Recent events in the financial markets, including the subprime meltdown, hedge fund woes, and bailout or takeover of various financial firms, that are suddenly strapped for cash, highlight a common problem of excessive leverage taken by the recently-failed or troubled institutions.

Current strain felt in the financial markets creates opportunities for disciplined investors with long-term perspective and value-focused investment approach. But these disciplined, long-term, value-focused investors who have beaten the markets for decades are few; Greeblat, Klarman, Buffett are the best-known ones. For the rest of market participants it is difficult the tune out the noise of short-term phenomena. Investors face enormous pressure, both real and perceived, to deliver positive short-term results. This however is contrary to the long-term view a top-notch investor is required to maintain. The pressure to produce positive short-term performance leads to excessive risk taking that manifests through fully invested portfolios, extreme leverage and market-centric orientation. This approach is faulty at the core.

Buffett most commonly-sited premise of investment success is 1 – not to loose money and 2 – not to forget the first rule. Very few investors, it seems, adhere to this strict standard of risk management. Majority of investment funds have a certain target return in mind, and in attempt to achieve it allow excessive risk into their portfolios, which generates loses. Instead of lowering the target rate of return if a particular asset mix is under performing, or as in Buffett’s example the fund becomes too large, many investment funds expose themselves to excessive risk not only through the positions they take, but also by deviating for the established strategy. In sharp contrast, the best investors (generally with extensive experience) do not target returns; they focus primarily on risk management which also helps to decide whether the projected return justifies taking the risk presented by each scenario.    

Return-focused investing leads to higher prices bid up by the herd, and lower returns, both of which are exacerbated through use of leverage. Leverage can be a slippery slope in that if some leverage is great, then more could be even better! And so it begins…The use of greater leverage is particularly notable in the alternative asset sector as managers try to generate their accustomed returns in the face of greater competition than ever before. The worst is yet to come for hedge funds and the financial sector at large.

Today’s leverage far exceeds historical levels, suggesting we are in the early stages of an overdue credit contraction. Recent bailouts by the Federal Reserve exacerbate the situation by failing to address the underlying problem of lax lending standards, poor credit quality and excessive leverage. In current economic markets many investors lack a strategy to handle increased volatility and a bear market. Small investors are even worse off, since by the time the news makes to into newspaper headlines, it is too late to act. In light of this investors are well served by following Graham’s (Buffett’s or Klarman’s as per your preference) margin of safety, and buying stocks at a discount from the value of the businesses they represent.  It is a strategy with substantially higher risk management hurdles, and where investors most consistently, really are, risk adverse.

NOTE: The following information is for entertainment purposes only and is not intended to be a qualified weightlifting advice. Consult with your physician and a competent fitness professional before beginning any new fitness regimen.

I was hesitant to write about maximum bench press because I am no longer a supporter of powerlifting; having committed 2 years to the study of and training in powerlifting, I find it to be very taxing on your body, and I recommend regular weight training over powerlifting to anyone who will listen. However, many requests for this article left me no choice.

If you are looking to reach a new 1RM (one rep max) or set a new regional or national bench press record for your weight class, by all means proceed. Some of the individuals I trained with are world-level competitors in this field, and coaches with numerous record-setting students. I followed MetalMelitia style and Rayan Kennelly’s personal training plan; their insights are worth adhering to.

I. Obtain The Essentials

Powerlifitng trainer - There are intricacies to bench press technique that I think are difficult to grasp without professional help. A good powerlifting trainer is essential to help you perfect the bench press technique, develop a split routine and push you beyond the limits you would normally push yourself. I made the mistake of thinking that I can figure out training details on my own; as the result it took me 2 years to bench press 500lbs+ raw instead of 1 year I originally planned to spend on this project. During my 1^st training session with world-renown powerlifting trainers I completed 23 sets of bench press, threw up, passed out 3 times during the press, and had the bench shirt cut all the way into muscle tissue in my arms. Reaching my goal would not have been possible without this brutal, yet professional training. 

Training partners and spotters – Training partners and spotters are essential to your bench press success. I attribute half of my results in powerlifting to great guys I trained with at Yale. DM helped me stay committed to my goal, hit my targets and regularly push for a new personal 1RM. PC held me back from injuries by making sure I don’t max out on the bench press more than once per week, keep the right grip, and have 2-3 spotters whenever bench press was above 425lbs. Great spotters who added the necessary structure, competition, and motivation to our training, they also kept me alive.

Equipment – Equipment for powerlifitng includes a bench, powerlifitng rack for lockouts, bench shirt, wrist wraps, powerlifitng belt to keep the bench shirt in place, boards, bands and chains. My 515lbs bench press was not ambitious, and to achieve it I benched raw most of the time. However, if you are looking to move weights in the 600lbs+ range, I highly recommend learning to bench press shirted as it is much safer than benching raw and easier to move the weight through the weakest range of motion.  

With that said, having good equipment is not a luxury but a necessity in this sport, so do not sacrifice quality for a bargain. Well-fitted shirt can make a difference between benching 200lbs more than you bench raw, or having a torn shoulder. Good wraps (properly wrapped) dictate how much weight you can stabilize in your palms. Every piece of equipment (since there is not much of it) is important. I used Inzer RageX bench shirt (double ploy, open back) when I trained shirted, Forever Belt 13MM powerlifting belt, and Long (36”) Iron Wrist Wraps Z, all of which can be purchased at Inzer website: http://www.inzernet.com/index.asp 

Supplements - Powerlifting destroys your body, literally. Your recovery time, and staying injury free is correlated to your ability to set new personal bench press records. Basic supplementation consisting of weight gainers, whey protein, liquid protein, designer protein with ZMA, BCAAs, L-glutamine, creatine, multi-vitamins, multi-minerals, and various energy boosters cost me around $400 per month during the peaks of training cycles. The best recourse to purchase all of the necessary supplements is www.dpsnutrition.net

II. Master The Bench Press Technique

Proper technique is the most important part of your bench press. Minor adjustments can lead to a 25-50lbs increase in your 1RM in just one workout, and up to 200lbs increase if you are using a bench shirt (numerous powerlifters who bench press 750lbs+ shirted cannot bench press 450lbs raw).  

Prior to setting up on the bench you want to make sure that you have stretched, warmed up and wrapped your wrists well. There are many wrong ways and one right way to wrap your wrists so that they your wrists are locked in place; make sure to wrap your wrists correctly and do not delay your 1RM as wraps do cut off most of the blood circulation into your hands.

These are the basic tenants of bench press:

• Dig in with your traps: Big chests do not translate into big bench-presses. Proper technique shift most of the movement onto the back (latissimus dorsi), triceps, and rear deltoids. On a standard bench place your head on the bench fist while you arch (holding the bar from underneath with both hands at the same time) and then pull your shoulder blades together so the traps and “upper” shoulders rest on the bench's surface. This shortens the distance from the chest to full extension, ads stability, utilizes larger muscle groups, and eliminates your arms' weakest range of motion.

• Bench with your legs: Strong legs make a much more powerful bench press than a large chest. To maximize your leg strength during a bench press, put your body into a near-full arch when performing a one-rep max bench-press by supporting your body on the balls of your feet (by putting your feet underneath your body and arching your back). Drive your legs into the ground hard to initiate the lift of the bar from your chest. I decided to bench press only after I could no longer leg press. Leg training was always the primary focus of my workouts since leg strength and endurance translated into quantifiable improvements in my martial arts, skiing and tennis, whereas a larger upper body did nothing for my athletics and was a waste of time. However, after leg pressing1650lbs, fracturing a disk, and enduring a long and painful rehab I had no choice but to transition into upper body training.

• Train for triples: Dedicate one work-out per week to the bench-press alone, performing 8-12 sets of 3 reps with about 5 minutes rest between sets. Use all 3 grips during this workout: wide, standard, and close grip (as per regulation, not according to what you think is a wide, standard, or a close grip). Start with 60% of your 1-rep maximum (1RM) and add 5-10% per workout going forward.

• Emphasize tricep, rear deltoid, and brachialis development: Following the above 8-12 sets of bench-press, perform one exercise for rear deltoids, one exercise for triceps, and one exercise for the brachialis. Perform 3 sets of 10 repetitions with 2-4 minutes between sets.

My favorite exercises for these body parts are as follows.

Rear deltoids-
Reverse dumbbell fly (performed standing).

Triceps-
My favorite by far were dips, weighted with four or five 45lbs plates. However, specifically for bench press, triceps extensions or close grip bench press is a better training choice.

Brachialis-
Hammer curls: bicep curls where the thumb is kept pointing to the ceiling and the palm is not turned upward.

Bombarded with newspaper headlines, it was hard not to notice the collapse of Bear Stearns regardless of the industry you are in. Unfortunately the headlines missed the most interesting details about the Bear – JP Morgan – Fed deal. Those details are worth noting.

On March 10^th 2008 Bear Stearns stock closed at $70 per share, as it did 2 months prior. On March 10^th (or days earlier) requests were made for the options exchange to open a series of April puts of $20, $22.5 and March’s $25. These requests were accommodated and these puts were trading at massive volumes (over 104,000 contracts in these 3 puts traded March 11-14).

Around March 13^th an additional request was made to open more April and March puts with exercise prices of $20, $15, $10, and $5. At the time of the request these puts were 5 days away from expiration (trading over 80,000 put contracts on the mentioned options). The insiders who knew that JP Morgan would buy Bear Stearns stood to make 5-10 times more money on the newly-created March options contracts.

Who capitalized on Bear Stearns’ collapse prior to the collapse taking place can be determined by checking the records of largest options betters and shorters of Bear Stearn’s stock.

Much like you, I read that the bailout by the FED was $30 billion. Only in the 2^nd session of Senate hearings it was made clear that the “primary facility by James Dimon” was to Bear Stears in the amount of $25 billion, and the “second facility by James Dimon” was $30 billion to J.P. Morgan. That is $55 billion.

J.P. Morgan received the loan by pledging Bear Stearns assets at $55 billion. LTV of 100%. $29 billion is non-recourse to J.P. Morgan. If the value of the secondary facility of $30 billion ($29 billion of which is non recourse) is worth only $15 billion, then J.P. Morgan has to pay back $1 billion of the $30 billion received, and keeps $14 billion that the Fed loses. This also suggests that the half a billion that Bear Stearns board members received in compensation to resign actually comes from your and my tax dollars.

Who did well as the result of the Bear Stearns collapse? The 2^nd request for extraordinary low puts came between March 11^th and 13th, so you would want to scan the news for a closed-door meeting between March 9^th and 12^th. I found one through Bloomberg; a luncheon on March 11^th, held at the New York Federal Reserve Bank. The following attendees drew my attention:

-     Bernanke, Chairman of the Federal Reserve Board

-         James Dimon, CEO of J.P. Morgan Bank and Director
of the New York Federal Reserve Bank

-         Richard Fuld CEO of Lehman Brothers and Director of the New
York Federal Reserve Bank

-         James Gorman Co-President of Morgan Stanley, formerly of Merill Lynch

-         Robert Rubin former Treasury Secretary representing Citigroup, the CBOE Designated Primary Market Maker for Bear Stearns Options. Citigroup requested the opening of the March and April far out of the money put series mentioned above

-         Timothy Geithner, President and CEO of the New York Federal Reserve Bank and formerly with Kissinger and Associates. A member of the Bilderberg Group along with Senator Dodd

-         Stephen Schwarzman started Blackstone Group along with Peter Peterson. Blackstone was mentioned at the Senate hearings as an advisor on valuing the $55 billion collateral and on managing it.

-         John Thain CEO of Merrill Lynch

-         Lloyd Blankfein CEO of Goldman Sachs

-         Stephen Friedman of Stone Point Capital LLC and Chairman of the Board of Directors of the New York Federal Reserve Bank along with Dimon and Fuld. He is a retired CEO of Goldman Sachs and presently sits on their Board

-         Kennith Griffin CEO of Citadel Investment Group LLC, a Hedge Fund with $12 Billion in assets. Citadel Derivatives Group is one of the largest options market makers in the world.

-         Kenneth Chenalt CEO of American Express

I am not publicizing my personal conclusions on this matter, but I think the facts presented are worth your attention.

The ranks of very successful money managers are filled with tennis enthusiasts who welcome on-the-court competition: Steven Schwarzman, CEO of Blackstone; David Swensen, CIO of Yale Investment Fund; and Nadar Tavakoli of Eagle Rock, just to name a few. Have you ever wondered why? Whether conscious or not, the same principle lies at the foundation of beating the market as in beating your tennis opponent – risk management.

After you learn to manage risk in a tennis match in three simple steps, you will immediately become a much better tennis player. You will make your opponents suffer (even if you don’t know the first thing about alpha returns).

An ever-changing opponent, many variable forces to account for, and different risk and reward scenarios with every new opportunity are constants in both investing and tennis. You must do your own research, stick to fundamentals, develop a proven strategy, understand how the strategy works to implement it, have the discipline to stick to your guns, and be quite competitive to consistently come out on top.

In both tennis and investing, you have to filter out a great deal of noise and be selective about every step you take; many tennis coaches have a tendency to overload new/average players with detail that is irrelevant and often ignore the fundamentals necessary for  quick and substantial improvement.

The ability to identify and stick with a proven strategy is the difference between consistent alpha returns and unprofitable gambles – that includes a healthy margin of safety, your own research proving favorable fundamental, risk controls in place and a catalyst to enter the position. A good money manager is good at managing risk. Similarly, a competent tennis player reduces the complexity of tennis, to focus on just a few fundamentals that makes the differences between winning and losing. In other words, a good tennis player is also good at managing risk.

You have a tremendous advantage over “better” opponents when you consistently pressure them to take on more risk, hit more difficult shots. This includes forcing him to be more consistent, play at higher speed, run more, hit shots off balance, and go for high-risk passing shots. Seem like a difficult task? Don’t worry; it’s much easier than beating the market net of management fees and expenses. In fact, managing risk (and beating your opponent) can be accomplished in three simple steps. All you need to do is execute all three steps together and stick to them throughout the match.

1. Drop your wrist under the ball – healthy margin of safety

It is not possible to win a match if you can’t consistently hit your ground strokes over the net, right? The fundamentals of a tennis groundstroke consist of (a) early setup, (b) dropping the wrist bellow the level of the ball, and (c) driving your racket through the ball in the direction where you want to hit it. While all three are important, it is critical to understand that it is not the racket head but the wrist of the tennis player that drops bellow the level of the ball before the contact with the ball is made.

This movement puts the laws of physics on your side by creating a trajectory for the ball to travel over the net. Dropping the wrist increases velocity through follow-through, while the low-to-high movement under the ball increases its spin to keep the ball in the court. Follow this simple rule to become a more consistent and intimidating player from day one.
 

2. Step into the court with every shot – minimize risk

If there is a magic bullet in tennis, this is it. By stepping into the shot (preferably off the baseline right into the court), you control the baseline, cut off angles to reduce the distance you run, quicken the pace of the game giving your opponent less time to react and prepare, create more angles for you to hit making your opponent run more, and reduce your probability of hitting the ball into the net. You also avoid backing up and giving up control of the baseline by taking all high bouncing balls on the rise. This has a wonderful effect on your opponent – it places him under high pressure and forces him to go for the most difficult, highest risk shots.

3. Shot selection – pick your spots, act with a catalyst

Now that you have consistency and control of the court, you need to figure out what to do with your shots to close off the point – and the match. Luckily you don’t need sophisticated investment skills to figure out when to exit a position. The positions are exited for you in the match incrementally, game by game, until you have won the match.   The problem with amateurs’ shot selection is that they either have none, or they create a strategy so complex it is not applicable to a real match.

Let’s simplify tennis decision making so it can actually be executed during a match. There are only three scenarios within a point: (1) where you are in control of the baseline and the point, (2) when there is a neutral shot exchange, and (3) when you are in trouble (on the run/off balance/off the court).

1. If you are in control of the baseline, stepping into the shot or taking the ball on the rise, you have received or are about to get a short ball. As the name suggests, it’s a weaker shot that bounces inside the court enough for you to take 2 or more steps into the court (off the baseline) in order to hit it. You want to hit this shot hard, straight down the line and come to the net behind it. Since you are closer to the net during a short ball, you maximize your angle advantage over the net to drive the ball hard and over the shortest distance. You come to the net to maximize pressure on your opponent and force him to come up with much better (and higher risk) passing shots. Many club players choke just from having their opponent come to the net. Having a good serve will maximize the number of opportunities you will have to put away this short ball.

2. During a neural shot exchange you have a good tactical advantage simply by sticking to steps 1 and 2. You can either continue to hit the ball crosscourt (that’s where the most neutral rally takes place), or move your opponent around the court if you are in good balance. If this is all you do, you will consistently be in a position where you control the point, during which your opponent will either make a mistake or you will have an opportunity to close off the point as described above.

3. When you are on the run/off balance/off the court, you should almost always go crosscourt. This is a matter of simple physics and managing risk. By being forced into an awkward position, you are obviously forced into hitting a more difficult shot. By hitting crosscourt you are hitting with the direction of your body (as it rotates into the shot), over the lowest part of the net, and over the largest court space, maximizing your chances of keeping the point going.

When in trouble, don’t increase your risk with fancy shots. Instead, get back to neutral, and at least force your opponent to hit another shot. After all, if you will have no problem winning every match if during every point you hit one more ball in than your opponent J

Of course, this is not all there is to winning a tennis match (but Graham’s/Buffett’s margin of safety is not all there is to value investing); it is meant as a guide to increase your chances of winning. Give it a shot, and enjoy beating your opponent! And please let me know how it works for you.

As always, you can leave a comment on any blog post or send me a message at comments@alekseyvaynerblog.com

For those of us who are passionate about the world of alternative investments, it has been an interesting few months.

For one, March was the worst performance month ever, as hedge funds struggled to handle high volatility. This makes me wonder whether the majority of hedge funds are really hedging and are worth the fees they charge. The ever-alluring promise of hedge funds is that they can deliver alpha returns even during down markets by hedging against downside risk. This is worth the industry’s standard 2 & 20 fee if the hedge funds can deliver on the promise – which is not the case as demonstrated by reported losses across strategies and fund sizes.

Poor performance resulted in the new efforts to force hedge funds to reduce systematic risks and increase transparency. This is partly a result of regulators’ concerns of accounting fraud, insider trading and questionable sales practices, which has prompted FBI investigations this past week.

Difficult market conditions are also forcing smaller hedge funds to merge with bigger rivals in their effort to survive. This practice has many benefits, the most obvious of which are exposure to new clients, and utilizing a larger, stronger research base.

Also, there is one comeback manager in hedge news; Jeffrey Larson is planning to launch a new hedge fund despite loosing $1.6 billion last July while managing Sowood Capital Management (Harvard lost $350 million investing in Sowood). While it is common for failed managers to try again, I doubt the common sense of investing in their funds. One instance of a comeback manager that comes to mind is that of John Meriwether, who lost $4 billion in 1998. According to readily available reports the largest fund of JWM Partners (JM’s new fund) lost a quarter of its value last year.

Not everything is dim in hedge funds though. Despite lackluster performance across the industry, and some institutional investors pulling out of hedge funds in attempt to capture alpha with 130/30-type strategies (and save on fees), AUM of the largest hedge funds in the U.S. have increased by roughly 35% in 2007. Absolute Returns magazine reports that additional $407 billion entered 262 hedge funds that manage more than $1 billion, despite the fact that 3 largest hedge funds (Goldman, JP Morgan, DE Shaw) posted combined losses of more than $24 billion.

Of the new money entering hedge funds, Global Macro funds have dominated investor interest over the last few years as they offered better risk-adjusted returns (factor in downside deviation). Since last quarter of 2003 the sector has more than tripled in size to $150 billion (which means that quarterly assets growth rate is about 15%). I think this growth is excessive and global macro funds we will see some outflow in the near future.

Regularly it seems that someone asks how I'd win a street  fight.  I feel the question is dangerously misguided.  The word "win" should not be used in a given context.

The real question is how do you survive a street fight?

Do not fight. Avoid physical confrontation at all cost. If you fight, you are part of the problem. If you fight, you are trying to win, which means you are playing the same game - a game where the street fighter has all the advantages (he even picked the time and the place where he has maximum tactical advantage).

Running away as fast as you humanly can is your best defense. No, you are not being a chicken. Put your ego aside and understand that in a street fight you are in mortal danger. Any semi-experienced street fighter will not corner you if he does not have something he can seriously hurt you with.

ONLY IF the fight is absolutely unavoidable, here are a few other suggestions:

• Do not say a single word. Look directly into the person’s eyes while remaining as composed as possible. Take your weight slightly off your heels.

The silence alone might save you while the other guy is thinking why you are so composed, why don’t you say a word, you probably know something he does not, you might be a very good fighter etc. Let the silence psyche the person out. 

•  Do not focus on wining the fight!

If you are focused on winning a fight, and are inexperienced, you will tense up and will not see the dirty moves that are coming your way. Your objective in the fight should be to protect yourself and to get out in the first possible window of opportunity.

•   Stick to fundamentals

Few very fundamental rules apply to every second of every fight regardless of your experience.

1. Secure yourself; do not leave space through which your soft belly cavity, neck, head can be attacked
2. Disrupt opponent’s ability to attack. Get him off balance, shift orientation and disrupt his structure so every movement he makes is to reset instead of attack.
3. Set up your move. Remember, you move should be to get out. But if you are still around for punching, then make sure every contact you make is intended to travel through your target rather than meet its surface.

(If you get hit and are dizzy, immediately close in and hold your opponent, boxing-style. If you are dizzy you can’t do anything except get the lights knocked out of you – so hold your opponent, this pain is short-lived).

•     It is never his turn.

In a real street fight the winner is usually the one who goes farther faster.

The street fighter has an advantage because he is probably willing to escalate the fight to a new level of pain faster than you. The fight is never won by one punch or kick. This means that if it comes down to hitting and kicking, act quickly and do not stop. It is never his turn.

Thank you everyone for sharing with me your positive feedback about my blog! A few of you also mentioned that I am not as personable in my writing as I am in real life, and that I don’t write often enough. I will make sure that some entries are more personal than others.

_____________________________________________________________

                     “To me, the function and duty of a quality human being is
                      the sincere and honest development of one's potential.”
                                                                                        – Bruce Lee

  Lets discuss something uplifting - a simple real-life system you can use right now to become the best at what we do, and achieve happiness. Another far-fetched promise? Lets see.

We are in recession and have just began to chip away at the tip of an iceberg that is credit crisis. Former Treasury Secretary Larry Summers recently stated, “We are facing the most serious financial stress that the U.S. has seen in at least a generation.” I think to call our economic situation a recession and the subprime bubble a credit crisis is a gross understatement.

This is just the beginning – an opinion shared by Satyajit Das, a world-renown expert on credit derivatives, who is also the author of 4,000+page reference text on this subject.

I believe we are going into a nasty bear market. Why?

1. Extraordinary level of debt characterizes a very weak economic state.
2. Political leadership with silly intervention proposals.
3. Subprime market bubble that is just a key to Pandora’s box…watch out!
   

Massive Debt

Bush’s oil war on Iraq is a $300 billion dollar per year burden on the U.S. economy (by many scholarly and economic estimates). This is expensive by itself, but becomes completely unaffordable when we factor in that the US Government borrows $250-300 billion dollars form China every year above and beyond what it already collects in taxes in spite of tax payers overpaying (i.e. most do not take advantage of the deductions they are legally entitled to).

These numbers do not factor in that Social Security and Medicare are in trouble, which will translate into increased taxes on U.S. citizens in a relatively near future. Our public education system is also a wreck, with 60% high-school drop-out rate in some larger cities…

But that’s only a part of the picture. Much larger debt and dangerous leverage hides in the world economic system and is unfortunately not limited to the U.S. credit crisis.

That said, some form of intervention is necessary to ease the pain; the problem is that no one really knows what this intervention should be. Many proposals are playing around with interest rates, which lead to my next point.

Silly Intervention Proposals 

Stimulus Package

If you are waiting for your stimulus check, I am very happy for you. But lets be blunt; it will not do jack to help the troubled economy. The government’s goal should be to make sure we do not dive into a greater mess than the one we already in. Mailing out checks is not a solution for a system for a country that is already so heavily in debt.

Excuse me for stating the obvious, but the government is planning to give out money it does not have! What is it going to do? Borrow another $200 billion from China or just print it up? The little I remember from freshman year at Yale when William Nordhouse still taught introductory economics suggests that created money (regardless of the method used) comes with negative repercussions of a plunging dollar and a rapid inflation.

As the stimulus package receives coverage by most major news channels, one item that is not getting much attention is that it will useless to those who really needed. To get a tax refund you must first be earning money, so the low class who are not required to pay federal income tax will receive half as much as people with higher incomes, while retirees on social security may not get anything at all. [To be precise, the relief package is not a tax refund. It has to be claimed as if there was an overpayment of an income tax]. When the check does arrive, (consumer agencies estimate that) about 80% of the people will spend it on pricey items like electronics in which case most of the money will go right out of the window to foreign manufacturers. This does not address the underlying issue.

The existing problem does not have anything to do with consumer spending. It does not even has much to with the homeowners who are defaulting on their mortgages and are eaten up by mass media, as I will discuss shortly. On the contrary, the problem has more to do with too much spending, highly leveraged financial instruments, and unrealistic real estate valuations.

Feldstein's Plan

Another plan, more colorful than the stimulus package, came from Martin Feldstein (former Reagan advisor). Recently presented in The Wall Street Journal, it proposed for the government to lend homeowners who are in trouble 20% of their outstanding mortgage balance. This money, according to Mr. Feldstein, would come from selling T-bills and have a payoff period of 15 years. The interest would be tax deductible.

So…the plan does not actually help the homeowners; it just moves debt from one place to another, and tries to pay off loans that were created on ridiculous real estate values (and should not have been underwritten at all). Government loans, as Mr. Feldstein pointed out, will lower the interest payments…but weren’t lower interest rates partly what got us into current trouble?

Reality Check

How much trouble our economy is in is debatable. The fact is that the real estate that is backing current outstanding mortgages is worth much less than it was worth before.

The most comparable historic scenario I can think of is Japan (albeit the magnitude of their real estate market was quite a bit larger). One industry fueled economy, leading to widespread speculations. The formed bubble raised real estate values sky-high. Then it came crushing. Then the Nikkei followed, falling for a decade. Sounds familiar?

The Japanese were reluctant to write off bad debt in hopes that the prices would eventually recover. This did not happen and as banks tried to survive, the credit crunch stalled the economic growth so much that for 9 or 10 years the average GDP was 1.5% despite near-zero interest rates.

If history repeats itself, then Japan demonstrated that waiting for property values to rise will not work. That interest rates are not the issue. And that trying to do everything possible to keep bad loans on the books will only exacerbate the bear market.

It Gets Worse

At the beginning I said that we are in for a nasty bear market, and that the subprime credit crunch is just a key to Pandora’s box...What I am talking about stems far beyond the defaulting homeowners, or yesterday's meltdown (and Federal Reserve’s rescue) of Bear Stearns (BSC). I am talking about global levels of debt beyond of what you and I can imagine.

What we are seeing now is that homeowners who are defaulting on their mortgages are being blamed for the credit crisis. This criticism is misdirected. The real players in this game are:

-         Financial Technicians who piled up mountains of “securitized” debt with mathematical models that were fundamentally problematic

-         US Banks who created genius methods of moving dangerously large amounts (trillions of dollars) of credit risk from their balance sheets into accounts of money managers and less sophisticated investors across the world

-         Regulators who stood by and allowed US banks to carry on

-         Hedge fund managers who invested heavily in high-yield debt products without thoroughly understanding them

15 years ago banks funded (and obviously wrote) their own loans. Already in 2003 when I was at a mortgage brokerage firm learning the ins and outs of back-end financing the banks would originate the loans through variety of subsidiaries (sometimes directly), and keep them on their own balance sheets for a relatively short period of time before pushing them to investors by rolling a batch of mortgages into CDOs (collateralized debt obligations). This system allowed banks to tie up much less capital in these mortgages, enabling them to put more money out to finance more loans.

The more loans sold, the more could be used to back more loans. The credit standards were lowered to sell more paper (something that the loan sharks helped considerably with). Buyers were primarily pension funds, insurance companies and hedge funds. U.S. and Japanese managers leveraged their bets by buying CDOs with borrowed money on low interest rates. Then credit-agencies (relying on the models developed by the above-mentioned technicians), claiming that these loans would rarely default, used CDOs as collateral to borrow more funds. If you followed me through the loop, that’s 3 stages of borrowed money further buying on borrowed money.

That is how the credit risk moved from the banks, where it was regulated, to places so obscure it was even difficult to observe.  In the mean time, it made sense to money managers that if these “assets” (purchased with borrowed money) rose in value, they should borrow more money against the same asset to buy even more in order to maximize returns.

The Problem

These triple-borrowed and inflated assets were then used to back commercial paper. According to several international credit experts, up to 55% of the $2.3 trillion of commercial paper in the U.S. market is currently asset-backed; 50% of that in mortgages.

To sum up, $1 real dollar has been leveraged to support $25-30 dollars of loans. These repeated rounds of loans that were financed in spite of decreasing presence of assets to back them up led to current world economy in which derivatives outstanding stand at $516 trillion (2007 figures) or roughly 8.6 times the global GDP of $60 trillion.

Leverage increases losses just as it increases gains. Attempts to sell “stuff” to fulfill the loan-to-value contracts will be desperate and fruitless. This is the reason why banks would’ve liked to stop clients from selling their derivatives at a discount. It would require marking down the value of all the assets in the debt chain, leading to margin calls on customers who already had very little cash.

More troubling, according to experts like Satyajit Das, is that recent gains in the stock market were underwritten by CDO-type instruments (aka structured finance; these include private-equity takeovers, leveraged buyouts and corporate stock buybacks). Now with the structured finance market unwinding, the support for equities will disappear, and many recent deals that depended on the easy a