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Economic Doom PPT

Loïc Le Meur / Loic Le Meur Blog:
Tough times.  Tough decisions.  —  As you will no doubt know we are all operating in some very challenging and uncertain times right now.  It's never easy to address topics like this but as a company we have felt the need to get Seesmic ready for what most are anticipating to be a bleak economic outlook …

YouTube gets Beverly Hills 90210, MacGyver, and Star Trek in a test of longer-form video that's theatrically presented and interrupted by ads.

Richard Behar / Fox News:
World Bank Under Cyber Siege in ‘Unprecedented Crisis’  —  The World Bank Group's computer network — one of the largest repositories of sensitive data about the economies of every nation — has been raided repeatedly by outsiders for more than a year, FOX News has learned.

The banking crisis story is an example of the downside of innovation. As many have reported, one major factor in the crisis was the use of new financial products, like CDOs (collateralized debt obligations). While the concept had been in use since the 1980s, it's only been the last decade that CDOs have been used so heavily, and a decade is a tiny hash mark in the history of banking.

We forget that innovations like CDOs are guaranteed to have unexpected effects. All innovations introduce some kind of change, and therefore all innovations create uncertainty and unpredictability. The bet is that the change will be positive, at least for someone.

But we never know with certainty the effects of adopting some new thing. We hope, and often assume, the positive changes outweigh the negative, but we can never be certain. And it often takes much longer than we think to sort out whether adopting a new innovation was the right move, or the wrong one.

For example, take gas-powered automobiles. In 1908, The Ford Model T was much like the Apple iPhone of today. It offered a revolutionary improvement in how common and critical tasks people needed to do were done. But no one could have predicted in 1908, that in 2008 we'd be desperate to get away from gas-powered anything, or that we'd be fighting a war in part over gasoline. Or that in the U.S. alone we'd have more than 40,000 deaths annually related to automobile accidents. And speaking of cell phones, I bet the rampant use of text messaging while driving will be an increasing part of those statistics in years to come.

An innovation that seems great in the first 5 years can create new problems that are impossible to predict, and that may be much worse than the original problem the innovation was trying to solve.

From wikipedia's entry on Innovation:

Failure is an inevitable part of the innovation process, and most successful organizations factor in an appropriate level of risk. Perhaps it is because all organizations experience failure that many choose not to monitor the level of failure very closely. The impact of failure goes beyond the simple loss of investment. Failure can also lead to loss of morale among employees, an increase in cynicism and even higher resistance to change in the future.

The wise recognize failure is an unavoidable part of innovation -- and the faster and more aggressively a company, or industry, pursues big changes, the greater the risks they take on, in exchange for greater access to the possible rewards. But when we push harder and harder to move faster and faster, it shouldn't be a total surprise that our urgency blows up in our faces now and again.

Morgan Stanley’s stock has dropped 20% after falling as much as 35%. It is trading at around $9.50 each share. Moody’s is threatening a downgrade. People are nervous.

Should they be?

Deal Journal set out to find out. Morgan Stanley filed its third-quarter 10-K last night. The highlights of the filing show that the bank is not in trouble — or at least, it certainly was not at the end of the third quarter. Deal Journal took a look at some measures of Morgan Stanley’s health, and whether they improved or became sickly.

Overall health: Morgan Stanley is healthy. As Sanford C. Bernstein analyst Brad Hintz wrote on Wednesday, “By all traditional credit measures, Morgan Stanley is well capitalized. Pro forma for the Mitsubishi investment, gross and net leverage has declined to 19.6x and 17.0x, respectively…We calculate that the firms’ net cash capital position (pro forma for the capital raise from Mitsubishi) is a very strong $51+ billion. The earnings performance of the company has recovered. In Q3, Morgan Stanley booked diluted earnings per share of $1.32 and achieved a return on equity of 16.5%. Its legacy [lending] exposures are limited.”

Tier 1 ratio: This is a measure of a bank’s capital, and regulators watch it carefully. The regulatory minimum is 4%. Morgan Stanley ended the third quarter with a Tier 1 ratio of 12.7%, up slightly from the second quarter. It is also stronger than Goldman Sachs’ Tier 1 ratio of 11.6% at the end of the third quarter. Barclays Capital research analyst Roger Freeman estimates that Morgan Stanley’s Tier 1 may be as high as 15.7% after the Mitsubishi UFJ capital raise, which is scheduled to close on Oct. 14.

Cash: Morgan Stanley needs $22 billion in cash in the coming quarter, according to Hintz. Currently, it has $70 billion of collateralized inter-company loans that can be called, $19 billion in cash and a $5 billion revolving credit facility. Overall, Hintz believes that Morgan Stanley can keep going until the third quarter of 2009 even if all of its access to the long-term debt markets is closed.

Capital-raising plans: Mitsubishi UFJ has said repeatedly that they will stick by its plan to inject cash into Morgan Stanley.

Lending exposures: These dropped, which is a good thing in this risk-averse market. The firm’s non-investment grade lending exposures were down 14% to $21.2 billion, and regular investment-grade exposures were down 10%, to $48.8 billion.
Morgan Stanley has also reduced its reliance on collateralized financings by 16% to $180 billion. All of its responsibilities for secured funding are 100% covered by its liquidity reserves, which is up from just 39% at the end of 2007.

Level 3 assets: These are the risky, hard-to-value assets that have everyone worried. They are so hard to value, in fact, that wags long ago made a pun on the “mark to market” rule and call Level 3 assets “mark to myth.” Morgan Stanley’s Level 3 assets increased 13% to around $78 billion. The jump came mostly because of $33 billion in corporate and other debt that Morgan Stanley underwrote but, presumably, could not find buyers for. Morgan Stanley’s management did point out on the conference call that Level 3 assets were at about 8%, so the disclosure is not at all a surprise.

Liquidity reserves: Morgan Stanley said it is implementing “liquidity preservation efforts.” The firm’s liquidity reserves appear to have fallen from where they were at the end of August, which was $179 billion. Morgan Stanley didn’t disclose where they are now, except to say that they are “well in excess” of the $85 billion average in 2007. That’s a big difference between those two numbers, and a little more transparency would help. Freeman estimates that Morgan Stanley’s “liquidity reserves have likely declined 35% - 45% since the end of August to $100 billion - $115 billion. This estimate depends heavily on conservatively interpreting the language in the 10-Q,” he wrote today. However, Morgan Stanley’s has added $10 billion to its unencumbered collateral and excess liquidity, which is now $179 billion.

With all of this in mind, why is it that the markets are still punishing Morgan Stanley? The threat of a Moody’s downgrade is a big part of the threat to Morgan Stanley right now. Moody’s reasoning is that an extended downturn in the capital markets would hurt revenue and profits in 2009, and that Morgan Stanley would probably make less money in its new structure as a bank holding company.

As Fox-Pitt Kelton analyst David Trone noted, however, all the financial health in the world would not be enough to allay the “fear virus” that killed Lehman Brothers and Bear Stearns. As with Lehman Brothers, investors are not worried about the Morgan Stanley of today; they’re worried about the Morgan Stanley of tomorrow. If the current credit crisis continues for, say, another year, Morgan Stanley won’t be able to survive. That’s enough to get people worried. But that may be a bridge to cross in several quarters, not right now.

Update; Clusterstock is reporting that Treasury is considering getting involved; http://www.clusterstock.com/2008/10/treasury-plots-morgan-stanley-bailout.

So what can you buy for $700 billion?

Well, according a chart over at Bespoke Investment Group, the rescue plan’s $700 billion represents over 55% of the S&P 500 financial sector’s market cap.

All of which raises again the question: Should the U.S. government nationalize its banks?

At the heart of this current crisis is the lack of trust banks have in each other. Yet every move the Treasury and Fed have taken to get banks to start lending to each other has failed.

Economist Paul De Grauwe, writing in the Financial Times today, thinks the answer to that question is yes. He argues that recapitalizing banks during a liquidity crisis won’t work. The only way to solve this issue? The governments of large countries should take over the banking system or at least the significant banks.

Over at the Big Picture, Barry Ritholtz lays out his plan to solve the crisis of confidence:

“So what would solve it? The first step to accomplish this is triage. Identify the banks that cannot survive, and like Old Yeller, “gently” put them down. Euthanize the bad ones so the good ones can survive. Nationalize ’em, sell their accounts to strong banks, and prevent further liabilities to the FDIC (which insures all accounts up to $250,000)…Next, recapitalize the banks that can survive by buying preferred stock.”

Meanwhile, Jim Rogers, CEO of Rogers Holdings, tells CNBC that the only way to solve the current crisis is to let firms go bankrupt and then the stronger firms will take over their assets. Rogers warned:

“The current rescue plans, which will force governments to issue more debt, print money and flood the markets with liquidity, will flare up inflation after the crisis is over and will create worse problems.”

Tidbits

• Who’s to blame for the current mess? The Aleph Blog plays the blame game and the list is long.

• From Slate: “Is the European credit crisis U.S.’s fault? Not really –they were dumb enough to buy the mortgages.”

• The National Debt Clock in New York has run out of digits for the first time, reports the Times of London.

• U.S. exchanges may seek to impose a temporary ban on short sales for individual stocks, Bloomberg reports.

• From Clusterstock: Now may be a good time to buy. Roger Ehrenberg has some different advice.

Investigation of 6,000 scores from 2004 to 2007 found that 12 people posted questions from the exam on Scoretop

At the very least, world power is likely to be share more, analysts say.