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What’s Driving the Market Lower Today?

Posted by Larry Doyle on March 2, 2009 9:50 AM |

markets-down-arrowStock markets are expected to open lower by another 1.5% on the open this morning. What’s driving them lower….again?

1. News that AIG reported an actual 4th quarter 2008 loss of $61 billion. The government will inject ANOTHER $30 billion into this black hole. WHY? Very simply because AIG is the largest holder of CDS (credit default swaps) that serve as insurance for a number of banks and money managers. These CDS cover a wide array of assets but primarily the sub-prime mortgage space. Kevin Doyle of 12th Street Capital, and a guest here on my weekly No Quarter Radio program back in early January, shares that the index that tracks the sub-prime market is at its lows. No surprise there.

While the various media outlets are highlighting this story now, I wrote extensively about AIG and How Does One Lose $125 Billion? on February 24th. I not only wrote about the losses, but also delved into the culture that developed over the years at AIG under Hank Greenberg.  Not a pretty picture and seemingly not a lot of integrity in that company. Now we pay.

2. The market is also focusing on Warren Buffett’s annual letter to shareholders and specifically his comment about the economy being in a shambles for the balance of 2009 and perhaps well beyond that.  I provided a summary on February 28th in When the Oracle of Omaha Speaks .

3. HSBC announced it is exiting the consumer finance business here in the United States. HSBC paid billions to purchase Household Finance in late 2003. More than a little bit of buyer’s remorse with that purchase. Additionally, HSBC is in the process of raising $17 billion in new equity capital. 

Last night on my weekly radio show on No Quarter Radio, I addressed the enormous demands for capital by global governments, municipalities, corporations, and consumers and why that will drive interest rates higher and equity markets lower. The show is archived and available as a podcast on iTunes.

As I continue to roll out Sense on Cents and attract many new readers, please let me know what you think of the site. What do you like? What would you like to see me address?  I hope you find it beneficial as we navigate the economic landscape!!

LD

  • fiscalliberal

    Larry – I have come to the conclusion that no business is going to inverst into the future untill this continual slide of the financial community cmes to the end. The weekly announcments will just reinforce that phenomona.

    AIG is a cancer on the system as is any of th eother institutions that engaged in the CDS industry. So untill AIG, Citi, JP Morgan and BOA are gone, the economy will continue slide or not grow, just like Japan.

    It is sad for BOA and JP Morgan as they seemed to be solvent untill they acquired the bad companies. However – who knows, they could have been part of the problem also. The whole industry was corrupt. The Russian Oligarks do not have much over us.

  • Larry Doyle

    Fiscal…There is little doubt that confidence is waning dramatically as the public gains greater appreciation for the depth of the problems.

    As capital is sucked out of the economy as a result, the price for the capital that needs to be attracted will only be higher. Those higher prices (rates) will keep a cap on equity prices for a while.

    I recently spoke with an individual who was asked to explain what was at the core of these problems. This individual is very highly respected in the financial community. He responded that a compensation system which pays for perceived profit now while leaving risk and returns (potential losses) in the future effectively corrupted the business models of every part of this food chain.

    It is going to take a while to digest, process, and recover.

  • fiscalliberal

    Well put by the individual you spoke to. Now does that say, the regulators have to look at the compensation packages to assess risk? I think all of us would have not expected that. I guess this is the direct result of not letting the corporations experience failure.

    This is really amazing. Risk is supposed to be assessed by the CEO and the Board of Directors. The corporate model is in fact broke. We need a good claw back rule if we do not let corporations fail and the government has to subsidize failures.

    Coming from a dairy farm which is a small business, I find this whole thing just amazing. By the way, on a farm you do whatever is possible to avoid debt because seasonal crop varitations can wipe you out. No farm bank would let you leverage to the levels these investent banks did.

    Again the Russian Oligarcs have nothing on these guy’s. And no one other than Bernie is going to jail.

    • Larry Doyle

      Fiscal…Ultimately this is a major failure by the management and boards of all the firms involved. Where were and are our real leaders?

      …and Washington was negligent and complicit!!

  • MPC

    Larry-

    Love the new site! I’ve just begun trolling through it, and it looks like every bit the well-organized compilation of your work that I hoped would come out of this process. This is a great layout, and I’m excited to come back here often in the future.

    Awhile back I found this page from the Berkshire Hathaway website (http://www.berkshirehathaway.com/letters/letters.html) with all of Warren Buffet’s annual letters to shareholders (back to 1977 I believe). I’ve read the past couple years’ letters, and I have been looking forward to reading the Oracle’s thoughts in this most recent edition. Anyways, I wanted to share the link since I think people might find it interesting and worthwhile. These letters are surprisingly entertaining and readable with plenty of light quips and frank observations from Buffet (for example, in reference to the future business outlook for GEICO insurance, he and his business partners feel like “hungry mosquitoes in a nudist colony”), rather than the usual number-intensive data tables and wordy self-congratulatory tomes that are produced for shareholders of other large, well known corporations.

  • Larry Doyle

    MPC,

    Thanks for the plug. I hope you find the site to be beneficial on a number of fronts. Please do not hesitate to pass it around.

    Also do not hesitate to ask any questions that may develop.

    Thanks for sharing the link to the Berkshire website. Warren is not getting any younger. His wisdom will be treasured. That said, in a deleveraging process EVERYTHING goes on sale, including Berkshire’s holdings.

    Thanks again for your support!!

  • Andy

    LD:

    Great site! I am really appreciative of your insight, analysis and explanations for what is happening. This are truly difficult and scary times and understanding what’s going on is paramount.

    Buffett lost 50 billions…WOW. He said in his letter he made “mistakes”. But do we know what were those mistakes? I remember when the market started sinking in the Fall he said it was a great time to buy stocks and that’s what he was doing. Was this a bad decision? I am sure it’s more complex.
    What say you?

    • Larry Doyle

      Andy,

      Glad you like the site. I hope it helps you navigate your own economic landscape. I do think the site will be very well received given all of the neat links to market data, career planning, newsworthy articles, financial primers, economists and money managers. Word of mouth is ALWAYS the best form of advertising so please share it with friends and others.

      Back to business. Buffett’s mistakes were primarily his investments in Conoco Phillips, an oil company, that sufferred as the price of oil plummeted. His investments in Irish banks were also big losers. Additionally Buffett wrote insurance on the equity market as a whole which allowed the buyers of that insurance to hedge themselves against further losses. Effectively Buffett was getting long the market. These trades/investments/insurance policies (call it what you want) have also been big losers to this point. That said, the expiration date on those insurance contracts is a long time off so Buffett could recoup these losses.

      Buffett is a value investor. That style of investing focuses on companies that appear to have a cheap valuation relative to their book value. However the question revolves around the accuracy of the book value in a major recession/depression as earnings slow dramatically. Other noted value investors have also been slammed in this selloff because they make investments when a company appears cheap but then it gets significantly cheaper. For example Bill Miller at Legg Mason had outperformed the S&P 500 almost every year of his career and was one of the most highly respected money managers in the business. In 2008 his returns were some of the worst in the market.

      Hope this explanation helps.

      Visit and write often!! Thanks for the support.

      • Andy

        Do you know how James Simons (Renaissance Technologies Corp.) is doing?
        He’s the ultimate guru (for me) They do real math and science in dealing with the markets….

        • Larry Doyle

          Andy,

          I am not privy to their returns. I know he has an unbelievable track record using the quantitative (computer driven)strategies developed over a long period.

          I did recently read that he had some money with Bernie Madoff in the early 90s but had taken it out. You can rest assured that if James Simons is not fully conversant in how a strategy works or why it works he is not investing.

  • Andy

    The AIG loss in the 4th quarter : was that despite the Gov. bailout? (ir. before or after). If after; then the loss is even worse than 61B, I suppose for it incorporates the Giv. $$ already (?).

    PS; Hope you don’t mind naive questions….

    • Larry Doyle

      Andy,

      To this point the government money went into AIG in the form of preferred stock and paid a relatively fat dividend. While the government investment could not be sold for what it may have been worth a few months ago there is still some value at AIG in the form of other divisions.

      The government is making the same move with AIG that they made with Citi last Friday. They are exchanging their preferred stock position for common stock. In doing that the government, that’s me and you, are taking greater risk. Why? Very simply AIG is effectively insolvent given their massive exposure to sub-prime mortgages. If the govt allowed AIG to fail, it would be the domino that would likely cause a number of other failures. Who and why? As AIG wrote insurance on the sub-prime market and other markets, the buyers of that insurance have AIG as their counterparty. If AIG fails then that insurance is worthless and the banks will take a major hit to their own capital. Thus the govt is trying to buy time so AIG can generate earnings to write off their embedded losses.

      In short, AIG is very much the center of our financial mess, if they go down it sets off systemic risk …that is, the financial system may fail or certainly large parts of it. While the govt is injecting $30 billion into AIG, that does not mean that they won’t be back for more. Remember many market participants forecast that our domestic banking system has another $750 billion in losses.

      Part of Obama’s budget addresses these needs.

      It’s a real mess. I hoep this helps clarify it for you.

  • Fantastic read…very informative and easy to understand. Love the new site!!!

    • Larry Doyle

      SoV…thanks for the plug!! Visit often.

  • JR

    Great site you have here, LD.

    I’ll mosey over every once in a while to ask questions.

    I learn best when I ask questions.

    What amazes me about the Sage Of Omaha is that he has been able to adapt his investment strategy successfully to periods of low to (for me) astronomically high PE ratios, over a period of 50 odd years. Buffet might be old, but he is Darwinian adaptive.

    Great Site!

  • Larry Doyle

    JR…..

    Thanks for the plug!! Buffett will certainly go into the books as one of the best investors ever. I have heard him say more than once, “when others are fearful, I want to be greedy. When others are greedy I want to be fearful.”






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