Handling Finances

This weekend, Bear Sterns, a major mortgage-backed investment firm, announced that they’d lost a whole lot of money and had to borrow money from the government and J.P. Morgan to avoid becoming worth less than they owed.  Bear Sterns stopped returning investor money as they worried they didn’t have enough assets to cover redemptions, and they agreed to be purchased by J.P. Morgan for $2 per share — a huge drop from around $60 per share just day ago!  J.P. Morgan is paying around a fifth of the value of just Bear Sterns’ Manhattan office building so they must have invested a whole lot of borrowed money in sub-prime mortgages to reach this point!

What’s interesting to me is that Bear Sterns profited heavily from sub-prime lending, but ended up losing everything by leveraging, or borrowing money to invest in these mortgages.  Just like people who took out home-equity loans when home values were rising, Bear Sterns made a lot of money investing borrowed money.  Similarly, just as many people are now left owing more money than their homes are worth, Bear Sterns proved once again that investing borrowed money is inherently risky.

The lesson: don’t place bets with borrowed money!  At Rocket Finance, rocketc is doing something similar — investing the money from 0% credit card offers in the historically safe money market funds.  Money market funds are historically extremely safe, but if he’d put the money in a stock market fund, he’d be seriously risking his money.  If you’re going to need the money in 12 months (say to pay back your credit card when the 0% offer ends, or to pay off investors when they ask for their money back) playing with borrowed money is risky.  In my mind, it’s no better than a lottery — in an up market you have a good chance of making a lot of money, but you can neither predict when the market will turn on you nor how far it will fall when it does.

This week has been rather crazy for me with some new responsibilities at my job and the hardest part is coming home and trying to feel productive (or happy being unproductive). It’s a dangerous feeling because it often leads to spending money — both to relieve boredom in the act of shopping and to try to buy stuff that will entertain me. Knowing why I feel like buying stuff helps me keep myself under control, and my budget is loose enough that I can afford to spend $100 on eating out and playing with photography, but it’s important to remember that spending money won’t help me feel more content.

Anyway, on to the riddles.

Last week, Rob, Patrick and Jennifer invested their money and earned 5.87%, 5.34% and 4.90% respectively. A year after they invested their money, their spouses, Linda, Rachel and Morgan took over investing and again, they each invested $10,000 at the start of the year at a fixed rate compounded monthly. This time, they were less open about their investing and while Morgan revealed that he had earned $600 in interest — as much in the year as Rachel had in 11 months, Rachel only revealed that she had earned as much in the last year as Linda had in only 11 months. How many months would it have taken Morgan to earn at least as much as Linda earned in 12 months?

I was listening to NPR and learned something very interesting on why oil is so expensive

these days.  At well over $100, oil is now more expensive than it ever has been — even adjusting for inflation.  There are some obvious reasons like increased demand in China and India and the possibility of an American invasion of Iran, but these factors are not enough to account for the current high price.  I found it interesting that apparently investors are driving up the price of oil — it’s not just supply vs. demand any more.  The report noted that funds like pension funds and sovereign wealth funds are putting billions of dollars into funds that trade oil much like others trade currency and stocks.

These oil-trading funds had a total of $9 billion in 2000.  Now, the oil-trading market is well over $250 billion.  In comparison, the whole world uses about $8-9 billion dollars a day, so it’s no longer just a inflation-proof investment but a full-blown speculative bubble!

While the high prices are making many oil companies a whole lot of profits, they’re also hurting industries like airlines and trucking that are heavily influenced by the price of oil.  I’ve seen a number of reports lately of airline representatives talking about how they won’t be able to run much longer at current levels.

What does this mean for us?  Well, unfortunately, the price of oil is being driven ever higher as speculative investors rush in to be a part of the soaring profits, and there’s really no way to know when it will end.  On the plus side, the bubble is bound to burst and the price of oil will plummet, but again, it will probably hurt consumers again as speculators drive the price of oil lower than it’s really worth.

Just like the ’90s tech bubble and the recent sub-prime financial bubble, the oil bubble is going to burst some time and when it does, a lot of people will lose money (and a rare few will end up on top).  I’m going to try to avoid investing in oil-related stocks in the near future since I’m not interested in trying to carefully follow it to have a chance of pulling out near the top of the bubble.  Of course, that won’t change my investing much as I’m largely invested in index funds and ETFs.

In short, expect the price of oil (and gas) to continue to climb way further than makes sense.  Also expect it to plummet when it stops climbing and investors try to protect their profits.  It’s unfortunate that such basic staples are affected by this type of speculative investing (similar to the increase in grain prices, though that was more organic and driven by farmers than investors in my understanding) but it’s just the way our capitalist world works.  Just stay alert and watch for this type of speculative bubble and above all, stay diversified!