At Arm's Length - Financial Commentary about Money, Investing, and How It Affects the Average Investor

At Arm's Length: 05.27.05

Nothing ado about Something

I'll be the first to admit, there is no love lost between this column and the Federal Reserve Chairman Alan Greenspan. I bow to this learned man for all the right reasons, many of which are becoming harder and harder to find, while I pan him for much more.

Back in the beginning of May, Mr. Greenspan spoke via satellite to bankers in Chicago. During that transmission, he noted that he was worried about the derivatives markets. These markets operate far beyond the reach of the average investor and because of that the Fed chairman mentioned his concern. It however drew little attention. The derivatives market, for those who don't know is basically a secondary market, financial type of contract that is often a bet on interest rates and time.

His comments should have been reacted to much the way tout television walks up the hype for each interest rate hike. If they had been taken to heart, stocks would have sold off instead of rallying on a week on no real news, good or bad.

Worse yet, bonds will, if the Mr. G.'s concerns are grounded in fact, sell off strongly driving prices down while sending yields higher. All of this concern is based on the rather obscure collateralized debt obligation market. According to Greenspan, hedge funds are a necessary financial tool that provides services and therefore should not be regulated. The Security and Exchange Commission, however would like to see hedge funds, one of the primary uses of CDOs to be more forthright and transparent in their dealings. This is largely because of the ripple effect such trouble in these markets could cause for the rest of us mere mortals.

Should a large derivatives dealer decide that the losses they had been experiencing of late were too great and sell a major position, more than bonds would experience difficulties. Many hedge fund managers offset these risky exposures by short selling stock. If Greenspan's worries become reality, both the fixed income and equity markets would fall and fall fast.

Immediately following the speech, according to Jim McTague of Barron's. Greenspan suggested that even though he was worried, he did not see a crisis looming. The worry is real and the warning he was making to banks is simple: be prepared to get out of the way. The reason is the continued flattening yield curve that is accompanied by a Fed tightening. These are not normal times and the belief that Greenspan and company has finished raising interest rates is crazy talk. Not just yet.

The problem is not when, but who. Somewhere out there, some hedge fund manager knows the choke point and will begin the selling. The reasons for it might come from a large client pulling out; it might come from depressed credit ratings in a specific sector; it might come from a margin call. No matter the origin, the problem will be widespread across many market hurting more investors than the moneyed few.

At Arm's Length: 05.24.05

Yuan Tough Customer

Consider the customer who waltzes his way into his local bank. This customer is justifiably angry. He has had the bank increase his credit limit almost monthly, revising almost daily the amount of money he needs to survive. The bank has been accommodative and has enabled the customer to continue to spend of frivolous expenditures. Even the reasons for borrowing that the customer has justified have been do so at the exclusion of valuable information. Yet the loans have been fully funded largely due to the belief that this customer is not only necessary for the livelihood of the bank but also its continued and unprecedented success.

The problem that has raised the ire of this customer is not the sudden change of attitude on the bank's part. The bank is willing to continue to lend money to the customer as long as he is willing to promise repayment. The customer's problem stems from the fact that it no longer trusts the bank.

The bank is not greatly phased by this accusation. Transparency was never part of the agreement. The bank has willingly matched the customer to other customers it also funded, except in this case, as suppliers. Backroom tactics, at least in the culture of this bank matter little to them when it comes to dealing with loans.

The customer then threatens to refuse to buy the products offered by the bank's other customers. The bank could care less but respectfully declines to explain the nature of how business between the two works - for now. They are in the midst of an accounting overhaul that would leave them better able to ignore threatening customers who mumble their dissatisfaction. The seemingly incessant complaints have increased of late and consist of threats to take their business elsewhere. Even if they know there is no 'elsewhere'.

While the bank restructures, it must continue to appease this customer and does so with polite nods to look into the situation. Meanwhile, the customer sends his spokesperson, a former corporate head who speaks the same language of mistrust but in more soothing and complacent tones. He has little luck so far but his job is to get the customer's wishes done, even if the customer's habits prohibit any real chance of success.

Unfortunately, the bank cannot tell the customer to go away - just yet. It has not fully perfected its new economic model, one that is not so dependent on a single disgruntled customer. Owning enormous amounts of promissory notes from that particular customer could be troublesome to the bottom line should the customer default. Each time the bank lends the customer money, it needs to weigh the fact the some of the money being borrowed by the irate customer is being used to service debt already incurred. This same customer uses the money to gift his best friends with permanent trust funds of dubious importance.

Of course there is only one customer who would level such complaints and one bank that would tolerate such treatment. Last week, George Bush kicked up the rhetoric against the Chinese and what he sees as a detrimental currency policy. The yuan continues to be pegged to the dollar which, Mr. Bush is quick to point out, is harming the United States and in doing so, creating imbalances on a global scale. The tantrum was suffered by the Chinese, whose own international actions should have made them the obvious bank to avoid when needing to borrow huge sums of cash.

Repeatedly the US has gone back to China to borrow money to buy goods sanctioned by the government. Growing into an economic chimera, a beast with two, sometimes three distinct personalities moving in a single direction and even if the United States changes its verbiage by sending John Snow, Secretary of the Treasury to soften the request, there is little likelihood that China will do anything before its plans are in place.

The stance the president has decided to take, championing labor and the trade imbalance that China seems unwilling to change - mostly because the amount of products US companies ship to China is almost negligible - seems too late to do anything substantial. The jobs we so willing let disappear are gone for good. Suggesting that China buy more goods from the United states when we allow them to steal the technology, mass produce it and sell it back is not going to change anytime soon.

Not that China's actions are anything but deplorable, but as debtors to the country on the cusp of becoming the economic powerhouse of the very near future, America has very little room to move. Before we suggest China fix its international trade policies and shore up its balance sheets to be more globally competitive, we should examine the glass house we live in because of our own excesses. I'm sure the Chinese have a proverb for just these sorts of situations.

The previous week's articles.

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