Professor Elam

How Wall Street Bought Washington DC

This article explains how the finance lobby has come to dominate Congress. It is also a simple explanation of how the derivative market grew and still threatens the financial landscape. 

We will be including this article in our modules on derivatives in intermediate II accounting.

Derivatives / Sub Prime Simplified

An Easily Understandable Explanation of Derivative Markets: Or, How the unemployed bought $300,000.00 homes.
 
Heidi is the proprietor of a bar in Detroit. She realizes that virtually all of her customers are unemployed alcoholics and, as such, can no longer afford to patronize her bar. To solve this problem, she comes up with new marketing plan that allows her customers to drink now, but pay later. 
 
She keeps track of the drinks consumed on a ledger (thereby granting the customers loans). 
 
Word gets around about Heidi's "drink now, pay later" marketing strategy and, as a result, increasing numbers of customers flood into Heidi's bar. Soon she has the largest sales volume for any bar in Detroit. 
 
By providing her customers' freedom from immediate payment demands, Heidi gets no resistance when, at regular intervals, she substantially increases her prices for wine and beer, the most consumed beverages. Consequently, Heidi's gross sales volume increases massively. 
 
A young and dynamic vice-president at the local bank recognizes that these customer debts constitute valuable future assets and increases Heidi's borrowing limit. He sees no reason for any undue concern, since he has the debts of the unemployed alcoholics as collateral. 
 
At the bank's corporate headquarters, expert traders transform these customer loans into DRINKBONDS, ALKIBONDS and PUKEBONDS. These securities are then bundled and traded on international security markets. Naive investors don't really understand that the securities being sold to them as AAA secured bonds are really the debts of unemployed alcoholics. 
 
Nevertheless, the bond prices continuously climb, and the securities soon become the hottest-selling items for some of the nation's leading brokerage houses. 
 
One day, even though the bond prices are still climbing, a risk manager at the original local bank decides that the time has come to demand payment on the debts incurred by the drinkers at Heidi's bar. He so informs Heidi. 
 
Heidi then demands payment from her alcoholic patrons, but being unemployed alcoholics they cannot pay back their drinking debts. Since, Heidi cannot fulfill her loan obligations she is forced into bankruptcy.  The bar closes and the eleven employees lose their jobs. 
 
Overnight, DRINKBONDS, ALKIBONDS and PUKEBONDS drop in price by 90%. The collapsed bond asset value destroys the banks liquidity and prevents it from issuing new loans, thus freezing credit and economic activity in the community. 
 
The suppliers of Heidi's bar had granted her generous payment extensions and had invested their firms' pension funds in the various BOND securities. They find they are now faced with having to write off her bad debt and with losing over 90% of the presumed value of the bonds. Her wine supplier also claims bankruptcy, closing the doors on a family business that had endured for three generations, her beer supplier is taken over by a competitor, who immediately closes the local plant and lays off 150 workers. 
 
Fortunately though, the bank, the brokerage houses and their respective executives are saved and bailed out by a multi-billion  dollar no-strings attached cash infusion from the Government. The funds required for this bailout are obtained by new taxes levied on employed, middle-class, non-drinkers. 
 
Now, do you understand?                          

Tax Increases on the Way

the US Tax System is all about social policy, it is not about collecting revenue. This article makes that clear. The Administration has favored athletes, writers, and performers but does not seem to like investors. Will this work come November?

Canada versus the US

The Banks in Canada did not go bust as they have in the US. The housing market did not go bust in the spectacular fashion of the US, though it is way up now given their resource based economy and the strength of the loon versus the buck. This article by the Cleveland FED examines the differences in the Canada versus the US approach. 

We will be studying liabilities in Intermed II this semester, well we do every semester in Intermed II but 

it is important to understand the regulations regarding off balance sheet debt and how companies try to conceal their real liabilities. We will be reading this article in the spring. 

Barney to the Rescue!

A Bloomberg reporter tackles HR 4173.

Surprise, Barney Frank's reform legislation promises banks up to $4 trillion in bailouts available, creates lots of new agencies, and runs some 1200 pages. 

Bottom line, congress will continue to throw money at the problem before it lets anyone face up to the problems they have created. 

More Education Audit Woes

San Antonio Charter Schools were found lacking by the US Education Dept. the Texas Education Agency, and a local CPA firm needed a year to complete what should have been a three month audit. 

If this was a private company would it still be in business?  Or would the Board be replaced?  Why do these things go for so long in Education before anyone seems to take action?

The Largest Dividend Cuts Since the 1930s

US firms have had the largest dividend cuts since the 1930s. 

NOw think what this means for stock prices. Yields therefore, dividend divided by stock prices have dropped. For yields to return to 'normal' levels, either dividends will have to be restored or prices will have to drop. 

As stock prices have risen, price earnings ratios have risen. The higher the p/e the more risk investors are assuming, and for lower than ever dividend yields. No wonder insider selling at companies continues at a furious pace. 

"It's not a very complicated story," said Charles Biderman, who runs market research firm Trim Tabs. "Insiders know better than you and me. If prices are too high, they sell."

Biderman, who says there were $31 worth of insider stock sales in August for every $1 of insider buys, isn't the only one who has taken note. Ben Silverman, director of research at the InsiderScore.com web site that tracks trading action, said insiders are selling at their most aggressive clip since the summer of 2007.

For those keeping track, the stock market peaked in the fall of 2007. 

Banks Move the Goal Post

Wednesday Dec 23 2009

Banks got  a reprieve from raising more capital to offset, well read the article and you tell me what they are offsetting. The fact is that the banks need more capital and have instead questionable assets.

The FDIC has granted more time but not the three years requested to implement new rules.

Taxpayer Funded Pension Plans?

Tuesday Dec 22, 2009

Pension plans helped sink GM and are now doing the same to YRC. YRC is the remnant of Yellow Freight and Roadway, now drowning in debt, and pension obligations. Seems that the surviving company is on the hook for all the laid off Teamster drivers of failed companies. Mish Shedlock takes an extensive look in his Dec 22 2009 post. 

The chapter on pensions is far too detailed in my opinion, it fails to give students the big picture of what is really happening in terms of liability to the employer, we will all be reading this column in Intermed II next semester. 

2010 will be characterized by these types of failed promises. Our template for the near future is 1968-82. This period was a series of ups and downs for the stock market, politicians and everything else. NYC actually defaulted because of its difficulties with municipal worker contracts. Now cities and states and employers have all made similar agreements that cannot be kept. This will come crashing down in spectacular fashion. Mish details how a congressman is trying to move the target on calculating the pension obligation. But there is no way all this can be paid. Expect pension funds to ask for bank status and TARP or other federal assistance. 

Pittsburgh's Fair Share Tax

Pittsburgh's City Council is proposing a 1% tax on the have nots, the city's college students, to fund the pensions of retired city employees.  It is brazenly called the Fair Share Tax. And it is referred to as 'an untapped revenue source.'

Let's follow the logic here. The City makes promises to city union employees that cannot be kept. Rather than just say no, or raise contributions from exisitng employed union workers, the City looks elsewhere. Would you go to college in Pittsburgh and pay more for a retired city employee?  

The latest Barron's quotes some financial planners that are putting clients into municipal bonds since 'taxes are going up.'  No question taxes are going up. But I doubt this sort of tax increase will be gladly born by the taxpayers.  The looming municipal fiscal crisis is simply another postponed train wreck. THe Barron's article noted that in the Great Depression only the state of Arkansas defaulted. This is not a valid analogy. In the 1930s we did not have union shop states and cities promising beanstalk to the sky pensions that the stock markets now cannot hope to fund. This is a time bomb that will eventually take some cities to default just as the unions took New York City to default in 1976.