July 2000 Newsletter
Issue Seven, Volume One

IT JUST NEVER STOPS, DOES IT?

By Mike Gasior

Well just when I thought the pace of change on Wall Street could not pick up anymore, it does anyway. This month's newsletter is jam packed with all sorts of breaking news items relating to all sorts of things affecting the people who process, account, audit and build systems for securities. I'll try to cover them in order of pressing concern and not necessarily importance.

Thank you all for the continuing deluge of notes both pro and con about this newsletter. Although I must accuse some of you of trying a bit too hard to get your quote into some future issue. Honestly, I don't even give you guys credit by name when I use one of your comments for God's sake. So I am a bit taken aback at the lengths to which some will go to get a mention. It does, however, explain that small segment of society which is showcased on the "Jerry Springer" show. Luckily 99.9999% of my audience is sane (at least outwardly) and the remaining fraction of a percent should never be too far away from their next Thorazene milkshake.

Imagine me having to endure this conversation:

Reader: "Mike, your opinion of the whole NASDAQ thing is ridiculous."

Mike: "Ridiculous? Why?"

Reader: "Because it's got to keep going up."

Mike: "It's 'got to'?"

Reader: "Sure. Where else are people going to be put their money? Plus, there is all that 401K money pouring into the market which is going to drive the indexes up for years to come."

Mike: "And then what's going to happen?"

Reader: "When?"

Mike: "After all those 'years to come'?"

Reader: "What do you mean?"

Mike: "I mean, after all that 401K money stops pouring into the market."

Reader: "Why would it stop?"

Mike: "Well you mentioned the indexes going up for 'years to come'. I'm asking you when you think that's going to stop."

Reader: "It's not going to."

Mike: "So when does the market finally come down?"

Reader: "It doesn't."

Mike: "Ever?"

Reader: "Well, not ever. Just not soon."

Mike: "But someday it will?"

Reader: "Sure. Maybe. Someday."

Mike: "But don't some of these valuations worry you?"

Reader: "Value doesn't help you pick stocks anymore. Value doesn't matter and it's overrated. This is the New Economy and older people like yourself look at things that are obsolete now."

Mike: "Older people??!! And what sorts of things are you talking about that we shouldn't be looking at anymore?"

Reader: "Like earnings and assets and stuff like that. This is the New Economy and Old Economy stock market data is a thing of the past. You have to forget all that stuff you learned and study the new measures. I still can't believe how much people still care about Alan Greenspan and Warren Buffet. These guys are dinosaurs. Even that George Soros guy. His days are over."

Mike: "Like what new measures should us dinosaurs being looking at?"

Reader: "Revenues. Hits. Stickiness. That sort of stuff."

Mike: "Can I pay my debt service with website hits?"

Reader: "What?"

Mike: "Can I meet my payroll with stickiness?"

Reader: "Umm. No."

Mike: "Can the New Economy fly me to LAX or build me a sexy red convertible with leather interior?"

Reader: "Of course not."

Mike: "Doesn't any of that bother you?"

Reader: "Should it?"

Mike: "Oh dear God....."

If you happen to think even a single word of that conversation is fiction, I can completely assure you IT IS NOT. Well this is what it's like to be me. I'm beginning to feel like that kid in the movie The Sixth Sense. Why does everything seem to be making itself available for me to see, and no one else seems to be seeing it; "I see dead companies.....". So keep those cards and letters coming and now onto the subject matter for this month.

DECIMALIZATION - MY FINAL WORD ON THE SUBJECT

It was delayed as told to you in this newsletter a month ago. The new dates have been chosen and the phase-in will begin in September on the New York Stock Exchange with a select group of stocks then will be phased over the coming months.

On September 5, 2000, about 50 stocks on the New York Stock Exchange will begin to trade in decimals with all 3400 or so issues moving to decimals by April 2001. The NASDAQ, which initiated the delay by claiming that increased trading volumes have prevented their members from thoroughly testing will begin their changeover by March 2001. All stock and option markets will be quoting in pennies by April 2001.

Arthur Levitt, Chairman of the SEC, stated that "Investors may benefit from lower transaction costs due to narrower spreads, and prices will be easier to understand." While I completely agree with Mr. Levitt's opinion on this matter, the fact is that plenty of securities are still going to be quoted in fractions for the foreseeable future. For example: Treasuries, Mortgage Backed Securities, Muni's, Corporate Bonds, Asset Backed Securities and many over-the-counter derivative products are among this group.

Remember what I also have mentioned previously in this newsletter; the U.S. is going to be the LAST major world market to move to decimal pricing. Nearly all of Asia, Europe and Canada have been trading in decimals for years and years now. And the NYSE and the NASDAQ won't even be the leaders here in the States either. Island ECN, which is one of those alternative after- hours markets will start trading in decimals next month (July 2000), with many U.S. newspapers already underway with their changes to quoting stocks in decimals right now.

T+1 POSTPONED? PIPE DREAM OR NIGHTMARE?

Back in May, the Securities Industry Association had an Operations Conference where there was heavy conversation about the move to a T+1 settlement cycle in June of 2002. As I read the comments of some of the conference attendees there seemed to be almost a consensus that the date would be pushed back to 2003 or even early 2004. There were even comments by some that the whole idea of the U.S. moving to T+1 in two years was a "pipe dream".

Well, for the sake of my audience, I certainly hope they're right this time. The move to T+1 was going to be, and still IS, a nightmare for the industry and everyone involved in the process. I heard remarks about how the SEC put the date of June 2002 out there just to scare the industry into action, and that without a deadline to meet, there would have been no sense of urgency. The idea was that if the SEC set a date where everyone would be looking, then at least the process might get underway and senior management might begin funding and working on the problem. Attendees of the conference agreed that it certainly has. Global Straight Through Processing is now on the front burner at most buy and sell side firms.

Here's my feeling on the matter; Why in the hell would a large federal agency like the Securities and Exchange Commission actually study a matter and put forth a date that they truly didn't mean to be serious? Do they actually think like that? Sort of like the school principal making you sit in the office while you wonder what your punishment was going to be, and the wait being worse than whatever punishment they could dish out. Or could it possibly be the industry who is hoping that the whole T+1 thing gets postponed so they'll have more time to deal with it? If I didn't mention it previously, all those remarks about how it was a "pipe dream" were all industry people. Not a single person from the SEC or other such regulator made a comment like that. Hmmmmm.

So you make your own judgement, but I don't know if I could gamble my company's future on a hope that the SEC is going to back off their date of June of 2002 for T+1. They haven't said "Boo" to that effect. Plus you should weigh what makes the most sense when you hear these "rumors" about the date being pushed back. Hey....if it doesn't fit, you must acquit.

THE INTEREST RATE CLIMATE

At the most recent Federal Reserve meeting June 27th and 28th, the Fed decided to keep interest rates unchanged. However they warned that they might still consider an increase later this summer if the economy doesn't cool somewhat. The response of the bond market in recent weeks has been a slow decline of longer term rates. We have seen a recent cresting of mortgage rates as well.

So what does all this mean for the markets and why should you care? Well there are a couple of things to be concerned about.

The recent trend among many participants in the fixed income markets has been to move money away from traditional bonds and toward the Mortgage Backed Securities market as spreads over Treasuries were getting wider and wider. This included all sorts of CMO products as well. They also hedge many of their interest rate investments and liabilities with interest rate derivatives like Swaps, Caps, Floors, Collars and Futures products.

Now bear with me here for a second, but I have this gut feeling that the economy has begun to slow pretty well already thanks to the moves by Greenspan and the Fed and there has even been recent evidence to that effect in various economic statistics. I even heard talk this past week about how Greenspan might actually be thinking that a recession might be a good thing for the economy at this moment in history. I don't give that rumor much weight, but I thought it provided some insight into what investors might be feeling about the economy. Now factor in the exploding price of fuel at this very inopportune time of year and I fear we could end up with a quickly slowing economy without any more moves to tighten by the Fed. Subsequently I feel we may have a rapid decline in rates. My feeling is that you might see the 30 year Treasury Bond somewhere in the neighborhood of 5.00% within the next 12 months. I would not be surprised that if an actual recession were to set in, you might see it lower than that. And don't you start thinking I'm insane all over again either. I am only suggesting a rate 90 basis points lower than where it stands as I type this.

If this were to happen, you would see the yield curve going back to a positively sloped position with longer rates higher than shorter rates. Currently the yield curve is inverted from about the two- year point; out to the thirty-year point; meaning the 2-Year Note is yielding more than the 30-Year Bond.

Okay. So what, you ask.

Well as rates begin to drop like that, the prepayment speeds of those Mortgage Backed Securities will start to increase until the cashflows begin to look like Niagara Falls. Perhaps asset/liability matches will become unmatched. At the very least those cashflows will need to be reinvested at these new, lower interest rates. This reduces margins. This reduces profits. This reduces the number of people the companies can employ profitably and these unemployed people contribute further to the underway recession. At the very least my securities operations and accounting people have an increased workload with these principal paydowns.

Let's not forget either about the implementation, finally, of FAS 133 which will require many investors to begin to mark much of their Derivative portfolios to market. This is no big deal if the assets and/or liabilities you are hedging are also being marked to market. But if those assets or liabilities are being carried at either cost, or amortized cost, look out. Any significant movement in interest rates in EITHER direction will have an enormous impact on the value of those Swaps, Caps, Floor, Collars and Futures. There might be many a senior executive choking on their breakfast when the reporting area breaks the news that they will be posting a HUGE gain or loss in the current quarter because of price swings in the Derivative holdings because of FAS 133. And right there you can see why I have always been against this new accounting standard. We all know that there will be companies whose senior executives will be unable to live with the bad PR of posting that gain or loss and might move to curtail their Derivative usage. That could ultimately prove to be a horrible idea, or even worse, suicidal. Any regulation which gives companies the disincentive to do the wrong thing is a bad idea. Remember one very simple and elegant thing: Companies that don't use Derivatives to hedge away legitimate business risks are MUCH riskier than companies that do. Period. Paragraph.

BERMUDA CONFERENCE IN NOVEMBER

The decisions are made, and the details will soon be posted on the Website at
http://www.afs-seminars.com The short story is that we will be hosting a week-long program in Bermuda beginning November 27th at the Sonesta Beach Resort in Southampton and the week will consist of five separate day-long programs. Our thought is this format will allow participants to construct a program of topics relevant to them, without having to sit through the other subjects. The topics to be covered and the dates are as follows:

Monday, November 27, 2000 - Equities Markets and Issues

Tuesday, November 28, 2000 - Debt Markets and Issues

Wednesday, November 29, 2000 - Mortgage & Asset Backed Securities

Thursday, November 30, 2000 - Derivatives

Friday, December 1, 2000 - Private Placements, Rule 144a and Restricted Securities

You may register for as many, or as few days as you wish and the program cost includes the seminar, training materials, continental breakfast, luncheon and snacks each day. Please call my office at (860) 347-6568 for more details. Printed materials will be available soon and they will be mailed to those of you who requested them.

REMINDERS

Also, the glossary of financial terms continues to expand. I am making an effort to constantly add new definitions, especially when readers bring missing terms to my attention. So please keep me up to date with terms you're looking for and can't find. I'll try to make the additions as rapidly as I can.

Copyright 2000, Michael Gasior. All Rights Reserved.

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