Proprietary Trading Gone Forever or Temporarily Hiding?

     Michael Lewis begins a recent article with, "In the run-up to the vote on the financial overhaul bill, the big Wall Street banks squashed an attempt by Senator Carl Levin to pass a simple ban on any form of proprietary trading." It would appear that the big banks were protecting their freedom; however, Lewis points out that recently "Morgan Stanley, JPMorgan and Goldman Sachs all intend either to close their proprietary trading units or to sell their interests in the hedge funds they control." Which begs the question, why fight to save something you don't plan to utilize? Lewis offers a few ideas, but I believe he avoids another likely possibility. 

The Classic Subprime Powerpoint

     This is a presentation that circulated soon after the crash in 2007 when people were curious about how we got to where we were. The slideshow comically addresses the way in which the housing bubble rose to such proportions and affected a variety of "institutional" investors. 

CDO Powerpoint SubPrime Primer

Umbrella Partnership REIT Structure

     URREITs offer significant tax advantages for property owners. The structure is used as a means to avoid unwanted capital gains, and subsequent taxation. Essentially these structures allow property owners to adjust their cost basis upwards by transferring their property to the REIT in exchange for operating partnership units. The value of units exchanged will equal the value of the property. By undergoing this transaction the original property owner receives units, which can be sold without incurring a capital gains.

     For example: one owns a property at a cost basis of $10 million, which has appreciated to $20 million. In order to avoid the capital gains on $10 million ($20mln - $10mln), the owner can exchange their property for units in a UPREIT. The UPREIT would supply say 20,000 partnership units to the owner worth $1,000 each. The original property owner could then exchange their partnership units for shares in the REIT. These shares could then be sold for their $20 million value, and as the cost basis is $20 million there would be no capital gains tax and the investor gained. 

The link below is to an article that outlines some of the challenges and advantages of engaging in a transaction with a UPREIT. 

The benefits of selling property through an UP-REIT

A little humor

This clip from South Park has got to be an all time favorite!

What a creative way to explain some of the causes of the crisis.

I found this great video while searching around another blog.

Tricky Policy

     What follows is a response to the the Economist's article "Economics focus: War footing” of Sept 4, 2010.

     This article discusses the challenges of simultaneous fiscal and monetary policy implementation. Having reached interest floors, central bankers are concerned with the sole option of applying fiscal policy. Although neither fiscal nor monetary policy is ineffective in theory; Eric Leeper’s presentation addresses the practical difference, whereas monetary policy undergoes vast economic analysis, “fiscal policy is highly politicised.” Politicization decreases the timeliness and effectiveness of policy, leading Leeper to say “Fiscal alchemy can undermine monetary science.”

     Leeper warns, if the public loses confidence in the Government’s ability to cover the cost of its fiscal stimulus and the central bank will “inflate away the debt,” hyper-inflation may ensue. To prevent this problem central bankers are calling for austerity measures or limits to fiscal stimulus. Along with the historically low interest rate environment, inflation expectations have been driven away, similar to Japan’s “lost decade.” To avoid deflation, Mr. Leeper suggests, “simultaneous fiscal and monetary expansion.”

     A key caveat to quantitative easing is that central bankers cannot “force banks to lend or companies and households to borrow.” Therefore, although QE is intended to increase the money supply and lower interest rates, the potential benefits may never reach the economy. This would lead to sustained high unemployment and the threat of deflation.

     The depression of interest rates and long-term threat of inflation caused by QE must be carefully dealt with. This is evident from the United States’ implementation of fiscal and monetary stimulus during WWII, which led to inflation thereafter. To avoid such a problem stimulus must be injected into the economy today and fiscal austerity imposed in the future. 

“A Bull Market in Pessimism”

     The following is a brief summary and response to the Economist article “A Bull Market in Pessimism” from Aug. 21, 2010.

     Currently in a tough place, the Federal Reserve is facing two threats: deflation and inflation. The Fed must tread lightly to avoid spiraling either monetary effect out of control. Were the Fed to inflate its way out of potential deflation, real-returns would rapidly turn negative (especially given the current low interest rate environment), thus leading to a mass exodus of Treasury bond-holders. Furthermore, were the fed to raise interest rates, bond-holders would also be squeezed out of the market, given the inverse relationship between bond prices and yields, the value of their bonds would decrease. As if the situation were not challenging enough, by purchasing Treasuries with the monies provided by maturing mortgage debt the Fed is adding to the downward pressure on Treasury yields. These combined effects; along with increased investor demand for Treasuries (putting further downward pressure on yields) has positioned the Fed with an inflexible exit strategy. Given the challenging situation the Fed’s attempts to alter monetary policy will likely be rife with error. 


The Economist

A lens into macro policy: Pension problems

     News outlets have recently been discussing underfunded pension funds. This discussion has been well timed given a recent concern of mine regarding macroeconomic policies. I have been questioning why it is that deflation and slow or no growth economic periods are so harmful to our economy, but more so why must macroeconomic policy always be pushed as expansionary? I don't understand why we must push for greater and greater growth than can be achieved without government intervention. The way I see it, expansionary policies are a form of economic leverage. For example, as opposed to having economic growth of 1%, expansionary policies leverage this growth to 3.5%. Why must a nation constantly force greater growth, as opposed to allowing organic expansion?

     I cannot see how any form of "macro-management" can go on forever, there must be a point at which economic policies cannot continue to support unsustainable growth rates. The US may be good modern example of when expansion works for a time, but will eventually be unsustainable. One would be hard pressed to find someone who believes that the US can continue to borrow to finance its economic expansion, as that is what all the borrowing is for. Yes, the US borrowed to stabilize its economy, but nonetheless this was to prevent economic contraction, but why not allow things to run a more natural course. Although I am a firm believer that the economy needed to be buoyed during this crisis, I do not see sustainability in constant expansionary policies.

Just don't call it stimulus

    Discussing Obama's recent economic proposals the Economist published an article by the title Just don't call it stimulus in its Sept 11th 2010 publication. There were a few things that caught my attention in this article: (1) the infrastructure bank and (2) the oil and gas tax breaks.     

     For a politician so hellbent on increasing transparency and decreasing politicization why would you propose an infrastructure bank. The economist cites one opinion of this as a politicizing action, but nonetheless it is upsetting to see hypocritical rhetoric and action. How another bureaucratic institution will  benefit the American public is beyond me. Paying more people to funnel money around to some more people who get paid to move that money to someone else is not efficient nor transparent. 

     Apparently to finance this infrastructure bill we will need to eliminate the "tax breaks for multinationals and oil and gas companies." How does eliminating the tax breaks for natural gas companies help utilize the abundant energy resources that the US posses? If the US is determined to eliminate its dependence upon foreign energy resources than why not facilitate the expansion of natural gas usage? This would be a logical step in securing the US' self-sufficiency in energy. However, eliminating the economic incentives for the private sector to expand upon this resource (especially considering the current economic conditions) is just plain stifling growth. 

Greed is good or maybe not…

     Mr. Gekko (played by Michael Douglas) said, “Greed, for lack of a better word, is good. Greed is right. Greed works. Greed clarifies, cuts through, and captures, the essence of the evolutionary spirit. Greed, in all of its forms; greed for life, for money, for love, knowledge, has marked the upward surge of mankind and greed, you mark my words, will not only save Teldar Paper, but that other malfunctioning corporation called the U.S.A.” However, a quick look at the US unemployment rate would make anyone question the current environment…

     So what brought us to these levels of unemployment? Have we not been greedy enough? Have we, in fact, been far too greedy?