Bring back Glass Steagall

The Great Depression brought about many needed regulatory reforms. These acts served to curb excess speculation, and to keep the funds of bank depositors safe. One of the primary reasons for the insolvency of many commercial banks in the 1930s was the loaning of money for stock market speculation in a market that allowed absurd levels of leverage. Many of these banks owned brokerage security operations, and found an easy path to executive riches by pressing these loans on depositors prior the 1929 crash.

The Glass-Steagall Act tamed this circus by prohibiting banks from owning financial companies. This created a wall that stopped the ridiculous activities of banks that were not in the best interest of customers. Coupled with the creation of the FDIC and other reforms included in the act, the Glass-Steagall legislation protected both bank account customers and investors. The act prohibited a commercial bank from offering investment and insurance services while maintaining better regulatory scrutiny on capital ratios.

Unfortunately, the provisions that separated cross-ownership were over-turned by the Gramm-Leach-Bliley Act of 1999. Financial companies spent more than $300 million in lobbying over 20 years in their attempts to repeal Glass-Steagall.

Not merely content to simply mine the riches offered by the combination of insurance underwriting, securities underwriting, and commercial banking; Wall Street championed unregulated derivatives. The securities industry claimed that these contracts would distribute risk and regulating derivatives would impede economic development. Supported by the Federal Reserve the merged financial industry drove the wide-scale introduction of derivatives into traditional commercial banking markets such as mortgages.

Since 1999, the derivatives have grown on a parabolic curve. There are now over $516 trillion in derivatives outstanding.

In a short eight years, the rapid proliferation of derivative contracts has become the Trojan horse that is likely to undermine the entire modern banking system. The collapse of Bear Stearns should act as a warning for the entire financial market. It is time for regulators to step in and properly unwind the most troubled instruments, while providing concrete oversight to the entire derivatives industry. Obviously the lunatics have been found unfit to run the derivative financial asylum. Deregulation has run amok, and financial checks and balances must be restored to protect the economies of major nations.

Investment banks’ culture of risk is diametrically opposed to the purpose of commercial savings banks which is the preservation of customers’ assets. The introduction of derivatives as the primary under-pinning for the mortgage industry with little regulatory oversight was an event that was obviously going to end in a calamity; similar to giving liquor and a car to a chronic drunk.

The continuous reduction of the protections of Glass-Steagall, by politicians in Washington driven by banking PAC money, is the root cause of the current painful credit crunch which is undermining the entire U.S. economy. In order to fix the core problems, the protections created by Glass-Steagall after the harsh lessons of the Great Depression must be restored by Congress. A clear separation of commercial and investment banking must be reestablished.

A recent PBS Frontline outlined The Long Demise of Glass-Steagall.

Schwab YieldPlus Funds Tank

For years, Charles Schwab marketed the YieldPlus funds as "a safe alternative to money market funds that preserve principal while being designed with your income needs in mind." Charles Schwab also represented that its YieldPlus funds were designed to provide "high current income with minimal changes in share price."

The Schwab YieldPlus Fund Investor Shares (SWYPX), and Schwab YieldPlus Fund Select Shares (SWYSX) have declined over 30% since July of 2007. Unfortunately for investors these funds had large investments in risky mortgage-backed securities. Morningstar now ranks these two funds as last among ultra-short-term bond funds. So much for the Schwab claim in the marketing literature, “The [YieldPlus] funds provide higher yields on your cash with only marginally higher risk [and therefore] could be a smart alternative.”

An earlier HingeFire article from October (see Grandma’s Money Market Fund feels the SIV pinch) outlined the risks of brokerage money market funds, and why investors should be wary of these instruments.

Now Schwab is offering investors a mere 5 to 12 cents on the dollar of their losses, and demanding that the account holders quickly take the offer. This, of course, drove investors to contact law firms to launch class action suits on their behalf.

Riots in the Streets: Food

Well not quite yet… however a number of media pundits are urging people to stockpile food in order to get the best return on their money. According the CNBC, the price of eggs has risen 45% in the past few months; milk is up 33%, and cheese up over 15%. Coupled with the rising cost of fuel at the pump, most families are facing a double wammy.

The trends in food pricing are not going to change, but are likely to get worse. Most analysts are expecting even steeper price increases over the remainder of 2008. Economists would classify the situation as stagflation despite the government claiming the official inflation rate is below 3%. The situation is reminiscent of some of the previous Western economic calamities where inflation spun out of control.

Obviously the Fed policy is focused on propping up the markets instead of controlling inflation. As the money supply is increased by billions of dollars per week, the door is left open to out-of-control inflationary pressure.

The average bank account is yielding under a 4% return. As food prices climb weekly, the obvious better return is to hold food instead of cash. This has created a situation where many smart consumers are stockpiling food from their local wholesale club (Sam’s etc.) to get ahead of the curve.

The Wall Street Journal outlines how consumers are stocking up the pantry.

Is there a future for Quant Funds

It appears the Quantitative Funds have been stranded on the lee shore, and a crowd is desperately trying to find a way to shove the ship off the beach. Even if re-floated the quantitative industry is mired in a cross-wind about its future direction; not knowing whether to tack or jibe in order to catch air in the sails.

The recent draw-downs during the credit crunch have raised the question if the mathematical wizards can navigate the waters; or if the conjurers would be better off safely ashore teaching theory at a university. Is there even a future afloat for these funds? The trends of lower cost IT, more powerful computers, mountains of instant data, and new modeling techniques can play both for and against these funds. The bottom line is that a proper definition of risk still haunts the players.

Earlier HingeFire articles (see Quants search for new math) discussed the confusion as these funds search for a new formula that will pull alpha out of the market while not leaving the funds sunk every few years. The current methods have proven to be more akin to gambling than investing.

Advanced Trading recently addressed the fund dilemma - Quants Searching for Alpha: Do the Pros Outweigh the Cons?

Two Days Left: Take the Gold Survey

Make your voice heard. Two days left to vote.

Where will Gold be on July 1st?

Gold has recently been reaching new heights while also taking dips in a very volatile market. Where will this precious metal be priced in two months. Many wonder if the technical or fundamentals are driving this market. Is gold merely in a inflationary dollar-induced bubble, or does it have long term holding power at these levels.

Take the survey at the top left of the HingeFire blog.

The Feds take Wachovia to the woodshed

In punishment for scheming with telemarketers to steal vast amounts of money from the accounts of thousands of victims, Wachovia will be paying nearly $145 million in fines and restitution. The bank supported the plundering in order to earn a substantial amount in fees, amounting into millions of dollars.

An earlier HingeFire article (see Banks Behaving Badly: Wachovia) outlines the scam perpetuated by the bank and telemarketers. Wachovia (WB) did not admit or deny wrongdoing as part of the settlement. In a statement, the bank said this "situation was unacceptable and we regret it happened."

The size of the penalties does not align with the obscene profits made by the bank in this telemarketer partnership scheme, which was fully supported by executives at Wachovia. The bank's actions were "part of a pattern of misconduct that resulted in" Wachovia collecting millions of dollars in fees, regulators wrote. Once again, a banking institution’s executives were not held criminally liable for their actions, and the penalties are a pittance when compared to the profits.

The settlement is disappointing because the victims do not automatically receive their money back. The duped, many of them elderly, will be required to file complex paperwork in order to claim their money. Many critics in Congress are demanding that the Office of the Comptroller of the Currency (OCC) directly mail checks to the victims, which was done in the past instead of requiring the account holders to file claims. The impacted account holders will have to submit forms through a complex bureaucracy. “Because many of the victims are elderly or poorly educated, it is likely many of them will stymied by these obstacles”, according to Rep. Edward J. Markey. This makes it likely that full compensation from Wachovia will never be paid.

While clearly this “settlement” takes Wachovia to the woodshed, the sting of the Federal switch will only last for a short period of time. After which the bank can romp, play, and continue to eat the candy it has stolen, while conniving its next scheme to slip a hand into the customers’ cookie jars.