Bring back Glass Steagall

The Great Depression brought about many needed regulatory reforms. These acts served to curb excess speculation, and to keep the funds of bank depositors safe. One of the primary reasons for the insolvency of many commercial banks in the 1930s was the loaning of money for stock market speculation in a market that allowed absurd levels of leverage. Many of these banks owned brokerage security operations, and found an easy path to executive riches by pressing these loans on depositors prior the 1929 crash.

The Glass-Steagall Act tamed this circus by prohibiting banks from owning financial companies. This created a wall that stopped the ridiculous activities of banks that were not in the best interest of customers. Coupled with the creation of the FDIC and other reforms included in the act, the Glass-Steagall legislation protected both bank account customers and investors. The act prohibited a commercial bank from offering investment and insurance services while maintaining better regulatory scrutiny on capital ratios.

Unfortunately, the provisions that separated cross-ownership were over-turned by the Gramm-Leach-Bliley Act of 1999. Financial companies spent more than $300 million in lobbying over 20 years in their attempts to repeal Glass-Steagall.

Not merely content to simply mine the riches offered by the combination of insurance underwriting, securities underwriting, and commercial banking; Wall Street championed unregulated derivatives. The securities industry claimed that these contracts would distribute risk and regulating derivatives would impede economic development. Supported by the Federal Reserve the merged financial industry drove the wide-scale introduction of derivatives into traditional commercial banking markets such as mortgages.

Since 1999, the derivatives have grown on a parabolic curve. There are now over $516 trillion in derivatives outstanding.

In a short eight years, the rapid proliferation of derivative contracts has become the Trojan horse that is likely to undermine the entire modern banking system. The collapse of Bear Stearns should act as a warning for the entire financial market. It is time for regulators to step in and properly unwind the most troubled instruments, while providing concrete oversight to the entire derivatives industry. Obviously the lunatics have been found unfit to run the derivative financial asylum. Deregulation has run amok, and financial checks and balances must be restored to protect the economies of major nations.

Investment banks’ culture of risk is diametrically opposed to the purpose of commercial savings banks which is the preservation of customers’ assets. The introduction of derivatives as the primary under-pinning for the mortgage industry with little regulatory oversight was an event that was obviously going to end in a calamity; similar to giving liquor and a car to a chronic drunk.

The continuous reduction of the protections of Glass-Steagall, by politicians in Washington driven by banking PAC money, is the root cause of the current painful credit crunch which is undermining the entire U.S. economy. In order to fix the core problems, the protections created by Glass-Steagall after the harsh lessons of the Great Depression must be restored by Congress. A clear separation of commercial and investment banking must be reestablished.

A recent PBS Frontline outlined The Long Demise of Glass-Steagall.

Schwab YieldPlus Funds Tank

For years, Charles Schwab marketed the YieldPlus funds as "a safe alternative to money market funds that preserve principal while being designed with your income needs in mind." Charles Schwab also represented that its YieldPlus funds were designed to provide "high current income with minimal changes in share price."

The Schwab YieldPlus Fund Investor Shares (SWYPX), and Schwab YieldPlus Fund Select Shares (SWYSX) have declined over 30% since July of 2007. Unfortunately for investors these funds had large investments in risky mortgage-backed securities. Morningstar now ranks these two funds as last among ultra-short-term bond funds. So much for the Schwab claim in the marketing literature, “The [YieldPlus] funds provide higher yields on your cash with only marginally higher risk [and therefore] could be a smart alternative.”

An earlier HingeFire article from October (see Grandma’s Money Market Fund feels the SIV pinch) outlined the risks of brokerage money market funds, and why investors should be wary of these instruments.

Now Schwab is offering investors a mere 5 to 12 cents on the dollar of their losses, and demanding that the account holders quickly take the offer. This, of course, drove investors to contact law firms to launch class action suits on their behalf.

Riots in the Streets: Food

Well not quite yet… however a number of media pundits are urging people to stockpile food in order to get the best return on their money. According the CNBC, the price of eggs has risen 45% in the past few months; milk is up 33%, and cheese up over 15%. Coupled with the rising cost of fuel at the pump, most families are facing a double wammy.

The trends in food pricing are not going to change, but are likely to get worse. Most analysts are expecting even steeper price increases over the remainder of 2008. Economists would classify the situation as stagflation despite the government claiming the official inflation rate is below 3%. The situation is reminiscent of some of the previous Western economic calamities where inflation spun out of control.

Obviously the Fed policy is focused on propping up the markets instead of controlling inflation. As the money supply is increased by billions of dollars per week, the door is left open to out-of-control inflationary pressure.

The average bank account is yielding under a 4% return. As food prices climb weekly, the obvious better return is to hold food instead of cash. This has created a situation where many smart consumers are stockpiling food from their local wholesale club (Sam’s etc.) to get ahead of the curve.

The Wall Street Journal outlines how consumers are stocking up the pantry.

Is there a future for Quant Funds

It appears the Quantitative Funds have been stranded on the lee shore, and a crowd is desperately trying to find a way to shove the ship off the beach. Even if re-floated the quantitative industry is mired in a cross-wind about its future direction; not knowing whether to tack or jibe in order to catch air in the sails.

The recent draw-downs during the credit crunch have raised the question if the mathematical wizards can navigate the waters; or if the conjurers would be better off safely ashore teaching theory at a university. Is there even a future afloat for these funds? The trends of lower cost IT, more powerful computers, mountains of instant data, and new modeling techniques can play both for and against these funds. The bottom line is that a proper definition of risk still haunts the players.

Earlier HingeFire articles (see Quants search for new math) discussed the confusion as these funds search for a new formula that will pull alpha out of the market while not leaving the funds sunk every few years. The current methods have proven to be more akin to gambling than investing.

Advanced Trading recently addressed the fund dilemma - Quants Searching for Alpha: Do the Pros Outweigh the Cons?

Two Days Left: Take the Gold Survey

Make your voice heard. Two days left to vote.

Where will Gold be on July 1st?

Gold has recently been reaching new heights while also taking dips in a very volatile market. Where will this precious metal be priced in two months. Many wonder if the technical or fundamentals are driving this market. Is gold merely in a inflationary dollar-induced bubble, or does it have long term holding power at these levels.

Take the survey at the top left of the HingeFire blog.

The Feds take Wachovia to the woodshed

In punishment for scheming with telemarketers to steal vast amounts of money from the accounts of thousands of victims, Wachovia will be paying nearly $145 million in fines and restitution. The bank supported the plundering in order to earn a substantial amount in fees, amounting into millions of dollars.

An earlier HingeFire article (see Banks Behaving Badly: Wachovia) outlines the scam perpetuated by the bank and telemarketers. Wachovia (WB) did not admit or deny wrongdoing as part of the settlement. In a statement, the bank said this "situation was unacceptable and we regret it happened."

The size of the penalties does not align with the obscene profits made by the bank in this telemarketer partnership scheme, which was fully supported by executives at Wachovia. The bank's actions were "part of a pattern of misconduct that resulted in" Wachovia collecting millions of dollars in fees, regulators wrote. Once again, a banking institution’s executives were not held criminally liable for their actions, and the penalties are a pittance when compared to the profits.

The settlement is disappointing because the victims do not automatically receive their money back. The duped, many of them elderly, will be required to file complex paperwork in order to claim their money. Many critics in Congress are demanding that the Office of the Comptroller of the Currency (OCC) directly mail checks to the victims, which was done in the past instead of requiring the account holders to file claims. The impacted account holders will have to submit forms through a complex bureaucracy. “Because many of the victims are elderly or poorly educated, it is likely many of them will stymied by these obstacles”, according to Rep. Edward J. Markey. This makes it likely that full compensation from Wachovia will never be paid.

While clearly this “settlement” takes Wachovia to the woodshed, the sting of the Federal switch will only last for a short period of time. After which the bank can romp, play, and continue to eat the candy it has stolen, while conniving its next scheme to slip a hand into the customers’ cookie jars.

What to do in a Recession

Our friends at Elliott Wave International have released another exciting resource that we think is well worth your time. We’ll, it’s actually a group of resources – more specifically – 3 FREE videos and 1 FREE report that all speak directly to what to do during a recession.

The 3 videos include Elliott Wave International CEO Robert Prechter’s latest appearances on Bloomberg television from March 2008, November 2007 and October 2007. The videos present Prechter’s interesting and unique forecast as well as his outlook for U.S. Stocks, Precious Metals, Currencies and other markets.

Plus, Prechter discusses how Fed Reserve rate cuts merely follow the U.S. Treasury Bill interest rate. And he goes on to ask and answer a fascinating contrarian question: “Why in the world are people rooting for lower interest rates?”

The report included in this group of resources focuses mainly on Prechter’s Gold and Silver forecast, the same forecast his subscribers pay up to $59 every month for. But, right now, it’s yours FREE.

In these resources, you’ll learn why Prechter says the U.S. has been in a bear market since – YES – the year 2000.

I know, I know, a bear market since 2000 is a shocking claim, but when you consider the massive amount of credit inflation, and when you measure how much gold or how many commodities you can buy with your Dow or S&P 500 shares, you’ll learn that, according to Prechter, stocks have been CRASHING since 2000.

In fact, here’s a little secret for you: When you measure the S&P 500 in a basket of commodities rather than the U.S. dollar, you will see it has declined as far as 75%.

But, what does this mean for the “Real Dow” and “Real S&P 500,” as Prechter calls them? Here’s a hint: The nominal Dow has a long history of catching up to the “Real Dow.”

Prechter’s outlook is more than unconventional. And it’s more than contrarian. It’s a crystal clear and downright frightening explanation of where the markets are today, according to a man that’s studied them for more than three decades.

You will not find this outlook from any other source but Robert Prechter.

I encourage you to hear his warning, then decide for yourself what you should do – if anything – to prepare for Prechter’s prediction that the nominal Dow, the one you read about in newspapers, will one day catch up to the “Real Dow,” the one measured in gold.

In these FREE reports, you will hear, watch and read Prechter’s chart-filled advice on how to survive a recession, how to make money in a recession and how to create a safe investment strategy in recession.

Whether you agree with Prechter’s bearish forecast or not, this FREE group of resources is prudent advice for anyone concerned about preserving wealth in a recession.

To learn more about getting your hands and eyes on Prechter’s 3 FREE videos and 1 FREE report, click here.

Home Prices: Down 13.3%

In case anyone is not a believer, the statistics firmly demonstrate that home prices not only go up. They can also go down – sharply – in short periods of time. The median price of a home sold in March dropped 13.3 percent when compared to one year ago. This is one of the largest declines ever, exceeding even the 14.4 percent drop in July 1970 when the U.S. was buried under high interest rates and stagflation.

The sales of new homes in March dropped to the lowest level in 16 ½ years, the slowest pace since 1991. The early part of the 90s was not merely memorable for outlandish music videos on MTV but for the S&L crisis that left many sub-divisions incomplete and housing market in absolute chaos. Having a housing market with lower sales then one of the worst real estate periods in recent memory can not be considered a positive sign. Not even NAR (National Association of Realtors) could spin this as good news.

New home sales plunge to lowest level in 16 1/2 years
New home sales plunge to lowest level in 16 1/2 years, prices drop by largest amount in 38 years

Tax Cut leads to surge in Chinese Indexes

Attempting to tackle a sharp decline in the indexes over the past months, the Chinese government reduced the tax on equity trading. In response the Shanghai Composite index surged 9.3% - an increase that is almost certainly temporary. The broader issues with lofty valuations, lack of transparency, and macro-economic issues driving the fortunes of companies in Asia remain unaddressed by this regulatory action.

Investors were delighted with the government action; however it did not boost the long term confidence in the stock market for most individuals. Smart investors will take advantage of the surge to exit their positions over the next week. Slower earnings growth and higher costs do not bode well for company results in upcoming quarters.

“The government is clearly concerned about the meltdown,'' said James Liu, Shanghai-based deputy chief investment officer at APS Asset Management, which oversees $1 billion. ``It's positive for the market in the short run.''

The primary words to focus on are “short run”. Simply reducing the stamp duty on stock trading to 0.1 percent from 0.3 percent will not eliminate the headwinds facing the market, nor change the primary trend of the stock market which is down.

Despite the optimism expressed from financial pundits, the proclamations that this denotes the market bottom are likely to backfire within the next couple of weeks. Certainly the government is pleased with this cheerleading from the financial sector, because after all markets are in reality a confidence game.

Chinese stocks soar after tax reduction

Few analysts believe share prices will reach a new high this year, but many investors and analysts are hoping the worst is over. Hoping and reality normally run on diverging tracks.

The Meltdown: Iceland

For many recent years, Iceland was touted as the new model for Europe. Investment poured in at record levels, lifting the entire economy of the small island nation. The geo-thermal energy was offered as an excellent power source for heavy industries such as smelting, while the onshore banking industry was presented as the new breed.

The local currency, the krona, was riding high while the government offered an environment where interest rates were much higher than other nations. The nation was splashed across the financial press as the next business center.

It only took six months for all the optimism to dissolve and the island to adopt a siege mentality. Government officials and the local press blame unscrupulous speculators for the meltdown that has left the nation’s financial infrastructure on the brink of ruin. The krona has sunk 25%, the stock market 40%, inflation has sky-rocketed, and the local interest rates sit as an unpleasant 15.5%. It is obvious that the island’s central bank does not have the liquidity strength to bail out any of the nation’s larger floundering banking institutions, effectively leaving banks un-backed. Bear Stearns recently suggested the tiny nation was about as safe an investment as Kazakhstan.

Consumer spending has slowed to a crawl as on-shore prices has risen greatly in the import driven economy. There is increasing recognition that the growth over the past few years was the classic definition of a bubble, however few in power are prone to admit it. Instead the leaders blame the demise on outside speculators with a Vegas mindset who want to make a profit on the pain of the nation.

In the past, Iceland was hailed as the new model of success. Now the fear is that mainland Europe will follow the model of this small nation, and crumble on a mass scale. Iceland may only be the leading edge of a cycle of credit defaults that will rip the European financial system asunder.

Iceland first to feel the blast of global cooling
Tiny country is like a canary in a coalmine signalling crises in toxic economies

What is an Analyst worth? Nothing!

It has become clear to most knowledgeable investors that analysts are nothing more than cheerleaders for the stocks touted from their firms. This was made obvious in the lawsuits after the NASDAQ implosion which found that leading analysts publicly touted tech stocks while privately calling the companies garbage (and worse terms).

Most of the stock portfolios pushed by analysts under-perform the market, while at the same time the Wall Street firms have cozy relationships with the promoted companies that drive millions in fee revenue.

A recent Bloomberg article, What's Analyst Worth? Not a Penny as Estimates Miss, touches on the failure of analysts to properly analyze the prospects of firms rather than simply relying on guidance. The article discusses the “management” of quarterly earnings and other dubious practices, while questioning if “buy” ratings have any value whatsoever.

Another good read about the manipulations of Wall Street is the book - Full of Bull: Do What Wall Street Does, Not What It Says, To Make Money in the Market by Stephen McClellan. The author highlights the shady practices of research analysts and how individual investors should look at their recommendations.

Come Watch the Death of a Bond Insurer

This week the market gets front row seats in the death of a bond insurer. In February, the forebearance for ACA Capital Holdings was extended to April 23rd. This date approaches in a couple of days and is unlikely to be extended. The outcome at this point is obvious according to most pundits, the complete implosion of the bond insurer.

The open question remains of what impact this event will have on the municipal bonds which are insured by ACA. In most cases, the expectation of the bond insurer failure is already priced into the munis. However this can not be a good sign for the jittery auction rate or municipal markets.

At minimum, mid-week will be the time to pull up a chair, grab a drink, and see how the entire situation with ACA unfolds. Will some firm magically step up and save the bond insurer? Will regulators from New York State step in? The flak from the implosion splatter across the Wall Street landscape? Will it give CNBC something to talk about instead of the mediocre first quarter earnings?

One recent BusinessWeek article outlines how Wall Street used ACA to hid loads of subprime risk with the eventual unintended consequence of sinking the entire business, including the bond insurance operations.

An associated story outlines the failure of S&P, the only credit-rating agency to follow ACA, to properly cut the companies rating in a timely manner. On December 19th, the rating agency cut ACA’s grade from A down to CCC overnight; immediately turning gems into junk.

Getting Robbed by your Broker

I had an interesting mailing from Fidelity today regarding “Important legal information for Fidelity clients”. With a banner that bold, I figured it was time to read the small print.

One of the most precarious situations for the customer of a brokerage firm is when the company operates it own clearing firm where the broker routes the customers' orders to. In my mind, this is worst than the simple payment-for-order flow set-ups with third party firms. A set-up where your order is routed to an affiliated company is the worse case scenario for an investor - a recipe for abuse.

In the case of Fidelity, the FBS routes your orders to their clearing firm affiliate, National Financial Services (NFS). The statement goes on to state that NFS looks at a number of factors when executing the order. The next section informs the reader that the order routing policies are designed to result in transaction processing that is favorable to its “customers”. Remember that the “customer” here is FBS, not you - the retail investor.

The next paragraph clearly states that FBS and/or NFS receives remuneration, compensation, and other considerations for directing orders to certain market centers. This allows the firms to get financial credits, monetary payments, rebates, volume discounts, or reciprocal business. Obviously the entire set-up is focused on making Fidelity money rather than getting the investor the best price for their trades.

Due to recent regulatory action, they now have to disclose these facts to investors who have accounts at Fidelity, and state the company will provide details of the compensation received in connection of the routing of a particular order upon request during the previous six month period.

In the past, the cross-ownership of brokerage and clearing/routing firms was not allowed. Unfortunately regulation got lax, setting the table in the 1990s for a significant amount of abuse. The recent notices coming from brokerage firms (Fidelity is not the only one) are a small step in informing investors of this conflict. The next proper step for the SEC is to force the separation of brokerage and clearing/routing activity. The utilization of related affiliate firms when routing brokerage customers’ orders should be strictly disallowed in the financial industry – it is the 21st century form of highway robbery.

Keep in mind that, despite this notice, I am a happy Fidelity customer for my retirement accounts. These funds are rarely traded and kept primarily in mutual funds that are part of their NTF family. I find Fidelity’s customer service generally to be excellent.

Chinese markets plunge 50% in six months

Earlier HingeFire articles outlined the risk of the Chinese stock market (see The Plunge Continues – China, Shanghai Index Double Top, ETFs to short China) and the probability of the bubble would implode. A summary from early April outlined the rapid deflation of the Chinese indexes. In the past week, the Shanghai index dropped another 11%.

The deteriorating situation has caught the eye of the mainstream press. The WSJ outlines the 50% fall of the Chinese market in a mere six months as a front page article. With the P/E ratio of the composite Shanghai index still at a frothy 35, the market still has plenty of downside. To reach a nominal P/E of 20, the index would slide to 1700; a 72% crash from the Shanghai market peak. A situation that is very reminiscent of the NASDAQ in 2002.

Dollar’s plunge enables corporate earnings

The recent round of earnings reports from large companies with international operations on the surface appear to be solid. Coca-Cola, IBM, Caterpillar, eBay, and others all hit the ball out of the park. A more detailed look reveals the weakness; the strong earnings were built on the back of the falling greenback. International sales did not explosively rise, they simply look much better in dollar terms as the greenback continues to steeply slide.

Understandably growth outside the U.S is stronger than domestic increases, with the economy on the brink of recession. The outsized 1st quarter earnings from international sources are more reflective of the greenback’s slide than improvements in non-U.S. sales. In actuality, it is possible to make a case that overall international sales are deteriorating as consumers become more cautious world-wide.

While the profits are reported in dollars on quarterly balance sheets, most of the currency remains offshore and is not converted into greenbacks. In many ways, this serves as paper tiger that helps the quarterly report look solid, while no real benefit is accrued to the company. If the effect of currency rate of conversion was backed out of the earnings, in some cases the international profits would look just as bleak as the domestic situation.

Additionally, most of these overseas profits are difficult to repatriate to the U.S. and put to work. This means that the cash will be put to work internationally or simply sit in offshore accounts; neither scenario helps drive growth or increase jobs domestically.

At some point the trend in the dollar will reverse; at this point many of these firms that excelled in previous earnings will have to mark their offshore cash hordes to market. If not properly hedged in the forex markets, these companies are likely to announce future write-downs in their cash and equivalents.

Dollar's plunge becoming lynchpin in 1Q earnings discusses this situation in more detail.

529 Plans: The Best and the Worst

A recent Morningstar article outlined the Best and Worst 529 College Saving Plans. States are regularly altering their plans to improve them (hopefully) so the rankings change every year. Another excellent 529 plan resource is the SavingForCollege website.

It is best to not take any plan offered through a broker, but always go direct to the state to set-up a 529 savings plan. This helps the investor to avoid the pile of fees that many brokerages add on top of base plans. "Broker sold" is bad news in 529 plans.

Another issue to keep in mind is the pending legislation in some states that improve the tax benefits if you select the plan of the state you live in. Some states are also proposing additional savings benefits for selection the home-grown plan. Pay attention to any pending 529 proposals in your state legislature when determining which plan may be best for you.

Watch out for Foreclosure Rescue Scams

ABC News recently presented a good segment on avoiding foreclosure rescue scams. There are two types of common scams; the first is where a firm charges you hefty upfront fees to negotiate with your bank and then promptly disappears while doing nothing. The second is where the firm buys your house for below market value, and leases it back to you on unfavorable terms. Eventually the former homeowner can not keep up with the rental payments and is evicted, leaving the firm owning the house.

Catch the ABC News clip:
http://cosmos.bcst.yahoo.com/up/player/popup/?rn=3906861&cl=7408730&ch=4226721&src=news

Wachovia: Take Three Steps

In a week in which North Carolina is celebrating the tradition of pirates like Blackbeard; articles are appearing asking if the Wachovia CEO will walk the plank? Ken Thompson the CEO of the Charlotte, North Carolina based bank appears to be stuck between a rock and a hard place.

Despite earlier statements that the bank would not cut dividends and was not facing a wave of mortgage trouble; this illusion was shattered in the recent first quarter report. Wachovia cut the dividend from 64 to 41 cents, while adding write-downs of $2 billion. The highly-touted acquisition of mortgage broker Golden West in 2006; has turned out to be a fiasco.

"Everyone points to the acquisition of Golden West, and I do, too," Townsend said. "Certainly that has to be viewed, in retrospect, as one of the most boneheaded decisions of recent times."

Will Wachovia’s CEO weather the storm or be forced to take three steps down the plank? If thrown overboard, he can join the cast of executives from large banks recently cast adrift.

Wall Street Journal parody has the paper scrambling

A parody of the Wall Street Journal appears to have the paper scrambling, according to the New York Times. Multiple reports show that agents of the publishing company have been running around to purchase all the existing copies of the parody, which skewers the new owner Rubert Murdoch, pummels a few politicians, and takes aim at financial industry targets.



It appears the parodies claim that the paper is Available now at Newstands everywhere! does not hold true. Fortunately it can be found on Amazon - http://www.amazon.com/Wall-Street-Journal-Tony-Hendra/dp/0615193323/

Circuit City: The vultures swoop in

Circuit City (CC), the electronics retailer in dismal shape due to gross mismanagement received a take-over bid from Blockbuster (BBI), the video rental retailer that has an existing set of problems. Vultures have been eyeing the carcass of Circuit City for a good period of time; it should not be a surprise that another retailer has swooped in to take a peck.

In terms of business intent, a combination with Blockbuster may be one of the better proposed deals placed on the table. Certainly better than simply selling out to a private equity firm. In reality, many would look at Blockbuster as being more of a white knight than a vulture.

Highlights of the offer include $6 to $8 per share in cash, a total of up to $1.3 billion. It appears that the chronically mismanaged Circuit City has effectively ignored earlier private proposals, so Blockbuster took the step of making this bid public and engaging shareholders. The press releases indicate that Blockbuster is proposing to use a rights offering, a mechanism that allows existing shareholders to buy additional shares of a company, in order to complete the transaction. Rights offerings are rare in the United States and typically occur at a discounted price.

Blockbuster has emerged as a survivor in a movie rental industry that is undergoing sharp transition. Over the past couple of years, several competitors such as Movie Gallery and Hollywood Video filed for bankruptcy or have been shuttering stores. Competition from online firms, delivering rentals via mail, such as Netflix (NFLX) have stepped up the bar in the industry. Pay per view films offered by cable operators have also deeply cut into the rental business. Being strictly a corner store video rental business is no longer a viable business model.

Blockbuster touted the synergies of the proposed combination; pointing to the ability to cut costs, exploit the growing convergence of media content and electronic devices, and benefit from selling complementary products. Circuit City stores are typically larger than Blockbuster storefronts; one could expect to see “Blockbuster super-stores” that sell electronics and rents movies. However, even if the deal is completed the expectation is that is would take over 12 months to see viable traction with the combination. A large number of existing neighborhood Blockbuster stores would probably be shuttered; frustrating consumers who have to drive longer distances to the new “super stores”, many which are located in crowded malls.

Investors also appear to be skeptical as they drove Blockbuster stock down over 10% in trading on Monday. Many doubt that Blockbuster can cure the problems plaguing Circuit City without causing a tremendous distraction to the company’s primary business. The financing for the transaction is also in doubt and may be dilutive.

Circuit City, winner of the dumbest retail business move of 2007, is a poorly managed underperformer. Its closest competitor, Best Buy (BBY), has been dominating the electronics retail segment. In a continuing sad saga, Circuit City handed out sizeable bonuses for executives while cutting top-performing employees at stores because they were “over-paid”. In response both the sales and stock price tanked. The ills of Circuit City can only be resolved by the replacement of the current management team, and a complete re-focus on the consumer.

Circuit City stock rose nearly 30% on Monday when the news hit the wire. The bid by Blockbuster may be just the front end of a chain of bids for the company. Other players, who have been sitting on the sideline, now may be forced to show their hands and open their wallets. Setting the table for a possible bidding war, an event that would please many long-suffering Circuit City stockholders immensely.

Financial Regulatory Reform

A lot of ink in Washington has been wasted recently mapping out proposed Finanicial Regulatory Reforms to prevent another subprime meltdown. The crux of the issue is not that the reform is desperately needed, but the nonsense being churned out of Washington is nearly worthless, more reflective of a turf battle than meaningful reform.

The first reasonable step should undo any of the changes done to the Glass-Steagull act, a bill that was implemented during the Great Depression to reform banking. Pressured by the banking industry, the Gramm-Leach-Bliley Act of 1999 unwound this earlier bill, allowing the cross-ownership of investment & commercial banks. This absurd change -- which allowed the financial industry to run amok with greed -- is one of the root causes of the current credit crisis.

Funds still flowing for student loans

The lock-up of the auction rate market has only impacted some student loans, a wide variety of government-backed and private-sector student loans are still available. One recent article outlines the Best Federal Loans for Graduate Students. Much of the content of the article is also applicable to undergraduates. Fixed rate federally backed student loans have many advantages over private loans. Eight key advantages are outlined in the article followed by a description of the best federal loan programs.

Anya Kamenetz outlines why There is No Student Credit Crunch. Despite several states having to cut back FFELP programs; there are still plenty of resources for low-cost federal student loans in the upcoming academic year.

It is best for students to focus on federally backed loans and stay away from private student loans with expensive variable interest rates and borrowing terms that make most people cringe.

Both of these articles are worthwhile reads for college students and their parents. Before applying for financial aid, it is important to have a sound understanding of the available programs.

Free Trading Lessons Now Online Until April 18

The Independent Trader Crash Course
Over $300 of Trading Lessons, FREE through April 18!

Click Here to Get Your Free Lessons

More About the Independent Trader Crash Course

You've heard them say, "Buy low, sell high." You've also heard, "The trend is your friend." Then there's, "Don't fight the Fed" and many other age-old trading principles.

But have you ever actually tried to live by them? If so, you know that it's easier said than done. Because, for example, how do you know if you're really buying "low" and selling "high"?

Elliott Wave International, the world’s largest market forecasting firm, is releasing 5 unique reports and videos that can help you bridge the gap between the theory of wise adages and the practice of benefiting from them.

The Independent Trader Crash Course compiles over 4 years of the best trading lessons from Elliott Wave International with 64 pages and 17 minutes of insightful online videos that you simply cannot get anywhere else.

These five reports and supplemental videos will reveal to you several key techniques of analysis, forecasting and risk-management that are tailored to fulfill one purpose: making you a better trader.

Click Here to Get Your Free Lessons

Quants search for new math

For many years, quantitative hedge funds were hailed across the Wall Street community as inspired leaders in the next generation of finance. All the old rules about valuation, risk control, and proper evaluation were all relics of the past. The next phase of the “brave new world” of finance was being defined by these mathematical geniuses, hailed by their colleagues and the press as brilliant.

Maybe the Long Term Capital Management failure in 1998 should have served as a warning about the train wreck that was ahead. (BTW John Meriwether, the most well known of the “Geniuses” who lost billions with LTCM, has just blown up his new hedge fund). Perhaps the notion that all these quantitative hedge funds were pursuing mirror strategies with no risk control should have waved a warning flag.

Over the past six months, Hedge Funds have been closing shop at the rate of over three per week. Among the most severely impacted are the funds pursuing quantitative strategies. Many are victims of the extreme leverage used to trade the risky computational strategies.

When discussing these distressing fund blow-ups the press has started to use terms like “bet on the market” instead of focusing on quantitative math when discussing the latest victims. Most quantitative funds are suddenly viewed as pouring money down a rat hole, with the perception that their “math” was doomed to blow-up suddenly regarded as the foreseeable outcome.

Earlier Hingefire articles (see The Redefinition of Risk and Quants Meet Reality) outlined many of the problems with quantitative strategies deployed by the Wall Street wizards. It was simply a matter of time before a multi-sigma event took out many of the funds. Black swans do exist, and strategies that do not deploy reasonable risk control measures all meet the inevitable brick wall.

So what are the quants doing now their house of cards has come crumbling down? The mathematical wizards are searching for new models to replace the old ones that have gone up in smoke. Maybe this time they should throw in several cups of risk control into the recipe.

A recent article in Alpha Magazine outlines The New Math. Hedge funds are pressing ahead with new mathematical concepts for trading. The math wizards are hunting for new arcane magic that will give them an edge on the street; molecular physics, mathematical linguistics, artificial intelligence, behavioral response, and any other possible concept are on the table. The funds are also looking beyond traditional financial instruments into other asset classes. The bottom line is that most quantitative strategies are still searching for instruments which are mis-priced, yet risk control is still not a priority.

While the community has to give credit to the quants for pressing the boundaries and searching for new math that will provide them a computational edge on the market; maybe it is simply time for the wizards to focus the effort on risk control in their models to ensure long term market trading success. Even at the cost of several basis points of profit in their models and a reduction of leverage; having a strategy that does not blow up the firm every few years must have some inherent value. At minimum, it will eliminate the need to update their resumes regularly and search for a new fund to hang their math diplomas at.

The new price tag: $945 billion

$200 Billion (nope)
$400 Billion (nope)
$550 Billion (nope)
$800 Billion (nope)

According the IMF the new cost of the subprime credit crisis is $945 billion globally. Over $565 billion of losses are expected for U.S. residential loans and securities. The figure has risen to $240 billion for commercial loans.

"The U.S. subprime crisis is not only eroding the U.S. economy -- the world's largest -- but also wreaking havoc on global financial markets, including Japan's stock and currency markets. "

There appears to be one item that the U.S. is very good at exporting – our credit crisis.

In other related news, it appears that the Wall Street investment banks are hooked on emergency funds. As outlined in an earlier HingeFire article, these financial institutions built on risk-taking are borrowing over $38 billion each day from the Federal Reserve.

The program was designed as a temporary measure to alleviate the credit crisis; it appears that the investment banks are using it as a payday scheme to make further bets in the market. Finally the mainstream press is coming to grips with the story, stating that the Federal Reserve will need to wean these banks off of these loans, similar to taking the needles away from a heroin addict.

ETrade: Standing at the edge of the cliff

A recent article in Fortune about E*Trade gives an insiders view of the panic that hit the firm as billions in losses piled up as customer fled. Defying Wall Street expectations, the firm fought back and stayed alive. However it is not out of the hot water yet.

Since October, E*Trade has watched $56 billion in customer assets evaporate, while it still has $39 billion in mortgage related securities and loans on its balance sheet. This is a significant exposure for a firm that only has a $1.9 billion market capitalization.

Only the intervention of Citadel, a Chicago-based hedge fund, enabled the firm to avoid bankruptcy in November, and these funds came at a tremendous cost. Citadel now owns 20% of the firm, holds 12.5% interest rate bonds from E*Trade, and acquired a $3 billion portfolio for $800 million. All of this for a mere $2.5 billion in cash. It provides the impression of a vulture picking at a carcass.

E*Trade is working to sell divisions to raise cash; nobody wants the toxic mortgage securities. The company expects to raise $350 million in cash by selling a wealth-management division, an institutional arm, and a partnership in Japan. Still the future prospects of the online brokerage firm are touch and go. A number of analysts question if it will survive 2008 as an independent entity or be purchased by a stronger firm.

A brief blip of good news for Washington Mutual

Back in November, HingeFire outlined that Washington Mutual was going down in flames. Today, WaMu received some good news that sent the already depressed stock up nearly 30%. WaMu is close to landing a $5B cash infusion from private equity group TPG; this will enable the bank to survive into 2009 without becoming illiquid. Of course, Washington Mutual (WM) had to basically give away the house to land these funds; nearly 25% of the outstanding shares, a seat on the board, and all sorts of other preferences. This appears to be the best deal that WaMu could land, considering their perilous….and nearly bankrupt position. Sadly the five billion dollar investment will not take Washington Mutual out of the woods; at least an additional $8 billion is needed to cover impending loan losses this year.

Many victims of Washington Mutual’s service practices will state that this fate is well deserved. Some are upset that the bank has not gone completely under. In reality the most likely course for WaMu still involves its acquisition by another institution.

Cartoon: Banks are golden

A cartoon that reflects the current climate where the banks are being bailed out but the homeowners are being cut adrift.

Will Congress pay off Credit Card debt next?

In a shocking surprise, all of those people who could not pay-off their mortgages are also having problems with their credit card bills. Late payments on consumer loans have reached 16 year highs. This does not bode well for the financial sector.

There are now a slew of plans being put forward by Washington to bail out homeowners struggling with their mortgage payments. Most of these plans reward brainless homeowners for taking risky loans, buying at the peak of the market, purchasing more home than they could afford, and not having any financial discipline. Of course, the smart homeowners who only purchased what they could afford within traditional lending ratios and used common-sense are the suckers in the proposed Washington plans. The majority of these hard-working homeowners will be paying for this bail-out via higher taxes and bank fees for a long period of time.

The concept that the loan values for under-water home owners will be set to 90% of the current house value, and the loss to the existing loans be taken by the banks and tax-payers is obscene. Especially when the government (meaning the taxpayer) will be on the hook for any of the new loans that still default. While Congress is at it -- why don't they just pay off all the late credit card debt, surely this will be a popular earmark attached to some bill.

Socialize Loss, Privatize Gain – Welcome the new Wall Street motto

On the other hand, now that the Fed has seen it fit to socialize investment banking losses by allowing trading firms to borrow at the discount window, and bailing-out Wall Street institutions; most of main-street America sees nothing wrong with bailing out homeowners directly for their poor decision making to the tune of 400 billion dollars in government loan guarantees. The axioms that currently apply to Wall Street should equally pertain to the individual consumer according to most sentiment surveys.

The discount borrowing by investment companies from the Federal Reserve ‘Discount Window’ reached $38.1 billion in daily borrowing this week; much greater than $7 billion averaged by standard banks. Rather than using these funds to improve liquidity in the credit sector, most of these firms appear to be using the borrowed funds to implement more risky carry strategies to make money. Someone at the Fed needs to close the barn door. The intent of the Fed program was to ease a potential liquidity crisis; in reality the action is expanding the bubble. The Fed should have placed more conditions on these loans when it agreed, for the first time, to let big investment houses temporarily get emergency loans directly from the central bank.

Thanks to Washington, it appears that there is no longer any punishment for poor business practices. No harsh (and proper) lesson will be learned by either the financial markets or individual homeowners about risk control or avoiding excess greed. A significant educational opportunity is being missed, and unfortunately it badly needs to be taught. The recent actions by the government will only increase risky behavior by institutions and consumers in the future.

Are you being throttled by your ISP?

Comcast recently was caught throttling P2P traffic leaving customers fuming. More than one has filed lawsuits accusing Comcast of false advertising over claims the service offered “unfettered access to all the content, services, and applications that the Internet has to offer”.

Many customers find that their broadband service slows to a crawl when they use particular bandwidth extensive applications. Multiple cable companies have been accused of throttling customer bandwidth. In some cases, the customer simply has the misfortune of being located in an over-subscribed node. In other scenarios, it is probable that the cable company is “managing” bandwidth. Throttling types of traffic or information exchanges with particular web locations violate the concept of Net Neutrality, one of the founding principles of the internet until large corporate interests decided to attempt to squeeze more money out of the web. SaveTheInternet has continued to fight for the rights of all Internet users.

The following video that explains why discrimination on the Internet is a problem and will continue to be as long as net neutrality rules are not enforced.



Another excellent video (and winner of the 2007 Webby People's Voice Award) is Save the Internet!



FreePress outlines 5 Ways to Test If Your ISP Throttles P2P.

Take action now to save the Internet by supporting the Internet Freedom Preservation Act.

From across the pond: The Banking Crisis

The mortgage credit crunch has not only impacted banks in the U.S., but has shocked financial institutions overseas. Filmed after the demise of Northern Rock in the U.K., this edition of Dispatches featuring Jon Moulton outlines the financial meltdown. The clip is an excellent educational summary of the greed-driven problems in the credit market that has left the world on the brink of recession.

New Poll: Gold

Gold rose above $1000 in March but has recently re-entrenched to below $900. The strengthening of the dollar and the perceived improvement with the credit situation on Wall Street put pressure on the price on gold. Gold is normally perceived as a precious metal which outperforms when the community has a lack of confidence in mainstream investments.

Where will gold be on July 1st? Take the new survey at the top left of the blog and give your thoughts.

What is that sound? It’s the market bubble bursting in China

Previous Hingefire articles in 2007 outlined the increasing risk in Chinese stock markets and how the Chinese indexes were not strongly correlated with other world markets. The Plunge Continues – China in June 2007 warned of the risk that the Chinese markets were in a bubble and it was just a matter of time till they burst. The lack of correlation to the world markets was discussed in August. A HingeFire article in November recommended ETFs to short the Chinese market.

Fast-forward the clock to April of 2008, the Chinese stock market has become the world’s leading example of a bursting bubble. The Shanghai composite index has plunged 45 percent from its high, reached in October 2007. While markets world-wide have been down since this time, other major world indexes have all dropped less than 20% in the same time period.

The frenzy that surrounded the upside of the market in China has now dissipated leaving many investors angry and demanding that the government take action. A good number of the speculators lost their entire savings. Many have learned a harsh lesson in how quickly a bubble bursts.

To See a Stock Market Bubble Bursting, Look at Shanghai

“Look,” he said, “it took two years to go from 1,000 to 6,000 but two months to go from 6,000 to 3,500.”

Triangle Housing Update

When driving around town, the pull-back in the Triangle real estate market is obvious to the casual observer. Houses sit on the market for many months and are still not sold. Land that developers planned to use for the next state of sub-divisions suddenly has large for-sale placards. Some developments have come to a screeching halt with no further construction

Most of the builders and real estate agents are absolutely glum about the local prospects. Many are fleeing to pursue other career opportunities.

Still the local real-estate organizations cheerlead, publicizing that the Triangle market is better off than other regions. Considering the state of real estate nationally, this is merely the equivalent of stating that being trampled by a wildebeest is preferable to being squashed by a hippo.

An N&O article today outlined that sales of the Triangle's existing homes fell for the eighth consecutive month in February. The local foreclosure rate has sky-rocketed while unemployment is now at 5%. Despite over 40,000 people coming to the region each year, most of the new-comers have not been able to unload their existing homes in other markets.

Despite the rise in inventory and drop in sales, the average price has managed to rise 3.1% from a year ago. Despite the attempts of the real estate industry to tout this, the news is actually dismal. Each month the average price rise decreases; shortly the figures will turn negative based on any type of statistical evaluation.

Local realtors are hoping for a strong spring/summer selling season, any type of evaluation of the market over time demonstrates that it is likely that their hopes will be crushed. There are no meaningful figures that indicate the local real estate market will improve during 2008. While the Triangle may not be as negatively impacted as other speculative markets, by no means is the region immune from real estate downside.

Sales of Triangle homes off again