A Return to Common Sense in the Financial Markets – What Our Predecessors Knew that We’ve Forgotten

In the past two weeks the sudden breakdown in the mortgage market has drawn growing attention and become a cause for concern among finance professionals and would be homeowners alike. Many large mortgage companies have faced major slides in their stock prices. The default problem, once thought to be contained to the “sub-prime” mortgage market (mortgages sold to people with below average credit scores) has now spread up the credit ladder to include people with good credit.

Countrywide Mortgage’s chief executive, Angelo Mozilo, is quoted as saying the recent meltdown in the mortgage market was a surprise to analysts. “Nobody saw this coming, S&P and Moody’s didn’t see it coming, but they simply just downgrade bonds and take hits. Bear Stearns sure didn’t see it coming, Merrill Lynch didn’t see it coming. Nobody saw this coming.”

The spread of mortgage defaults out of the sub-prime market caught the banking industry and credit ratings agencies by surprise. According to some experts the final number of foreclosures could reach as high as two million mortgages in default by year end 2007.

Funny…no body saw this coming??…Nobody, that is, except my fiancĂ© and me. She’s an RN working in pharmaceutical research and I’m a recently graduated marketing major. How is it that we have been talking about the mortgage market for well over a year now, while the (so called) experts completely missed it? I never realized that we currently rank among the world’s best economic prognosticators! We recognized that this was a time bomb waiting to explode. And all the financial analysts on Wall Street missed it? It seems that the finance industry needs a return to common sense and away from their mathematical “expert systems” modeling methods that seem to fall short of their “expert” status time and time again. Anyone willing to apply a little common sense would have seen this coming.

The recent breakdown might trace back to changes in lending practices that were instituted about 4 years ago (coinciding with the up wave in real estate prices, is that why prices went up?). The new easier guidelines allowed borrowers to take out loans for up to five times their annual incomes for the purchase price of a home, with their payments equal to a ceiling set at 50% of monthly income.

Let’s apply some old fashioned Common Sense:

Our ancestors had a better understanding of money than most modern Americans (even the experts). Our American founding father, Benjamin Franklin, was one of the wealthiest men of his time (Did you know that?). His prescription for wealth was based on common sense, thrift, and long term savings, not an artificial mathematical model, as are many of our lending and investment practices today.

An old friend of mine, whose predecessors were one of the founding families of Oregon, shared with me his grandfather’s wisdom about money, “Spend 10 cents of every dollar you make on some fun, take 40 cents and save it to buy more land, take 20 cents to buy more cattle and horses, then pay your (farm) hands and buy your vittles with what’s left over, I tell you that you’ll never be poor.”

How’s that for a hard dose of old fashioned economic common sense?

Now let’s take that old time wisdom and break it down into modern terms. Spend 10% on having fun, save 40% and set it aside to invest in a conservative growth vehicle (real estate in the example), take 20% and invest in something a little risky, but still sensible, lets compare cattle and horses to a modern CD or money market fund (if your not a farmer!) Or you could invest that money directly back into your business if you’re a business owner. The last 30% he says is to make your payroll and buy groceries (“vittles”). I’m not sure how to translate that last comment, but I think you get the gist of his economic theory. The take away is that he was talking about living without borrowing money.

Most American’s fail to realize that the idea of home mortgages never existed before the end of WWII. They were created to allow for the proliferation of home ownership and the fulfillment of the “American Dream”. Unfortunately, credit, and its overuse, has become a way of life for most Americans. “We work to pay the bills”, is an oft repeated mantra of the middle class. Almost no one alive remembers the days before “easy” credit came along to make our lives easier. Given the growth in bankruptcies, and the current surge in mortgage foreclosures, I have to ask….has it really made things easier?

Trading on the Forex Market – Basic Concepts

The Foreign Exchange is the world’s largest financial market, with over $3 trillion traded daily. By way of comparison, the Foreign Exchange market is 100 times larger than the New York Stock Exchange, and triple the size of the US Equity and Treasury markets combined. Foreign Exchange is an over-the-counter market (no central trading arena), meaning that transactions are conducted via telephone or internet by a global, decentralized network of banks, multinational corporations, importers and exporters, brokers and currency traders. This is in contrast to, for example, the NYSE, which is a centralized equities trading location.

The Foreign Exchange is the world’s largest financial market is the buying of one currency and the selling of another concurrently. Typically, the major currencies-the British Pound (GSP), the Euro (EUR), the Japanese Yen (JPY), and the Swiss Franc (CHF)-are traded against the US Dollar (USD). Trade pairs in which the USD is not included are called cross pairs, and occur much less frequently.

The currency pairs are expressed with a base currency as the first part of the pair, followed by the quote currency. (For example, USD/JPY would be the US dollar as the base against the Japanese Yen as the quote.)

Accompanying the currency pair is the quota, or bid/ask price. This is expressed in the following format: EUR/USD: 1.2836 1.2839. The first number in the series represents the bid price, the cost of selling the Euro against the Dollar, or going ‘short’ on the Euro. The second number is the ask price, the cost of buying the Euro against the dollar, or going ‘long’ on the Euro. The difference between the bid/ask price is called the pip spread.

A pip is the smallest unit of measure for any currency. In most currencies, this is the fifth digit, or the fourth after the decimal point; in dollars, each pip is equivalent to one-hundredth of a penny. One important exception is the Japanese Yen, in which each pip is the second unit after the decimal point, meaning each pip equals one cent.

Leverage is another key to making money in the Foreign Exchange. No other market in the world allows the leverage that this incredible market offers. Normally, 100:1 leverage is the amount that most brokerages allow investors to trade with. For each $1000 that you put up in cash, the brokerage allows you to control $100,000 worth of currency.