More History Lessons about the Financial Crises:

http://www.pbs.org/wgbh/pages/frontline/warning/themes/

After a bearish downward trend look for bullish reversal patterns by looking at candle sticks

http://stockcharts.com/school/doku.php?id=chart_school:chart_analysis:candlestick_bullish_


After a bullish upward trend look for bearish reversal patterns by looking at candle sticks

http://stockcharts.com/school/doku.php?id=chart_school:chart_analysis:candlestick_bearish_

http://www.nytimes.com/2002/07/24/business/missing-the-90-s-bubble-looks-prescient-in-2002.html

Missing the 90's Bubble Looks Prescient in 2002



By JONATHAN FUERBRINGER



Published: Wednesday, July 24, 2002



At the time, they must have felt left out at cocktail parties and dismissed
as slightly crazy by many of their neighbors. But those who ignored stocks in
the mid- and late-1990's -- and all the hype that was swirling around them at
the time -- are now significantly better off than those who put their money to
work on Wall Street.

The decline in the stock market has been so steep in the last two and a half
years -- including a 19 percent plunge in the Standard & Poor's 500 index
since the end of June -- that anyone who put money in bonds between the
mid-1990's and now is doing better today than those who trusted in stocks. On a
total return basis, the starting date has to be pushed back to July 1995 before
money invested in a broad portfolio of major stocks would have outperformed an
investment made at the same time in Treasury notes and bonds.

The realization that bonds are not so bad is nothing new in a down stock
market. But since the belief in stocks as the only investment has been in vogue
so long, bonds have not been on the alternatives list of many investors.

Now they are, and those rushing into the bond market -- while too late to head
off big losses in their stock portfolios -- could help buoy the economy and
eventually contribute to a stock market recovery as well.

Rising bond prices push interest rates down, and that is fueling not only a housing
and refinancing boom but also increased consumer borrowing at relatively low
cost. Those actions seem to be what Alan Greenspan, the chairman of the Federal
Reserve, is counting on to carry the economy through a rough spot until the
stock market settles down and businesses start spending again.

In the last four months, the yield on the Treasury's 10-year note, which has
a big influence on home mortgage rates but also affects equity loans and even
other borrowing rates on everything from cars to college tuition, has dropped a
percentage point to 4.42 percent.

This has brought mortgage rates near their lowest levels in decades, with
the average national rate on a 30-year mortgage now at 6.49 percent. Falling
mortgage rates prompt homeowners to refinance their home loans. In turn,
homeowners can lower their monthly payments and borrow additional money. Both
activities can free money for anything from home improvements to vacations.

As a result, the decline in interest rates serves as a stabilizer for the
economy, offsetting the blow to consumer spending expected by some economists
from the stock market decline.

''Greenspan is betting that the tail wind of a stronger property market will
offset the headwind of the stock market,'' said Paul A. McCulley, portfolio
manager and economist at the Pacific Investment Management Company in Newport
Beach, Calif.

While Mr. Greenspan has plenty of supporters among economists, skeptics
abound as well. Robert J. Barbera, chief economist at Hoenig & Company, for
one, has his doubts.

''If you go half a percentage point below where we are now on mortgage
rates, then everybody in the United States will refinance their mortgage and
that is a pretty potent force,'' he said. ''Unfortunately, the driver on the
other side, stocks, is also a potent force -- negatively.''

Since stocks began their latest plunge four months ago, Merrill Lynch's
index of Treasury notes and bonds has had a total return of 6.6 percent through
Monday. The gains, though modest by the outsize standards of the 1990's, are
far superior to bank deposits and a counterpoint to the total-return decline of
29 percent in the Standard & Poor's 500-stock index in the same period.

With investors putting more money into bonds, bond traders are dealing with
an onslaught of new money.

The positive impact from falling interest rates and the negative consequence
of falling stock prices work through the economy in many ways, but one of the
most important comes from the so-called wealth effect. Under this theory,
consumers are more willing to increase their spending when they feel richer
because of the rise in the value of their stocks or their homes. The wealth
effect, of course, can also move in the opposite direction. While estimates
vary, economists think that many people might spend anywhere from 2 cents to 5
cents more for every dollar of increased personal wealth and cut their spending
by a somewhat smaller amount when their wealth declines.

Mr. Greenspan indicated last week that he thought the housing wealth effect
has the upper hand, for now. ''Fixed mortgage rates remain at historically low
levels and thus should continue to fuel reasonably strong housing demand and,
through equity extraction, to support consumer spending as well,'' Mr.
Greenspan said in his semiannual economic analysis for Congress.

It certainly was not Mr. Greenspan's intention, but there is one other
consequence of the end of the stock boom, the fall in interest rates and the
better performance of bonds. Mr. Greenspan's own portfolio -- invested in the
Treasury market and money market funds to avoid any conflicts of interest --
now looks a whole lot better than when he was being celebrated for helping
bring about an economic miracle.

Chart: ''The Point of Better Return'' Investors who put their money in
Treasury notes and bonds on July 20, 1995, or anytime after that, have received
a better total return than those who chose a portfolio of stocks represented by
the Standard & Poor's 500. Investing on that date, both would have gained
just under 66 percent. Graph tracks times when an investment in bonds did
better than an investment in stocks, and when stocks did better than bonds
(Note: timeline is reversed JULY 22, 2002-JULY 20, 1995) Graph tracks U.S.
TREASURY NOTES AND BONDS* Total return from any date to July 22, 2002 STANDARD
& POOR'S 500-STOCK INDEX Total return from any date to July 22, 2002 *Based
on Merrill Lynch's U.S. Treasury index (Sources: Standard & Poor's; Merrill
Lynch; Rhodes Analytics)(pg. C8)

http://macroblog.typepad.com/macroblog/2006/12/how_to_characte.html


December 21, 2006





How To Characterize Economic Policy In The 90's




A comment made by pgl in one of yesterday's posts at Angry Bear caught my attention:

And
[why is chairman of Bush's Council of Economic Advisers Ed] Lazear
opposed to my suggestion of easy money with tight fiscal policy, which
was the 1993 approach?

What got me
thinking was this: Was the policy in the period referenced by pgl
really one of "easy money" and "tight fiscal policy"?


Answering that question requires answering the prior
question of what, exactly, do those terms mean. That is not a
straightforward task, but let me give it a shot. I'll start by
suggesting -- as I have done before
-- that a characterization of the stance of monetary policy -- as tight
or easy, restrictive or stimulative, contractionary or expansionary --
can be found in the yield curve, or the spread between short-term
interest rates and long-term interest rates.


What about fiscal policy? I suppose that what many people
have in mind is the government surplus of revenue over expenditure
relative to GDP or, alternatively, the "standardized" or
"cyclically-adjusted" budget surplus relative to "potential" GDP. As explained by the Congressional Budget Office:

The
size of the budget deficit is influenced by temporary factors, such as
the effects of the business cycle or one-time shifts in the timing of
federal tax receipts and spending, and the longer-lasting impact of
such factors as tax and spending legislation, changes in the trend
growth rate of the economy, and movements in the distribution and
proportion of income subject to taxation. To help separate out those
factors, this report presents estimates of two adjusted budget
measures: the cyclically adjusted surplus or deficit (which attempts to
filter out the effects of the business cycle) and the
standardized-budget surplus or deficit (which removes other factors in
addition to business-cycle effects).

With that background, here are pictures of the difference
between the yield on 10-year (constant-maturity) Treasury securities
and the effective federal funds rate...









...and various measures of the government surplus:









Is pgl right? Does it look like, let's say the Clinton years, were a period of tight fiscal policy and easy monetary policy?


You are not surprised, I presume, to see that there is a
pretty good case on the fiscal policy characterization -- though it is
interesting that the G.H.W Bush years look every bit as good as the
Clinton years by the standardized surplus measure. (I haven't checked
this carefully, but I suspect this may have something to do with
smoothing out expenditures and receipts associated with the activities
of the Resolution Trust Association created to manage the aftermath of the S&L crisis of the 80's, as well as adjustments for extraordinary capital gains taxes in the latter 90s.)

The case for easy money is a bit tougher. If you accept the
10-year/funds-rate spread as being related to the relative ease of
monetary policy, then the period from 1993 to 1995 looks relatively
stimulative. But the latter part of the decade is not so readily
characterized in that manner -- and that is precisely the time when the
budget deficits really shrink.

The story can get complicated if you throw in the proposition that
the relationship between short-term and long-term interest rates
changed in the past 10 years or so, an idea that is currently in favor
as a rationale for not worrying about the inverted yield curve today.
And, of course, you might reasonably object to my whole exercise by
arguing that fiscal and monetary policy are really as much about what
people expect to happen as they are about what is actually happening at any point in time.

I can readily agree to the proposition that fiscal policy ought to
"tighten" up - though I would emphasize entitlement and tax reform in
that definition, as opposed to any particular stand on how fast or how
far deficits should recede. As for monetary policy, I'll appeal to higher authority:

Price stability plays a dual role in modern central banking: It is both an end and a means of monetary policy.

As one of the Fed's mandated objectives, price stability itself is an end, or goal, of policy...

Although price stability is an end of monetary policy, it is also a
means by which policy can achieve its other objectives. In the jargon,
price stability is both a goal and an intermediate target of policy. As
I will discuss, when prices are stable, both economic growth and
stability are likely to be enhanced, and long-term interest rates are
likely to be moderate. Thus, even a policymaker who places relatively
less weight on price stability as a goal in its own right should be
careful to maintain price stability as a means of advancing other
critical objectives.

If that ends up being "easy" money, well, so be it.

UPDATE: pgl responds
in his usual intelligent fashion, noting (as he does in the comments
below), that the high-growth late 1990s did indeed call for a tighter
fiscal policy. What this suggests to me (as I also note in the
comments below) is that it is not so clear that we ought to think of
the stance of monetary policy in relation to fiscal circumstances. My
inclination is to suggest that something like the Taylor rule
-- with its emphasis on inflation goals and the level of economic
activity relative to its potential - is a more robust approach to
characterizing the appropriate course of monetary policy.

http://www.federalreserve.gov/newsevents/speech/bernanke20090414a.htm





Speech



Chairman Ben S. Bernanke



At the Morehouse College, Atlanta, Georgia



April 14, 2009




Four Questions
about the Financial Crisis

I am pleased to have the privilege of speaking today to the students and
faculty of Morehouse College, the only all-male historically black institution
of higher learning in the United States. It is sufficient to note that Martin
Luther King, Jr., was a graduate of Morehouse. Yet a roster of distinguished
alumni that also includes former Atlanta Mayor Maynard Jackson, former U.S. Surgeon
General David Satcher, and filmmaker Spike Lee testifies to the success of your
stated mission of "producing academically superior, morally conscious
leaders for the conditions and issues of today."

My remarks today will focus on the ongoing turmoil in financial markets and
its consequence, the global economic recession. The financial crisis, the worst
since the Great Depression, has severely affected the cost and availability of
credit to both households and businesses. Credit is the lifeblood of market
economies, and the damage to our economy resulting from the constraints on the
flow of credit has already been extensive. With recent job losses exceeding
half a million per month, this year's college graduates are facing the toughest
labor market in 25 years. In the communities in which you and I grew up, many
families are trying to cope with lost employment and depleted savings or are
facing foreclosure on their homes. Firms have shut factories and cancelled
construction projects. States and municipalities are scrambling to find the
funding to provide critical services. And although we naturally tend to be most
aware of conditions in the United States, we should not overlook the impact
that the crisis is having virtually everywhere in the world, particularly on
many citizens of countries that struggle economically even when the global
economy is doing well.

In the midst of all of these concerns, many Americans have recently
celebrated Easter or Passover. As you may know, a highlight of the traditional Passover
meal occurs when the youngest child asks four questions, the answers to which
tell the history of the Jews when they were slaves in Egypt and during their
exodus to the Promised Land. In the spirit of the holiday, today I will pose
and answer four important questions about the financial crisis. Of course, my
answers will have to be brief, but we will have more time for additional
questions at the conclusion of my prepared remarks.

How Did We Get Here?
The first question I would like to address is: How did we get here? What caused
our financial and economic system to break down to the extent it has? Not
surprisingly, the answer to this question is complex, and experts disagree on
how much weight to give various explanations. In my view, however, to tell the
story fully--and, in particular, to understand its international scope--we need
to consider how global patterns of saving and investment have evolved over the
past decade or more, and how those changes affected credit markets in the
United States and some other countries.

At the most basic level, the role of banks and other financial institutions
is to take the savings generated by households and businesses and put them to
use by making loans and investments. For example, financial institutions use
the funds they receive from savers to provide loans that help families buy
homes or allow businesses to finance inventories and payrolls. Financial
markets, such as the stock and bond markets, perform a similar function, as
when a firm raises funds for a new factory by selling a bond directly to
investors. When the financial system is working as it should, it allocates
funds both prudently (that is, with proper attention to risk) and efficiently
(to the most productive uses).

Importantly, in our global financial system, saving need not be generated in
the country in which it is put to work but can come from foreign as well as
domestic sources. In the past 10 to 15 years, the United States and some other
industrial countries have been the recipients of a great deal of foreign
saving. Much of this foreign saving came from fast-growing emerging market
countries in Asia and other places where consumption has lagged behind rising
incomes, as well as from oil-exporting nations that could not profitably invest
all their revenue at home and thus looked abroad for investment opportunities.
Indeed, the net inflow of foreign saving to the United States, which was about
1-1/2 percent of our national output in 1995, reached about 6 percent of
national output in 2006, an amount equal to about $825 billion in today's
dollars.

Saving inflows from abroad can be beneficial if the country that receives
those inflows invests them well. Unfortunately, that was not always the case in
the United States and some other countries. Financial institutions reacted to
the surplus of available funds by competing aggressively for borrowers, and, in
the years leading up to the crisis, credit to both households and businesses
became relatively cheap and easy to obtain. One important consequence was a
housing boom in the United States, a boom that was fueled in large part by a
rapid expansion of mortgage lending. Unfortunately, much of this lending was
poorly done, involving, for example, little or no down payment by the borrower
or insufficient consideration by the lender of the borrower's ability to make
the monthly payments. Lenders may have become careless because they, like many
people at the time, expected that house prices would continue to rise--thereby
allowing borrowers to build up equity in their homes--and that credit would
remain easily available, so that borrowers would be able to refinance if
necessary. Regulators did not do enough to prevent poor lending, in part
because many of the worst loans were made by firms subject to little or no
federal regulation.

Mortgage markets were not the only ones caught up in the credit boom. The
large flows of global saving into the United States drove down the returns
available on many traditional long-term investments, such as Treasury bonds,
leading investors to search for alternatives. To satisfy the enormous demand
for investments both perceived as safe and promising higher returns, the
financial industry designed securities that combined many individual loans in
complex, hard-to-understand ways. These new securities later proved to involve
substantial risks--risks that neither the investors nor the firms that designed
the securities adequately understood at the outset.

The credit boom began to unravel in early 2007 when problems surfaced with
subprime mortgages--mortgages offered to less-creditworthy borrowers--and house
prices in parts of the country began to fall. Mortgage delinquencies and
defaults rose, and the downturn in house prices intensified, trends that
continue today. Investors, stunned by losses on assets they had believed to be
safe, began to pull back from a wide range of credit markets, and financial
institutions--reeling from severe losses on mortgages and other loans--cut back
their lending. The crisis deepened last September, when the failure or
near-failure of several major financial firms caused many financial and credit
markets to freeze up. Stock prices fell sharply as investors lost confidence in
the financial sector and became gloomy about economic prospects. Declining stock
values, a teetering financial system, and difficulties in obtaining credit
triggered a remarkably rapid and deep contraction in global economic activity
and employment, a contraction that has persisted through the first months of
2009. Both the ongoing financial crisis and economic contraction have posed
major challenges to economic policymakers.

What Is the Fed Doing to Address the Situation?
Those challenges bring me to my second question: What has the Federal Reserve
been doing to address the economic and financial crisis?

The Fed's mandate from the Congress is to promote maximum sustainable
employment and stable prices. In addition, the Fed is expected to contribute to
financial stability by acting to contain financial disruptions and prevent
their spread outside of the financial sector. Thus, we have been serving as a
first responder to the crisis.

The Fed's basic policy tool for influencing economic activity and inflation
is its ability to control very short-term interest rates--specifically, the
federal funds rate, which is the rate that banks pay each other for overnight
loans. Lower interest rates can be used to stimulate private-sector borrowing
and spending at times like the present when the economy is suffering from a
lack of demand. In September 2007, shortly after the turbulence in financial
markets began and signs of economic weakness started to appear, the Federal
Open Market Committee (FOMC), the body that determines the Federal Reserve's
monetary policy, began to aggressively reduce the federal funds rate. By the
spring of 2008, we had cut that interest rate from 5-1/4 percent to 2 percent,
a highly proactive policy that helped to cushion the economy from some of the
effects of the financial turmoil. But, as I mentioned a moment ago, the intensification
of the financial crisis in the fall of 2008 led to a further significant
deterioration in the economic outlook. The FOMC responded with additional
interest rate cuts, and since December, our policy interest rate has been
essentially zero. In addition, the FOMC has made clear that it expects economic
conditions to warrant holding the federal funds rate low for an extended
period.

However, given the ongoing problems in credit markets, conventional monetary
policy alone is not adequate to provide all the support that the economy needs.
The Fed has therefore taken a number of steps to help the economy by unclogging
the flow of credit to households and businesses. In doing so, we have
demonstrated that the Fed's toolkit remains potent, even though the federal
funds rate is close to zero and thus cannot be reduced further.

We have taken a wide range of actions to help restore the flow of credit, of
which I will only mention a few of the most important. One set of actions
involves making short-term loans to banks and other financial institutions.
Banks and other financial intermediaries normally make longer-term
commitments--such as residential mortgages and business loans--yet rely on
funding that may be relatively short-term, such as customer deposits that can
be withdrawn at any time. To have the confidence to commit to longer-term loans
and investments, banks must be sure that they will have ample access to funding
when necessary. To give this assurance to banks, the Federal Reserve has made
clear that it will provide short-term credit to sound financial institutions as
needed. Indeed, serving as a lender of last resort to financial institutions is
a method that central banks have used for centuries to try to calm financial
crises.

To underscore our commitment to providing short-term funding to banks when
they need it, we have lowered the interest rate we charge for short-term loans
and extended the term of the loans to up to three months. We have also begun to
auction funds to financial institutions, thereby allowing the interest rate
paid to depend on the level of demand. Importantly, this lending is extremely
safe from the point of view of both the Fed and the taxpayer. Not only is our
lending short-term and restricted to healthy institutions, but we require that
the borrowers pledge, as security, collateral whose value exceeds the amount we
are lending. The Fed's lending to financial institutions has helped to ease
conditions in a number of key financial markets, reduced important benchmark
interest rates (such as the London interbank offered rate, or Libor, to which
payments on some mortgages and other types of loans are tied), and increased
the willingness of banks to make credit available.

A second strategy the Fed has employed is to use targeted lending to help
free up critical credit markets outside of the banking system. A good example
of targeted lending is our efforts in the commercial paper market. Commercial
paper is a form of short-term debt issued by a variety of businesses to finance
their operations; paychecks and payments to suppliers can depend on it. Among
the largest investors in commercial paper are money market mutual funds. At the
peak of the crisis last fall, many people who had invested in money market
mutual funds lost confidence in those funds and withdrew their money; this loss
of funding forced money market mutual funds to reduce their own investments,
which in turn caused serious problems in the commercial paper market. Through a
series of lending programs, and in coordination with steps taken by the
Treasury, the Federal Reserve helped restore confidence in both money market
mutual funds and the commercial paper market. Over time, withdrawals from money
market mutual funds have been replaced by modest net inflows, and borrowers in
the commercial paper market have seen significant improvements in the cost and
availability of funding.

More recently, the Federal Reserve has also initiated a lending program,
with the cooperation of the Treasury, designed to free up the flow of credit to
households and small businesses. Among the forms of credit on which the program
is currently focused are auto loans, credit card loans, student loans, and
loans guaranteed by the Small Business Administration. We are currently
reviewing other types of credit for possible inclusion in this program. In all
cases, we will be taking the appropriate measures to minimize the risk of loss
to the Federal Reserve.

Restoring stability to the market for housing and home mortgages has been a
particular area of concern. To address this problem, the Fed has employed a
third type of policy tool--namely, buying securities in the open market. The
FOMC has approved purchases of well over $1 trillion this year of
mortgage-related securities guaranteed by the government-sponsored mortgage
companies, Fannie Mae and Freddie Mac. Buying mortgage-related securities helps
to drive down the interest rates that consumers pay on mortgages, and, indeed,
the rate on a traditional 30-year fixed-rate mortgage has recently fallen to less
than 5 percent, the lowest level since the 1940s. Certainly, the housing market
remains depressed, but lower interest rates and house prices are making houses
more affordable. For example, two years ago, when mortgage rates were higher
than 6percent, payments on a mortgage covering 80 percent of the cost of a
$215,000 home would have been more than $1,000 per month; today, the price of
that same house may have fallen to $170,000, and, at today's mortgage interest
rates, the monthly payment would be about $700. Lower mortgage rates are also
helping some homeowners refinance their mortgages to reduce their monthly
payments.

The Federal Reserve will continue to take the necessary steps to unclog the
credit markets and strengthen the economy. We will also continue to work
closely with other agencies, such as the Treasury and the Federal Deposit
Insurance Corporation (FDIC), each of which has also taken a variety of actions
to help stabilize financial markets, as well as with other central banks around
the world.

Does the Fed's Aggressive Response Risk Inflation Down the Road?
The multifaceted policy response that I've described has been aggressive. I am
confident that such a proactive policy response is well justified by the
serious ongoing problems in financial markets and the economy. However, some
have raised the third question I will address: Could the Fed's aggressive
actions to stabilize the economy today lead to an inflation problem down the
road?

I mentioned earlier that the Fed's mandate from the Congress is to foster
price stability as well as maximum sustainable employment. The FOMC treats its
obligation to ensure price stability extremely seriously. Price stability
supports healthy economic growth, for example, by making it easier for
households and businesses to plan for the future. In practice, price stability
does not require that inflation be literally zero; indeed, although inflation
can certainly be too high, it can also be too low. Experience suggests that
inflation rates that are close to zero or even negative (corresponding to
deflation, or falling prices) can at times be associated with poor economic
performance. Cases in point include the United States in the 1930s and the more
recent experience of Japan. In their latest quarterly projections of the
economy, most members of the FOMC indicated that they would like to see an
annual inflation rate of about 2 percent in the longer term. Right now, because
of the weakness in economic conditions here and around the world, inflation has
been running less than that, and our best forecast is that inflation will
remain quite low for some time. Thus, the Fed's proactive policy approach is
not at all inconsistent with the goal of price stability in the medium term.

Although inflation seems set to be low for a while, the time will come when
the economy has begun to strengthen, financial markets are healing, and the
demand for goods and services, which is currently very weak, begins to increase
again. At that point, the liquidity that the Fed has put into the system could
begin to pose an inflationary threat unless the FOMC acts to remove some of
that liquidity and raise the federal funds rate. We have a number of effective
tools that will allow us to drain excess liquidity and begin to raise rates at
the appropriate time; that said, unwinding or scaling down some of our special
lending programs will almost certainly have to be part of our strategy for
reducing policy stimulus once the recovery is under way.

We are thinking carefully about these issues; indeed, they have occupied a
significant portion of recent FOMC meetings. I can assure you that monetary
policy makers are fully committed to acting as needed to withdraw on a timely
basis the extraordinary support now being provided to the economy, and we are confident
in our ability to do so. To be sure, decisions about when and how quickly to
proceed will require a careful balancing of the risk of withdrawing support
before the recovery is firmly established versus the risk of allowing inflation
to rise above its preferred level in the medium term. However, this delicate
balancing of risks is a challenge that central banks face in the early stages
of every economic recovery. I believe that we are well equipped to make those
judgments appropriately. In addition, when the time comes, our ability to
clearly communicate our policy goals and our assessment of the outlook will be
crucial to minimizing public uncertainty about our policy decisions.

Why Did the Fed and the Treasury Act to Prevent the Bankruptcy of Some
Major Financial Firms?
The final question is as difficult as it is important: Why did the Fed and the
Treasury act to prevent the bankruptcy of some major financial firms, such as
the investment bank Bear Stearns and the insurance company American
International Group, or AIG? We must answer that question not only because the
decisions have been controversial, but also because it bears on the steps we
need to take as a country if we are to avert a repetition of the crisis.

As a general rule, my strong preference is that any firm that cannot meet
its obligations should bear the consequences of the marketplace. But recent
circumstances have been truly extraordinary. Consider the situation on
September 16 of last year, when the insurance conglomerate AIG faced pressures
that threatened to force it imminently into bankruptcy. At that time, the
strains in the global financial system were unprecedented and extreme, and the
confidence of financial market participants in the system was rapidly eroding.
The investment bank Lehman Brothers had filed for bankruptcy the day before,
and the mortgage giants Fannie Mae and Freddie Mac, after suffering losses that
threatened their solvency, had effectively been taken over by the government
just two weeks earlier. As waves of panic and fear washed over the markets, the
Fed and the Treasury became very concerned about the stability of a number of
other major financial firms.

Large, complex financial institutions tend to be highly interconnected with
other firms and markets, and AIG was more interconnected than most. For
example, AIG had insured many billions of dollars of loans and securities held
by banks around the world, and its failure would have rendered those insurance
contracts worthless, imposing large losses on the global banking system. In
addition, banks had extended more than $50 billion in credit to the company,
much of which would have been lost. Many other serious consequences would have
followed from a default by AIG: Insurance policyholders would have faced
considerable uncertainty about the status of their policies; state and local
governments, which had lent more than $10 billion to AIG, would have suffered
losses; workers whose 401(k) plans had purchased $40 billion of insurance from
AIG against the risk of loss would have seen that insurance disappear; and
holders of AIG's substantial quantities of commercial paper would have also
borne serious losses.

But much more important, the disorderly failure of AIG would have put at
risk not only the company's own customers and creditors but the entire global
financial system. Historical experience shows that, once begun, a financial
panic can spread rapidly and unpredictably; indeed, the failure of Lehman
Brothers a day earlier, which the Fed and the Treasury unsuccessfully tried to
prevent, resulted in the freezing up of a wide range of credit markets, with
extremely serious consequences for the world economy. The financial and
economic risks posed by a collapse of AIG would have been at least as great as
those created by the demise of Lehman. In the case of AIG, financial market
participants were keenly aware that many major financial institutions around
the world were insured by or had lent funds to the company. The company's
failure would thus likely have led to a further sharp decline in confidence in
the global banking system and possibly to the collapse of other major financial
institutions. At best, the consequences of AIG's failure would have been a
significant intensification of an already severe financial crisis and a further
worsening of economic conditions. Conceivably, its failure could have triggered
a 1930s-style global financial and economic meltdown, with catastrophic
implications for production, incomes, and jobs.

The Federal Reserve and the Treasury agreed that in the environment then
prevailing, AIG's failure would have posed unacceptable risks for the global
financial system and for our economy. Accordingly, the Federal Reserve, with the
full support of the Treasury, made a loan to AIG to prevent its failure. The
loan imposed tough terms; in addition, senior management was replaced, and
shareholders lost almost all of their investments. However, because the firm
avoided a declaration of bankruptcy, creditors of AIG were protected.

In my view, preventing the failure of AIG was the best of the very bad
options available, but it nevertheless involved major costs, including
financial risks to the taxpayer. The American people also quite correctly see
as unfair that AIG was saved from bankruptcy because of the dangers to the
system that its failure would have posed, even as many other companies,
including nonfinancial and smaller financial firms, have not received the same
treatment. Allowing AIG to at least partly avoid the discipline of the
marketplace also sets a bad precedent.

For these reasons, it is essential that we make changes to the financial
rules of the game to prevent a similar episode from occurring in the future.
First, we must ensure that all types of financial institutions, especially
large and interconnected ones like AIG, receive strong and effective government
oversight. AIG's regulatory oversight was limited, which allowed it to take
dangerous risks largely out of sight of federal regulators.

Second, the AIG experience demonstrates that federal regulators urgently
need a new set of procedures for dealing with a complex, systemically important
financial institution on the brink of failure. Such rules already exists for
banks: If a bank approaches insolvency, the FDIC is empowered to intervene as
needed to protect depositors, sell the bank's assets, and take any necessary
steps to prevent broader consequences to the financial system. However, for an
insurance conglomerate like AIG, or for a large financial holding company that
owns many subsidiary companies, these rules do not apply. Among other things, a
good system for resolving nonbank financial institutions would allow federal
regulators to unwind a failing company in ways that minimize disruptions in
financial markets. An effective regime would also provide the authorities
greater latitude to negotiate with creditors and to modify contracts entered
into by the company, including contracts that set bonuses and other compensation
for management. More generally, we need significant reforms to financial
regulation and financial practices that will reduce the risk of future
financial crises like the one we are currently experiencing. The Federal
Reserve strongly supports such reform efforts.


Conclusion
The current crisis has been one of the most difficult financial and economic
episodes in modern history. Recently we have seen tentative signs that the
sharp decline in economic activity may be slowing, for example, in data on home
sales, homebuilding, and consumer spending, including sales of new motor
vehicles. A leveling out of economic activity is the first step toward
recovery. To be sure, we will not have a sustainable recovery without a
stabilization of our financial system and credit markets. We are making
progress on that front as well, and the Federal Reserve is committed to working
to restore financial stability as a necessary step toward full economic
recovery.

I am fundamentally optimistic about our economy. Among its many intrinsic
strengths are universities and colleges like Morehouse, which help talented
students gain not only a command of a body of knowledge but also the capacity
to think creatively and independently. Institutions like this one train the
professionals, entrepreneurs, and leaders who will shape our economy in the
future. Today's economic conditions are difficult, but the foundations of our
economy are strong, and we face no problems that cannot be overcome with
insight, patience, and persistence. The Federal Reserve will certainly do its
part to help restore prosperity and opportunity to our economy.

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Mortgage Interest Rate History, and a Change for the Future





Today's economy is very dependent upon mortgage
interest rates. Right now the interest rates are very low.
This, of course, is good. Today, a 30-year mortgage can be obtained for about
6%, maybe less. At 6%, a $200,000 mortgage for 30 years would result in a
monthly payment of $1,199.10.

What would happen if mortgage
rates suddenly went up to 10%? Well, this same mortgage would
require a monthly payment of $1,755.14. It doesn't take much imagination to see
that this would have a negative effect on the overall economy. Someone
requiring a $200,000 mortgage to buy a home, would need to be able pay $550
more per month to qualify for the same loan.

To the economy, this is wasted money. If a person was required to come up with
$550 more per month to buy the house because the price was that much higher, it
would be negated by the fact the seller would have made more money by selling
the house.

If the seller happened to be an entrepreneur, this extra money would end up
creating more jobs. In any event, the extra money would be put to some use in
our economy, even if it were just put into a savings
account. However, paying a higher price because interest
rates are higher means no one gains anything. This, in itself, would cause an
economic slowdown.

However, interest rates are good and have been for quite some time. So, you may
ask how do these interest rates compare with other rates throughout history?

Fannie Mae and interest rate stability

In 1938, Fannie Mae was instituted. This put mortgage rates into a particular
market. Before this time, mortgage rates varied wildly from lender to lender
and between different areas of the country. With Fannie Mae, loans could be
sold between different institutions. Having more people involved in a market
tends to stabilize the price of the underlying commodity.

Back in 1938, there wasn't a lot of money around. Because of this, mortgage
rates were very low, as low as even 3%. In the '40s mortgage rates stayed low
in part because during wartime most of the economy was regulated and buying a
house was very difficult. So, there wasn't a lot of demand for mortgage money.

The early mortgage rates

In the '50s and right up until the mid '60s mortgage rates hovered around 5% to
5.5%. This is very close to where mortgage rates are now. However, starting in
1971, mortgage rates started to increase. In fact by the late '70s, they had
become out of reach. People who didn't enjoy a top credit rating were asked to
pay as much as 23% for a mortgage. This of course, was devastating to the
overall economy, so much so, a misery index was even created to gauge how bad
consumer sentiment was.

Controlling the price of oil is not a new idea

Part of the reason interest rates were skyrocketing during the '70s, was the
fact price controls were tied to oil prices. This had a very negative effect on
the overall economy. It made gas unavailable to consumers and disrupted the
normal American way of life.

Starting in the early '80s, Reagan-omics started interest rates falling once
again. This trend, which started in about 1983, has not ended yet. The interest
rates of the '90s ranged between 7% and 9%. Since about 2001, they have been
between 5% and 7%. All in all, for the last 20 years we've enjoyed moderate
interest rates.

Now that we're a closing in on a 50-year low for mortgage rates, it makes us
wonder if this downward trend is ending and if mortgage rates will once again
head upward. When I think of the possibilities, I must say I am petrified!

Is anybody for a change?

In this presidential election year, I hear many people say they're looking for
a change. To me, this means interest rates being low is not what these people
are looking for. Perhaps they would like interest rates at 15 to 20%. In their
quest for change it would mean they would have to give up on the war against
terrorism. This is a war we are winning, but change would mean they're looking
to lose it.

Though the economy is no longer screaming along as it did for most of the last
23 years, the economy is not in a recession.
In fact, it's not really close. But change would mean a recession. A profound
change would mean a depression.

In our current economy the unemployment rate is about 5.2%. Not long ago, full
employment was considered an unemployment rate of 6%. Within the last two years
the unemployment rate reached an all-time low of 4.5%. However, people are
looking for change. Perhaps the German-French style 13% unemployment rate is
what they desire!

During the last 20 years, we've made many trade agreements with other
countries. This has resulted in lower prices to consumers and lower prices to
small businesses. This has been healthy for our economy because it has allowed
the small businesses to expand and create. It has also allowed people to save
and invest.

Those looking for change want to do away with our trade agreements with other
countries. They have bought into the notion that free trade exports jobs.
However, without free trade the common PC would cost about $15,000. This would
be a change!

In 2003, our income tax rates were lowered. This has been very healthy for our
economy. One of the changes some are looking for is to raise those income taxes
again.

Worst of all, another one of the changes would be following those who want to
put price controls on oil again. This would do the trick! It would indeed, mean
change. Are you ready for 23% mortgage rates?

About the Author



Ed Lathrop is a series 3 commodities futures broker. He has extensive
knowledge of the economy in general. He has developed EzCalculator, a Mortgage
Calculator that includes the famous "How to Make $100,000 on Your
Mortgage" calculator. Free Financial
Calculator! get as many free amortization schedule printouts as you want
at: Amortization Schedule Free.
These sites are not affiliated with any lender.

11:00 PM: I crawl into bed. Wow, I’m going to get almost 7 hours of sleep!


Day 3

6:00 AM: Wake up. Back at it…


48 Hours in the Life of a Sales & Trading Intern: Japan

The following takes place between 6 AM and 6 AM, at a large investment bank in Tokyo. Events occur in real time.

6:00 AM: The alarm goes off. I really want to snooze but via sheer willpower I jump out of bed – need to impress my boss and co-workers.

6:30 AM: For my breakfast, I buy bottled tea and onigiri (rice balls) at a convenience store. I listen to the Nikkei Shimbun (analogous to the Wall Street Journal) podcast while walking to work.

6:50 AM: I am one of the first people at the
office. I breathe a sigh a relief after confirming that my boss isn’t
here yet – sometimes he comes in early too.
I had promised myself that I would prove to my boss what a
hardworking intern I am. I hastily start the menial task of copying and
passing out materials (e.g. research reports, recap of other world
markets, latest rates data, etc.) to each trader’s desk. I wonder how
many of the traders actually read what I pass out.

8:00 AM: The trading desk is almost full now. I am
skimming articles on financial websites and Bloomberg, preparing myself
to sound well-informed on the markets when talking to people for the
rest of the day (Note: Many trading interns do not get access to
Bloomberg since it is very expensive… to the tune of $1500 USD per
month). I try to predict how the news will affect the markets for the
day.

8:15 AM: All the equity traders have arrived at their desks – fixed income trading
is on another floor. Everyone gathers for our morning meeting. Some of
the salespeople that work with the traders float over to listen in.
Traders that specialize in each sector or type of trading – vanilla
equity, options, portfolio trading, agency trading, etc. – give quick
overviews of what happened the day before and their predictions for the
upcoming trading session.
What happened overnight in the US/European markets is also naturally
a point of discussion, since markets tend to follow each other.
Sometimes I struggle to understand all the jargon or the specific
concepts underlying their comments, but overall I can grasp what
they’re saying. Everyone speaks in English at the meeting, but many
revert to Japanese afterward.
9:00 AM: The Japanese stock markets open. Today I
am spending the first couple hours sitting next to an equity options
trader, having gotten his permission the day before. I make sure to
stay especially quiet right before and after the market close, since
those are the busiest times for traders.Out of his 6 monitors,
he has Excel open on 2 screens, Bloomberg open (usually charts) on
another 2 screens, Reuters open on 1 screen, and another screen for
Microsoft Outlook. The numbers in Excel update every second. I see the
trader wrinkle his eyebrows and I wonder why.

10:00 AM: I wait for a moment when the trader seems less busy, and I ask him
about what happened. Apparently his gamma had not been hedged as well as he had thought
– shortly after the market opened his gamma rose to a higher level than he had anticipated,
which meant more risk than he wanted.
I nod in appreciation; I know that some other traders would not have bothered to answer my question.

11:30 AM: Today is a volatile day in the market,
and many traders don’t feel comfortable leaving their desks for lunch.
I am sent to McDonald’s to buy burgers for most of the equity traders.
I’m OK with doing a bit of grunt work; after all, I am an intern, and
I’m way better off than the interns in Liar’s Poker.

12:30 PM: By now my eyes and neck are a bit sore
from looking at the equity trader’s 6 screens while sitting at the edge
of his desk. The market is slowing down a bit now anyway, so I return
to my own desk and read some articles and midday market recaps.
I work on the stock picking analysis project that my boss assigned
to me, but I know I won’t be able to get any serious work done until
the late afternoon.

1:30 PM: I figure I’ve annoyed the equity option
trader enough for the day, so I try to find someone else on the desk
that’s approachable enough to let me sit by them. I end up sitting next
to an equity trader who focuses on retail stocks. Unfortunately, he is
one of the more introverted types, and it’s hard to get him to say
much. I see him make two trades for the rest of the day.

3:00 PM: Japanese stock markets close. Of course,
there’s still after-hours trading, and much work to be done. I see the
equity options trader I sat with get up and go to the coffee room. I
“coincidentally” happen to go to the coffee room for a break.
There, I thank him again for letting me sit with him, and I do the
best job I can of commenting on what happened in the market that day,
while asking his opinion on a few points.
He comments that I am pretty knowledgeable for an intern, and it
seems like I have made a good impression on him. I think to myself,
“Yes…. one step closer to getting a full-time offer…”

4:00 PM: I go out for coffee with a guy from the middle office, an appointment made previously. He’s one of the junior guys, so he’s not too much older than me.
As an intern, not everyone is willing to go out to coffee with you –
and sometimes you can learn a lot from people other than the managers
and star traders.
I milk him for information: Which traders are more approachable?
Exactly how do you interact with the traders? What happens when a trade
doesn’t settle correctly? We also bond by talking about which girls in
the office are cute.

5:00 PM: My manager takes me to a small conference
room for my 10-minute weekly meeting. How much have I learned so far?
Which type of trading was I most interested in? Did I have any
questions? He reiterates that the competition is tough and that I’ll
have to keep working really hard to impress everyone if I want a
full-time offer.
5:30 PM: I start working on my stock picking
analysis project once again. By downloading data (both fundamental data
and technical analysis data) from Bloomberg into Excel on thousands of
stocks, I try to figure out a handful of stocks that would be good long
trades, and some that are good short trades. This is only one of
several projects I am working on.

7:00 PM: Many of the traders have left their desks
by now. I wander around the trading floor trying to find someone who’s
not in a hurry to go home, and I try to start a conversation to learn
something about their trading that day.
Sometimes traders are more relaxed at this time of the day and it’s easier to talk to them.

7:30 PM: I get an email with a link to 50-page economic report from the research team. I interrupt my work to skim the report.

8:00 PM: Almost all of the traders have left the office. Why is my manager still here?

8:30 PM: My manager finally goes home. Whew. I try
to wait at least 15 minutes after he leaves so it doesn’t look like I
am leaving right after he does.
While there’s less face time in trading compared to investment banking, you still don’t want to leave before your boss – especially as an intern.

9:00 PM: Meet up with a friend and some of her
friends for dinner. Most of them are done eating by the time I arrive,
but at least I get to say hi.

11:00 PM: Arrive at home. I plan to go to sleep
within 30 minutes but after checking email, I end up staying up past
midnight. I cringe when I think about how hard it’ll be to wake up the
next day. Then I think about my investment banking intern friends – who are still at the office – and I feel a bit better.



Day 2

5:40 AM: Wake up. I had set my alarm earlier
because the day before I had trouble finishing the grunt work on time.
I pummel my own head in an attempt to feel awake.

6:30 AM: I arrive at the office… and there is only
one other person there. Hmmm, am I working too hard? I tell myself
it’ll all be better once I am a full-time employee – which is usually
true, at least in trading – and then I begin copying research materials
that need to be passed out later.

7:00 AM: The copier is jammed, and I didn’t notice for 15 minutes. Crap. I start to multitask, using 3 copiers instead of 2.

8:00 AM: Today, before the general traders’ meeting, I go to the agency traders’ smaller meeting,
which is only in Japanese. The agency traders are responsible for
executing the large orders placed by large buy-side institutions, like
mutual funds. They talk mostly about news and overseas market movements, but they
also talk about the previous day’s order flow, and about how a research
report produced by our firm today might cause a lot of orders for a
specific stock. The meeting lasts about 10 minutes.

9:00 AM: The Japanese stock markets open. Today I
am spending the first couple hours sitting with the agency trading
team. Agency trading is really different from proprietary trading
because all the decisions about what and how much to trade are decided
by the client – the only decision made by the trader is how to divide
the order into smaller trades and when to execute them.
The trader I am sitting with has been doing this for years, and is
able to constantly submit trades while barely looking at the screen and
talking to me at the same time.
I pray that his discussion with me doesn’t cause him to make any mistakes. Fortunately, he doesn’t have fat finger syndrome.
The trader has 4 screens – 1 for order submission and order details, 2
for Bloomberg (charts), and 1 for email / browsing. I am able to ask a
dozen or so questions, which is more than usual.

11:00AM: The Japanese market closes for the lunch
break (1.5 hours). I go out to lunch with the agency traders, who have
less work than the other traders since they don’t have to do as much
analysis. Half of our conversation is about trading, and the other half is
about Japanese celebrities. My knowledge of celebrities helps me bond
with them… which might increase my chances of getting a full-time
offer? I later realize that bonding with traders and being liked are quite important for getting an offer.

M&I Note: This is an important and oft-overlooked point. As an intern, people need to like you if you want a full-time offer – and the same goes for entry-level interviews as well.

12:30 PM: Since the agency traders don’t seem to be
annoyed by me, I keep sitting with them until the markets finally close
at 3 PM. I start to get bored and tired near the end, but I keep myself
busy thinking of new questions for them.

3:30 PM: I had previously made an appointment for
coffee with one of the sales traders, but he cancels on me for the
second time. Maybe I just should give up on talking to this guy.

4:00 PM: The Head of Prop Trading is having a
meeting with some other traders and some middle office guys and
suddenly calls me and another intern into the meeting. He wants me and
the other intern to help with trading commission calculations, and I
have to collect some of the information necessary to do so myself.
I am surprised that a bulge bracket investment bank doesn’t
precisely track its trading commissions – but later, I realize that
even the biggest financial institutions are full of problems you
wouldn’t expect. I think about how I already have a big trading analysis project AND
an equity research project AND grunt work AND other random stuff I have
to do, but at the same time I can’t bring myself to say no. This guy is
an MD, so I’ve got to impress him. Fortunately the other intern pipes
up and finds excuses for why we can’t help.

4:30 PM: Afternoon snack. I go downstairs and make
sure nobody I know is in the room, and then I eat a sandwich while
massaging my eyes and neck. I don’t want to come off as stressed or
physically strained to anyone.

5:00 PM: I spend an hour trying to figure out some
Excel VBA for automating organization of data in the trading analysis
spreadsheet I’m making. After some trial and error, I get it to work.
The other intern sucks at Excel and is having trouble doing his
analysis, so he comes to annoy me with questions. I wonder why an MBA
knows less than me about Excel.

7:30 PM: I eat some ramen. Mmmmm. No matter how unhealthy or cheap it is, I still love ramen.

8:00 PM: I feel really tired, so instead of working
on my project I just read tons of financial articles. Nobody is paying
attention to what I’m doing, anyway.
8:30 PM: Half of the trading desk is still here,
mostly junior people. What are they still doing? I go over and talk to
them – they are planning and analyzing trades for the next day.
I conclude that if these people weren’t workaholics, they probably
wouldn’t be here. Then again, if you’re making or losing millions of
dollars every day, sometimes overnight, maybe you’d never be
comfortable being away from work anyway.

9:00 PM: I go home and cook noodles with canned
fish, seaweed and soy sauce and eat them while watching Japanese music
videos. Actually, it’s a pretty good way to cool down. I read a chapter
of Future, Options, and Other Derivatives by John Hull.

11:00 PM: I crawl into bed. Wow, I’m going to get almost 7 hours of sleep!


Day 3

6:00 AM: Wake up. Back at it…

Nice article about working in a jap ibank batman. I think many people in this forum can appreciate what this intern is going through. Its a nice affirmation that at least for me and you that we are doing the right thing.

http://siliconinvestor.advfn.com/subject.aspx?subjectid=57934 --> people post their trades if they do well> good for confirmation to see what other tradres are doing and what side of the trade they are on.

http://www.schaeffersresearch.com/ -> excellent resource for options and multi-legged strategies ( EXTREMELY COMPLICATED). Though also good for getting option data and pricing and open interest


http://finviz.com/ --> want a quick market snap of the biggest gainers and loosers? Across all markets and very useful.

More from Bulge Bracket S&T via: Mergers and Inquisitions.

=====================================================================

Trading is divided into groups depending on whether or not you have clients or you’re making your own decisions – agency trading and prop trading, and then the gray area of flow trading in between.

And then it’s also divided according to what you’re trading – stocks, bonds, currencies, or derivatives of those.
Originally Fixed Income
was supposed to mean only securities that involved debt, but these days
FX and commodities traders are often put under the umbrella of “Fixed
Income” as well inside investment banks.
Similarly, “equities” originally just meant trading stoc ks of
companies, but these days it has expanded to cover a couple different
areas.
So let’s delve in and see what you do in equity trading besides gambling, eating junk food, and abusing interns.

Agency Trading
This is the most basic type of equity trading: you work at a
sell-side financial institution, like a large investment bank, and you
execute orders for clients throughout the day.
You don’t make decisions on what or how much to buy – you just take what the client wants and you make it happen.
Why do they need to go through an investment bank just to buy or sell stocks? Couldn’t they just use E*TRADE?
No – because of the size of the transactions.
Let’s say that a mutual fund wants to buy 1 million shares of
Microsoft – if that order were placed immediately, it would be too big
for the market to absorb and it would disrupt the share price by quite
a bit if they attempted to buy all 1 million shares at once.
So it’s your job to divide this into smaller pieces and buy a portion at a certain interval throughout the day, or through another period of time – usually you follow a fixed schedule for buying the stock (e.g. every 20 minutes).
The only thing you control is how to vary the order timing and order
routing – if you work in the US you have more control over these
variables because of the sheer number of ECNs (electronic communication networks) and dark pools. In other markets you don’t have as many options.

Pros: If you’re interested in trading but you’re
not quite ready for more advanced jobs, this could be a good fit to get
your foot in the door.
Also, the work hours are much shorter than most other jobs in finance:
you might arrive right before the market opens and leave right after it
closes; there’s not much analysis to do since you’re not making your
own decisions on what to trade.

Cons: The job itself can be boring at times, and you don’t have many exit opportunities. Also, more and more agency traders are being replaced by automated trading algorithms over time.

Proprietary Trading – Plain Vanilla Equity
Plain ol’ stocks. As cool as “synthetic collateralized mezzanine
bespoke hybrid exotic derivatives structuring / trading” might sound as
a job title, there are still plenty of benefits to being a normal stock
trader.

This is the opposite of the agency trading discussed above, because you’re making your own trading decisions and there are no clients.
You don’t have to deal with too many logistical or IT issues that come with trading over-the-counter instruments,
and the market liquidity is excellent in developed markets – so you
don’t have to worry about not being able to exit your positions.
Bid/ask spreads
are small, trading fees are low, and if you make a mistake you can even
undo your trade immediately without much damage. (Note: the Obama
administration is currently considering implementing a trading tax that
may slightly increase the costs of trading)
The only problem is that there are so many market participants that it’s very difficult to find great trading opportunities that everyone else has missed.
Usually you focus on a specific sector and you hold positions for a
few days to several weeks; you normally do both micro- and
macro-analysis, though there are some traders who ignore the
fundamentals and just focus on technical analysis.
You don’t need to be a rocket scientist to do the job: you just need to be good with numbers and a quick decision-maker.

Pros: More interesting work than agency trading;
better exit opportunities within trading; potential to make more money
than agency traders.
Cons: Hours tend to be longer, especially if you
need to do a lot of analysis; you could argue it’s still less
“interesting” than trading more exotic securities.

Proprietary Trading – Equity Derivatives
There’s a smorgasbord of derivatives based on equities, but here I’ll just focus on the most basic one: options.
They’re generally riskier than plain vanilla stocks and require more
skill to trade: the bid-ask spreads are higher, there’s less liquidity
than with stocks, and any one stock could have a few dozen different
options with different strike prices and maturities.
There are also more inputs in valuing the options: just as one
example, you need to decide what measure of volatility to use, which
makes the task considerably more complicated than just valuing the
underlying stock.

The coolest part about options is that you can make a LOT of different types of trades.
One common example is a straddle
– buying a call option and put option at the same strike price, which
gives you a positive payout if the stock moves up or down past a
certain amount by maturity.
Even the names themselves sound pretty creative: besides the straddle, you’ve also got the butterfly, the iron condor, and the strangle.
You can also come up with all sorts of crazy payout profiles of your own by combining options and plain vanilla equities.
Leverage is also built into options, so you can easily quadruple the money you put into one stock option: the risk management department
would never let you put most of your money into a single option, but
even trading smaller amounts of money gives you an adrenaline rush with
options.
Even though more math is required, you still don’t need to be the
next Isaac Newton to trade derivatives: being able to derive the Black-Scholes equation from Ito’s Lemma isn’t necessary.
However, you do need to understand the Greeks
– how an option’s price responds to changes in time, interest rates,
volatility, the underlying stock price, and more. You also have to be
good with Excel because you need to make more calculations than plain
vanilla equity traders.
Pros: More “interesting” and quantitative than
plain vanilla equity trading; you can be more creative in devising your
own trading strategies.
Cons: Again, hours are longer than agency trading; more quantitative ability is required; as you move up and become more specialized your exit opportunities also narrow.

Algorithmic Trading
No, I’m not talking about the trading robot here (please don’t fall for that scam).
Also known as algo-trading or program trading, in algorithmic trading you don’t actually trade anything yourself: you just program a computer to trade for you based on technical analysis, market volume, or even parsing news headlines.
To do this, stock analysts need to look at historical market
patterns, programmers need to implement the system, and everyone else
needs to use, monitor, and configure the system.
Sometimes algo-trading is 100% automatic, but it can also be combined with human trading.
Some hedge funds do 100% algo-trading and have performed well – but
ever since the financial crisis and the onset of apocalypse in the
markets, many previous market patterns stopped holding true.
The result: trading algorithms that had made a lot of money in the past started to lose money in 2007 and 2008 and thousands of hedge funds and trading firms collapsed.
That’s not to say this is a “bad” field to go into: it’s just that
the financial crisis made it necessary for trading algorithms to change
their assumptions, and that may mean more challenges for those
designing the algorithms.
When people say algo-trading, you would normally think of
proprietary algo-trading – but there’s actually agency algo-trading as
well, which focuses on how best to execute a client’s trades.
If you’re coming from a highly analytical or IT background,
you like working with data, and you want the thrill of huge trading
profits without having to stare at charts every second, this could be a
good option for you.
Pros: What could be better than machines making
money for you when you’re not even there? Also, this is a good option
if you’re from a more technical background and you want to move into
finance. Since there’s analysis and programming, you can also exit to
non-finance jobs more easily.
Cons: Financial crisis will present new challenges
for trading algorithms; also, a lot of the work in actually creating
the algorithms and sifting through data can be rather tedious.

Exit Opportunities
Not too much is different here vs. fixed income: you either stay in
trading at an investment bank, or you move to a hedge fund or prop
trading firm.
Or if trading is not for you, you move to a different industry.
If you haven’t been in the field too long then it’s possible to move
over to investment banking or others in your bank – but if you start
out a hedge fund or prop trading firm, your mobility is more limited.
All of the above is true for the same reason it’s true of fixed
income: your skill set is more specialized than, say, an investment
banker’s, and on paper most of what you do doesn’t seem relevant to
other fields.

Fixed Income Trading at an Investment Bank....



Fixed Income

Originally, Fixed Income meant that whatever you
traded had a “fixed” income stream – think bonds, loans, or anything
else based on bonds or loans (derivatives). If it paid a certain
interest rate and was redeemed at the end of a specified period, it was
fixed income.
But once clever bankers started creating collateralized debt
obligations (CDOs) and other fancy instruments that no one really
understood, the term “Fixed Income” lost its meaning – all of those
were placed into this category, even though nothing about them was
“fixed” other than the potential to destroy the economy.
Prices of these securities are affected mostly by interest rates set
by the Fed and by the credit quality of the corporate and government
issuers.
FX and commodities traders work closely with those in Fixed Income
and they are often classified in the same group, even though nothing
about exchange rates or commodity prices is “fixed.”


Types of Fixed Income Trading
Groups are usually divided by the types of instruments you trade –
whether they’re relatively “safe” government bonds, more risky
corporate bonds, or even more exotic securities. Of course,
occasionally traders will venture a bit out of their own turf to trade
other instruments if it is allowed at their firm.


Government Bonds
This includes US government debt (notes, bills, and bonds, known as
US Treasuries), Euro-denominated German debt, and yen-denominated
Japanese government bonds. There are also others like
inflation-protected bonds, repurchase agreements, and bond futures.
Usually you only trade the government debt of one country, and if
your team is big enough you might specialize in a certain area like
5-10 year bonds.
Although government bonds are “safer” than other fixed income
securities, the job itself can be stressful because these markets are
constantly trading – even in off-market hours. And that means that you need to follow these markets, even when you’re out of the office.
Since there’s so much liquidity, you can take huge positions without
too much trouble (unlike, say, buying 20% of a company’s stock where
you would have to disclose it). Traders who bet on the US lowering
interest rates in 2008 made small fortunes by betting big.


The Work Itself
You spend most of your time as a junior trader predicting changes in the shape of the risk-free interest rate curve, because that is the #1 factor that impacts government bond prices.
There’s not too much valuation work; usually you just do simple DCF
calculations in Excel or on Bloomberg to get prices – it’s not like
investment banking or private equity where you use many different
methodologies to value companies. Your main concern is DV01, or how
much you make or lose for every 1 basis point move in interest rates.
If you like macroeconomics rather than analyzing individual companies, government bond trading may be good for you.


Corporate Bonds and Credit Default Swaps
Corporate bonds are just like government bonds, except companies
issue them so there’s always the chance of default – and the yield is
higher to compensate for that.
If you’re working with smaller or non-US/European companies, you
need to watch the news constantly to stay on top of things – but
compared to government bond trading there’s less emphasis on macroeconomic happenings.
Credit Default Swaps (CDS), meanwhile, are like insurance on bonds: they’re derivatives that let you separate
the risk of default from the risk of interest rates falling, so you can
effectively “insure” yourself against losing your investment.
Most banks combine these two groups, since the value of corporate bonds and credit default swaps are closely related.


The Work Itself
You spend most of your time analyzing the credit profiles of
different entities and weighing the bond yield against the risk of
default – so you follow both company-specific and macroeconomic news.
You analyze credit profiles by looking at the financial statements
of a company, the sector as a whole, and companies’ credit ratings.
Some say the work is more “interesting” than government bond trading because you’re working with different companies and because there are more trade possibilities – buying one company’s stock while shorting competitors’, for example.
These days it would be tough to get a job in this division due to
the financial crisis and the sheer number of credit teams that have
been laid off.
CDS may become more “standardized” on an exchange, which might
improve liquidity and transparency – so opportunities there may return
in a few years.


Structured Credit Trading
Of the different Fixed Income groups here, Structured Credit Trading is the most different because they don’t spend all their time checking the market and keeping up to date on the news.
Instead, they price and package complex financial products in Excel and then sell them to investors.
They don’t make trades every day, but when a trade does happen it
could be for an amount of hundreds of millions or billions of dollars –
compared to the other two groups above, where the size of individual
trades is typically much smaller.
Although Structured Credit Trading is the most “quantitative” of
entry-level Fixed Income jobs, you don’t need a Math Ph.D. or anything
because you don’t actually create the tools used to price complex securities – that’s for the Ph.D.-level quants. You just need to understand the tools and how to use them to create your own products.
You don’t spend much time looking at individual companies, since
most of these “financial products” involve hundreds of companies.


The Work Itself
See above. You spend a lot of time in big Excel spreadsheets figuring out how to price different securities. This is more quantitative than what you do in investment banking or private equity
– in those fields, you mostly just do addition and subtraction, and
sometimes multiplication or division if it’s super-advanced.
Right now it would be very difficult to actually get into Structured
Credit Trading because of the financial crisis – most groups have been
hit hard, just like everything else related to credit.
However, in the long-term there will still be possibilities here, so
it’s something to consider if you’re still a few years away from
looking for internships or jobs.

Do yourself a favor and learn about the Money Supply:

http://economics.about.com/cs/money/a/reserve_ratio.htm
http://economics.about.com/cs/money/a/reserve_ratio.htm

http://www.investopedia.com/articles/04/092904.asp

http://pages.stern.nyu.edu/~adamodar/pdfiles/papers/VAR.pdf

http://en.wikipedia.org/wiki/Value_at_risk

Lets learn VaR !!! Start incorporating this in spread sheet analysis on your trades and pitches!

http://www.hedgeco.net/hedgeducation/industry-overview.php

Good intro to hedge funds!