My latest column from the weekend.
Q. What exactly is going on in Greece?
A. This week a leading ratings agency lowered the credit rating of Greece to junk status. Combined with a bigger than expected budget deficit and a widespread worker strike, that has created considerable uncertainty in the financial markets.
Investors should pay attention to Greece. A massive joint bailout of Greece by the Eurozone countries and IMF has already been announced, but it is unclear when that money will actually show up. In the meantime, investors fear a bad precedent should Greece ultimately default on its debt since Portugal, Spain and Ireland are also in poor fiscal shape.
Greece simply spent too much the last few years, financing that spending by issuing debt to foreigners. Rather than paying interest on that debt outright, however, Greece basically refinanced its interest payments each year by issuing new debt. In a sense, the country has been constantly taking out home equity loans to make its monthly mortgage payments. If you’re saying that sounds short-sighted, you’re right. If you’re thinking there may be a lesson to be learned here at home, you’re also correct.
Despite the stock market’s reaction to Greece’s woes, most of the possible outcomes from this situation will likely have only a minor direct impact on U.S. stock market investors. To be clear, there is a potential very bad scenario if multiple European countries default on their debt. As I write, however, the odds of that occurring appear remote.
There are plenty of other reasons to keep an eye on the indirect effects of Greece’s woes, however. The debt crisis in Greece is an indicator of the state of the European economy, which is recovering much slower than the U.S. Europe is obviously an important market for many U.S. companies, too, and those companies could see difficulties in the months ahead, potentially delaying their recovery.
For now, there are two takeaways for individual investors. First – think “debt is bad, thrift is good.” The second is that international investing, even in Europe, may not be all that it’s hyped up to be.
Cale Smith is the portfolio manager of the Tarpon Folio. More info can be found at www.islainvest.com and www.caleinthekeys.com.
My column today from the best little newspaper south of Jewfish Creek, the Keys Weekly.
Q. What exactly did Goldman Sachs do to get into such trouble?
A. Late last week, the country’s premier investment bank Goldman Sachs was accused of securities fraud in a civil suit filed by the Securities and Exchange Commission. The SEC claims Goldman created and sold a complicated mortgage investment that was covertly designed to fail.
The investment that Goldman sold to investors was called a synthetic collateralized debt obligation, or CDO, which is essentially a bet on another bet tied to a bundle of very low quality mortgages. Goldman appears to have tricked investors into believing the CDO was being managed by people who wanted mortgage holders to keep making their payments, when in reality it was secretly created by a hedge fund that was the world’s biggest short-seller in the subprime mortgage market. Those guys badly wanted the mortgage holders to default, and they did. Investors lost over $1 billion, while the short-seller made a profit of $1 billion.
Why would Goldman do this? Fees – both from their own role in structuring the deal, as well as those paid by the hedge fund for other services it may have had Goldman provide. Whether or not Goldman made money by actively betting against the same bad CDOs they secretly helped create remains to be seen.
The case is significant for a number of reasons. The first is – and there is really no pleasant way to put this – the SEC has been a consistently horrible regulator for quite some time now. Pursuing this case against Goldman may mean the agency has finally found a spine. It also means the odds of serious financial reform just increased dramatically because Goldman can no longer push back.
This case highlights a major flaw in the business models of Wall Street banks, too. Namely, they treat their customers atrociously. The ultimate outcome of this case is in some ways immaterial. Everything you could ever want to know about how dishonest a big Wall Street bank can be is summarized in this case. And it is far more damaging than a lawsuit could ever be.
My column in today’s Keys Weekly.
Q. What’s going on with financial reform in Congress?
A. As you have probably heard by now, there is a significant financial reform bill currently making its way through Congress. The House passed its proposed reform bill at the end of last year, and the Senate will take up its own version at the end of this month. Prepare for heavy spin.
As one Senator memorably said a year ago in the midst of the credit crisis, “The banks are still the most powerful lobby on Capitol Hill. And frankly, they own the place.” So I think it’s notable that some fairly serious reform efforts have survived thus far.
The reform of our financial system is an issue that should be bigger than politics. The massive bailouts of “too big to fail” Wall Street banks were deeply offensive to just about everyone, regardless of political beliefs. They demonstrated at a shocking level the unholy alliance that has grown between politics and finance over the last few decades. In what may be one of the great ironies of our time, it turned out that Wall Street banks were bad for free markets.
I think it’s also important to understand that Wall Street banks didn’t get to be so big because of their economic advantages – they got there because of subtle political ones. What also should be kept in mind, however, is that regulation can unequivocally make the risk in the system worse. And it doesn’t make any sense to leave financial reform up to the same regulators who just failed us all so miserably.
I think Teddy Roosevelt had it right. The big banks should be broken up – not because that alone will guarantee our financial system will be safer, but because it will end this dangerous mix of politics and finance that nearly led to the collapse of the most advanced economy in history. One year later, the surviving Wall Street banks that helped cause the crisis are even bigger and more powerful. And until we address “too big to fail,” we’re really just kicking the can down the road.
$TNDM This is the comp the mkt worries about? Peerless can't seem to raise VC $, more discounts & use credit lines...? http://bit.ly/bQo0Fd 2 days ago
