Rating the Rating Agencies

November 30, 2008

Among the culprits to our current financial meltdown are the ratings agencies.  In fact one can point back to the summer of 2007 and the initial down-grading of large tranches of repackaged debt products linked to sub-prime exposure as the initial convulsion in our current economic paralysis.

Investment banks, commercial banks, insurers and the Fed have been the culprits in the spotlight around the financial crisis to date.  Admittedly we are still at a point where solutions should trump finger pointing.  However, we cannot ignore all of the complicit constituents to the current financial crisis if we are hoping to avoid seeing a recurrence of it in the future.

I have seen few intelligent discussions in the media regarding the incentive problems at the big-three ratings agencies: Fitch, Moody’s and S&P.  However, an article by Tom Sullivan in this weekend’s Barrons does a nice job of highlighting the misguided rules, the missteps, and the poor incentives of the big-three ratings agencies.

Sullivan points to the pending vote by the SEC to review the regulation surrounding the ratings industry which has historically been subject to self regulatory rules.  He also distills some of the dramatic differences between ratings among the big-three agencies and some of the newer, smaller players.  There is a straightforward depiction of the agency-problems around having issuers (vs. investors) paying for ratings, and a number of clear examples of the results of such problems.

As Late as March 13, Moody’s and S&P, by comparison, rated Bear as single-A, while Fitch was a notch higher at A-plus — both are investment grade ratings. Three days later JPMorgan said it was buying Bear. Sean Egan, Egan-Jones managing director, explains that his firm noticed that the fundamentals for the mortgage business had started to falter and “killed a major source of profitability” in January, when it stripped Bear of its single-A-status.

S&P, Moody’s (a unit of Moody’s Corp. , MCO), and Fitch, a unit of Fimalac (FIM.France) all rated Lehman Bros. at single-A or better in September, before it crashed, while Egan-Jones had it at triple-B-minus, Rapid Ratings at the equivalent of a high triple-B and Gimme Credit at “Underperform.”

The biggest split between the majors and the alternatives is in the ratings for bond insurer MBIA (MBI), also caught up in the subprime mess. Egan-Jones has the company rated triple-C, a weak, non-investment-grade rating, since mid-May. Moody’s has it at Baa2; S&P two notches higher at A-minus. That’s a difference of 11 notches. Fitch yanked its rating in April as the scope of MBIA’s problems became more apparent. [More]

This will be an important story to monitor.  This issue will have a major impact of the recent deployment of TARP dollars and a major impact on navigating future government intervention.

Rating Agencies Under Review for Downgrade
Tom Sullivan, Barrons, November 29, 2008


S&P 500 Tea Leaves

November 23, 2008

Another poor attempt, by me, at reading technical tea leaves.

White line below would be a test of secular bear market lows back to 1982 at approximately 700.  Red line represents long term, historical highs without the cheap credit and leverage of the 1990’s and 2000’s.  Green line (approx 950) is a guess at a likely best case high in the near to mid-term.  I’m willing to bet that we will at worst be trading in a range on the S&P 500 between 700-950 for the better part of the next few quarters, unless something extraordinarily good or bad happens. Citi?

S&P 500 Chart 11.28.80-11.21.08 Monthly

S&P 500 Chart 11.28.80-11.21.08 Monthly

Why Alternative Energy Has a Bright & Immediate Future

November 23, 2008

Despite recent and dramatic fall in oil prices, this piece of news about WalMart is quite promising.  There is a good story behind the push into alternative energy despite the relative cost of carbon based alternatives.  Corporations, particularly today, are most concerned with modeling accurate cost structures.  Without accurate cost and revenue projections, corporations cannot plan well, and are subject to wild swings in earnings.   With the ability of energy prices to double or triple within a five year planning cycle, CFO’s are going to become more amenable to smoothing energy costs.

Our recent volatility in energy prices, whether oil, natural gas or coal, has created an incentive for corporations to consider alternative energy sources not because the offer a greener environmental solution, but because the cost of such sources promises a much more steady cost structure.

Removing volatility in costing models is in and of itself a major selling point for alternative energy providers.  I imagine that we will see a lot of cash rich companies investing in wind and solar in the near future as an alternative to the worry of competing for natural resources with the emerging economies when the global recession subsides.  After all if cash is only yielding 1% or less, 5%, 6% or 7% IRR’s begin to look very attractive.  Add to that the cost of solar energy in particular is about to implode do to falling ASPs, I think we will soon awaken to a bright future adopting alternative energy solutions. 

But be careful if you invest, a number of the current players will probably be gone soon, leaving behind larger swaths of market share for the survivors.  In this climate a healthy balance sheet cannot be underestimated.

WalMart buys wind energy supply

The world’s largest retailer said Thursday the Duke Energy farm is being built in Notrees, Texas, and is to start production in April. The retailer will purchase electricity directly from Duke’s Notrees Windpower Project, Duke Energy Corp. said.

The Bentonville, Ark.-based company has 360 stores in Texas, and the 54 stores represent 15 percent of those properties.

Wal-Mart says it will pay traditional rates for the electricity, but doing so will decrease greenhouse gas emissions and will help the company reach its goal of using only renewable energy sources.

WalMart buys wind energy supply
Associated Press, Nov 20 2008 7:50AM

Mad Magazine Fold-Ins Online

November 23, 2008

Neat interactive page at the New York Times.  I grew up enjoying Mad Magazine like a lot of other Gen X-ers and Gen Y-ers.  One of the treats in Mad Magazine were the fold-in sections.

Some ingenious programmer found a way to make the fold-in page work on line.  Click the image to launch the site then click start to begin.

Mad Magazine Fold-Ins

Mad Magazine Fold-Ins

Fold-Ins, Past and Present
Neil Genzlinger, Tom Jackson and Sylvia Rupani-Smith, The New York Times

Your Tax Dollars at Work

November 22, 2008

Nice dynamic interactive chart from the New York Times online outlining the amount of allocated, pending and uncommitted funds under the Treasury Department’s TARP program.  The table allows you to sort by columns and I assume will be updated regularly.  Nice way to keep up with who’s gotten what.  Somewhat surprising are some of the smaller institutions and equally smaller allocations as small as $1 million dollars.  One has to wonder what the cost of allocating the TARP in increments of $1 million must be.

One reason for the continued credit crisis is that banks have been slow to use the money they are receiving.  Other reason is the slow speed at which funds are being deployed. Looking at the chart I’m not sure whether to be happy or concerned that only $158.6 billion has actually been deployed to date.

Dozens of banks and a handful of insurers have applied for funds from the Treasury Department as part of the $700 billion Troubled Asset Relief Program. The Treasury has transferred capital to 30 of these companies and to A.I.G. More are expected to announce their participation in the coming weeks.

Click on the image for a direct link the the interactive site.

Tracking the $700 Billion Bailout

Tracking the $700 Billion Bailout

Tracking the $700 Billion Bailout
New York Times Online, Accessed November 22, 2008

Washington Square Park

November 22, 2008

One of those random articles that is close to my heart.  Excerpt about the storied history of this park from a longer article about the controversial renovations at Washington Square Park from today’s New York Times:

…Washington Square first became a park in 1827. Once farmland for freed slaves, the site was acquired in 1797 by the city as a communal graveyard for the thousands of victims of yellow fever. Hangings were performed there, and later military parades were held. Between 1890 and 1892, the Stanford White marble arch was erected at the park’s northern entrance.

In the 19th and 20th centuries, the park became associated with Henry James, Eugene O’Neill, Edward Hopper and other cultural figures. From the 1950s on, the park was integral to the folk-singing scene; Bob Dylan played there. It also functioned as a dividing line between wealthy, genteel lower Fifth Avenue and poorer neighborhoods south of the park, a division that still exists.

In the 1950s, the community blocked plans by Robert Moses to drive a road through the square and wipe away redevelopment in some of the poorer southern neighborhoods.

“A lot of the animosity and attachment today goes back to that great victory against Moses that the Villagers won to preserve the integrity of the park and the existing demographics of the Village,” said Tony Hiss, who is the author of the book “The Experience of Place” and has lived on the square since he was 6.

Despite this substantial history, and despite a refurbishment in 1970, by early in this decade, the space was looking frayed and dirty. Central Park, City Hall Park and other municipal parks had had makeovers in the previous 20 years. The parks department saw an opportunity to replace the swaths of asphalt and clunky seating and lighting dating to 1970 and transform it into a much greener space.

“Nineteen-seventies notions of landscape architecture had been put in,” said Adrian Benepe, the parks commissioner. “From the beginning, the idea was to try to restore some of its historical character and to try to make it a greener park.”…[More]

Washington Square Park Circa 1950's

Washington Square Park Circa 1950

The Battle of Washington Square
Graham Bowley, New York Times, November 21, 2008

Oil Consumption and Reduction of the G7: Gratuitous Charts

November 21, 2008

For those who think that alternatives can’t replace oil in a low-price-of-oil environment check out the chart below.  Germany is known as one of the most progressive renewable energy economies in Europe, and of course France is keen on nuclear sources.

G7 Oil Consumption 1980-2007

G7 Oil Consumption 1980-2007

Looking for a reason why oil consumption in these countries has grown or declined significantly faster than in the US and Canada?  Then consider this chart.

G7 Oil Prices (by Litre)

G7 Oil Prices (by Litre)

The rest of the G7 have placed significantly larger taxes on oil consumption compared to the US and Canada.  The price at the pump for most of Europe has been considerably higher than in the US for a very long time on a relative basis.  This has helped create inertia that has lowered consumption both by crimping demand, but also by encouraging alternatives.

While a bit dated in recent terms, the chart below offers some perspective on what the price at the pump actually pays for.  Given that as of today oil has fallen back to 2005 levels, this might be closer to accurate again.

What Do We Pay For in a Gallon of Regular Grade?

What Do We Pay For in a Gallon of Regular Grade?

Thinking that alternative energy solutions will systemically reduce the long term price of oil?  Think again. The chart below represents that as of 2004 oil demand was driven 60% by the transportation industry.

U.S. Oil Demand by End-Use Sector, 1950-2004

U.S. Oil Demand by End-Use Sector, 1950-2004

Notice the sharp decline in the use of oil for electricity generation and residential and commercial after the last spike in oil prices in the late 1970’s.  That spike forced us to limit our uses of oil for the most essential, non-replaceable purposes, namely industrial production and transportation.  Today, in part to relative uses, approximately 70% of US consumption of oil is accomplished by the transportation industry as noted in this other chart below.

U.S. Primary Energy Consumption by Source and Sector, 2007

U.S. Primary Energy Consumption by Source and Sector, 2007

The next largest use of oil in the US is for industrial production, which accounts for another 24% as noted above.  The chart below outlines some of the industrial uses for oil which include heating oil, propane, diesel, jet fuel and plastics.

U.S. Petroleum Consumption, 2001

U.S. Petroleum Consumption, 2001

Thus transport and industrial production alone represent 94% of our oil consumption.  However, until a fuel with similar properties is commercialized dramatically, a rapid reduction in our oil consumption is unlikely in the near term.  Even a pinched consumer and a shrinking economy cannot sustainably reduce the price of oil.  A slowing economy will make a dent in our oil consumption.  And that dent will create some slack in the demand side of the equation, which will work its way through he system like a snake swallowing a mouse.

Once back in equilibrium it is unlikely that oil will sustain its recent free fall.  The group of oil exporting countries have found production to be more costly today than just a few years ago.  Dwindling reserves requires more energy and labor intensive processes for extraction, delivery and processing.  In addition, oil remains the primary source of GDP growth for a number of oil rich countries.  It is less than likely that these countries will maintain output while demand contracts, even temporarily.  The cost of producing oil profitably has risen in recent years, and without a profitable industry a number of these countries would begin to run up a deficit.

In addition, at some point in the not so distant future when deflation subsides and industry picks back up, there is going to be a prisoners dilemma on oil.  Oil intensive economic powers will want to and need to hoard as much cheap oil as they can.  Some of these countries, like China have large piles of cash on hand for such a tack.  In addition, if loose US economic policy leads to inflation, a future weakening dollar will drive the nominal price of oil back up as well.

At the end of the day, however you slice it, cheap oil is not hear to stay.  Best advice is to keep you tank full.

Other oil related chart:

Distribution of Proven Reserves 1987, 1997, 2007 from BP

Distribution of Proven Reserves 1987, 1997, 2007 from BP

Change in Petroleum Consumption for G7 Countries 1980-2007

Who gets what from a litre of oil in the G7?

A Primer on Gasoline Prices
Energy Information Administration Brochures, EIA

U.S. Oil Demand by End-Use Sector, 1950-2004
Demand Graphs and Charts, EIA

U.S. Primary Energy Consumption by Source and Sector, 2007 (Quadrillion Btu)
Annual Energy Review 2007, EIA, Report No. DOE/EIA-0384(2007), Posted: June 23, 2008, Next Update: June 2009


How the U.S. Uses Oil [PDF]
Time For Kids, 2003 World Report Edition

Distribution of Proven Reserves 1987, 1997, 2007 from BP [PDF]
BP Statistical Review of World Energy June 2008, BP, p7