swaps. Banks made crazy mortgages, and they didn't have any good reason to believe that, say, the Target cashier buying a half-million-dollar house would actually pay the mortgage back. Since the derivatives market is essentially unregulated, you can actually buy the equivalent of a credit-default swap on your deadbeat Brother-in-Law. In real insurance, you can't do that - you can only insure against a risk that neither side could reasonably predict. Letting someone buy insurance after, say, the house burns down, would mean that the only people buying insurance are people whose houses are on fire.
Given the loosey-goosey rules around derivatives contracts, people can use options contracts responsibly and irresponsibly. The only limit is whether you can find someone to trade risk with you. And, mostly, you can - it's like having a group of dumb, fun-loving friends who will actually sell you fire insurance even after finding out you store kerosene next to your woodstove, and you're fixin' to build a fire.
And derivatives traders have something else in common with dumb frat boys. They'll bet on pretty much anything. If you've ever looked at a friend across a bar table and said "I'll bet you $10 she shoots him down," you're qualified to be a derivatives trader. Because derivatives contracts don't require that either side be directly involved in the transaction that the contract derives its value from. I don't have to own Corning stock to buy a put option on Corning, and you don't have to own Corning stock to sell me a put contract. So derivatives contracts can work as side bets - just like that bar bet about whether some guy you don't even know gets a date with some woman you don't even know.
So, that's a very rough description of these derivatives things people are talking about. My next post will provide some wild conjecture about how big the risk is in derivatives trading.
Tuesday, October 21, 2008
One of The Joys of Living in Northern California
I found a juvenile black widow spider in the house. It is now dead. The adult black widow is black with a red hourglass marking on her belly. The juvenile is brown and black. Although the picture here isn't as clear as I'd like, it does show the beginnings of the hourglass shape on the juvenile's belly.
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