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Archive for the ‘Finance & the Public Interest’ Category

While sophisticated bankers and their wealthiest clients continue to take a pass on investments with even the slightest hint of risk, it seems strange that many investment advisers continue to sing the same soothing lullaby to individual investors:  “No need to panic, remember, you’re investing for the long run.  And that is what stocks are for!  If you get out now, you will miss the ups as well as the downs.”

Now I am certainly not advising you to panic (in fact, I am not advising you at all, because I am a mere finance professor, not a certified investment advisor).  But it does seem like a good time to revisit what we know (and don’t know) about personal investments and asset allocation, and to try to reassure you that there is no dishonor in prudence. (more…)

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The problem with commenting on the financial rescue plan is that Fed Chairman Ben Bernanke and Treasury Secretary Henry Paulson Jr. have not told us all that they know about the financial crisis. Specifically, we don’t know about the financial health of banks individually or in the aggregate. In this entry I will offer a guess: There is widespread bank insolvency and the point of the rescue plan is to use asset purchases to save banks that are good and, just as important, to facilitate closing banks that are bad. If this is right, the rescue plan is a sensible response to the crisis. In effect the plan has a secret component: widespread and controlled bank closings. (more…)

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The root cause of the liquidity freeze on Wall Street is clear:  Financial institutions, for various bad reasons that have been discussed at length elsewhere and are beside the point here, made huge bets that house prices would continue to defy gravity.  They didn’t.  Now the losses from those failed bets keep on popping up in unexpected places; no one knows who can be trusted.  For a bailout to solve the trust problem, it has to reveal who just got singed by the housing fallout, and who is still hiding third degree burns.  Until that uncertainty is resolved, investors are going to be justifiably cautious about putting their capital at risk. (more…)

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We seem to have entered a new phase of the credit crisis. We spent a number of months learning just how much house prices would fall and which institutions had exposure to mortgage loans. Now, as credit problems cascade and liquidity remains scarce, events seem to have moved beyond mortgages. Now we are concerned, for example, about which firms are exposed to other firms via credit default swaps.

In this entry I will make some observations about a few of the extraordinary events of the last week, specifically about money market funds, short sales, and the need for centralized clearing of financial products. (more…)

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In a blog entry almost six months ago, I suggested that prices for credit default swaps (CDS) would tell us when the financial crisis was winding down. Unfortunately, the data this week tell us that the end is not in sight. This is probably obvious to you given the news headlines of the last few days, but looking at credit default swaps can help us understand how bad things are. (more…)

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“In an abusive naked short transaction, the seller doesn’t actually borrow the stock, and fails to deliver it to the buyer. For this reason, naked shorting can allow manipulators to force prices down far lower than would be possible in legitimate short-selling conditions.”

-  “What the SEC Really Did on Short Selling”, by Christopher Cox (SEC Chairman), Wall Street Journal, July 24 2008, P. A15. (more…)

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As the debate continues over the wisdom or lack thereof of Congress having given Treasury Secretary Paulson a blank check to keep Fannie and Freddie afloat over the next 18 months, a point that seems largely overlooked is that there was only one realistic alternative. Either Congress could explicitly provide a financial backstop such as the one just enacted, or the Federal Reserve could later ride to the rescue a la Bear Stearns should the need arise. After all, there is widespread agreement that Fannie and Freddie are too big, and at the moment too important, to fail, and that taxpayers are ultimately on the hook. (more…)

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It’s official.  After the administration’s protestations to the contrary last week – read my lips, no new bailouts – this morning Treasury announced a plan to inject “billions of dollars in loans and investments” to shore up Fannie and Freddie. (more…)

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“We’re structure experts, we’re not underlying-asset experts.”

—Moody’s employee

How exactly did the credit rating agencies assign ratings on collateralized debt obligations backed by mortgages? In “Triple-A Failure” in the April 27 issue of the New York Times Magazine, Roger Lowenstein explains in detail how Moodys rated one such issue, which Lowenstein calls “Subprime XYZ”. Lowenstein’s article is notable for the insight it provides into Moody’s ratings process. The ratings agencies were not the only culprit in this crisis, but they played an important role, and the Lowenstein article helps to elucidate that role. (more…)

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Reporter: But now I’m asking you: When will we know?
Henry Hurt: Blackout lasts for 3 minutes. If they’re not back in 4, we’ll know.
Apollo 13

When will we know that the credit crisis is over? One way to tell will be by looking at the market for credit derivatives. Credit default swaps (CDSs) permit investors to buy or sell insurance against the event that a specific company defaults (or more generally, experiences a “credit event”). The buyer of insurance pays a quarterly or semiannual premiums to the seller. In return, the seller promises in the event of default to pay the buyer the loss in bond value due to default. When CDS premiums are high, it is a sign that investors are worried about a default. (more…)

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