Tuesday, September 30, 2008
As I've said before the problem is not access to credit right now - it's liquidity. Many people today started down the right path by suggesting an increase in FDIC insurance limits (currently $100,000). In theory, this might draw some additional capital into the system, but frankly if I'm worried about losing money due to bank failures I would just put $95,000 in each of 10 separate accounts at 10 different banks, 5 of which I'd actually tell my wife about :)
However, the reason I won't move money out of money markets into the banking system is because the returns are so pathetic. Banks need money (deposits) and in a nation dictated by capitalist rules like supply and demand, they way to gain deposits is by paying an above average market rate.
If banks were to offer one year CD's paying say 7% and a national campaign was launched to encourage purchase of CD's as a patriotic act (like the old War bond commercials) money would flood the banking system (and while we're at it let's bump the insurance on these CD's up to $500,000). Yes, you say, but banks would get killed paying 7% interest for a year.
Here's where the government can play a role - the government could make up the difference between the market rate (about 4.5%) and the above market rate (in this case 2.5%). If the US citizens deposited a whopping $1 Trillion in 1 year CD's, the cost to the government would be $25 billion. The banking system would be saved, you and I would earn a decent return, capitalism can flourish again and American can regain it's status as a global financial power thanks to some creative thinking.
Unfortunately, we're going to proceed down the path of a bailout for the banks that has no guarantee of increasing liquidity and will likely lead to lower confidence in our US corporations (see the post on mark to market).
Oh, by the way, remember what caused all of this mess --- housing? Well, the numbers out yesterday continued to show substantial price weakness across the country. While the rate of decline slowed a little in July (the data lags by two months) there is no sign of a bottom.
"Little positive news can be found when cities like Las Vegas and Phoenix report annual declines as large as -29.9% and -29.3%, respectively, and all 20 cities are still in negative territory on a year-over-year basis. The Sunbelt continues to be the story, with the seven cities that basically represent that area reporting annual declines roughly between 20 and 30%. While some cities did show some marginal improvement over last month's data, there is still very little evidence of any particular region experiencing an absolute turnaround."
I had the opportunity to join Jeff Cole again via phone on WWNY's morning show. I was a little thrown by some feedback on my phone early on so excuse my deer in the headlights reaction to the first question.
It's too early to say what the new bailout package will include but I'll try to provide some color on the plan tomorrow.
Rarely are accounting rules exciting or for that matter even vaguely interesting, but the SEC and the Financial Accounting Standards Board have caved to political pressure on one issue that needs to be addressed. Politicians have been on a rampage over the past week in an attempt to eliminate the mark to market rule. In summary, the mark to market rule says that you need to report the value of your assets as if you were to sell them today. Given the illiquid markets in many securities today, this means that many financial assets would have to be written down because they have a lower value today.
"Blaming fair-value accounting for the credit crisis is a lot like going to a doctor for a diagnosis and then blaming him for telling you that you are sick.'' -Dane Mott , JPMorgan Chase & Co.
But despite calls to resist this change the SEC seems to be caving according to this article.
Under intense political pressure, regulators for securities and accounting standards this afternoon issued what they called a "clarification" to provisions that have come under fire from bank executives and some lawmakers for contributing to the credit crisis. Regulators said that the new guidance will help companies figure out the value of complex mortgage-related investments at a time when there are few trading partners willing to purchase them.
The three-page joint statement today from the SEC and the Financial Accounting Standards Board does not do away with fair value accounting provisions altogether. But it gives companies more leeway to employ estimates and their own judgment in many cases when they deem the market to be "disorderly" or seized by liquidity problems.
Let's say you invested your kid's college fund in Barry Bonds rookie cards for $50,000 in 2006. Now those cards are worth $2.33, but thanks to having "more leeway to employ estimates and your own judgement" you can tell your wife that the cards are still worth $50,000. Problem solved, right?
At a time when confidence in the quality of earnings by American companies is being questioned this type of financial smoke and mirrors game is a terrible idea. No one with any investing skill will ever consider investing in a company whose assets do not reflect reality but rather the estimated value deemed to be correct by the company themselves.
It strikes me as strange that none of the financial companies complained about fair value accounting when asset prices were rising, earnings were growing and bonuses were robust.
Monday, September 29, 2008
The markets were clearly in trouble early this morning as bank failures in Europe were signaling that bailout or no bailout, the global economic backdrop is deteriorating.
However, the one thing Wall Street hates more than yacht docking fees at the World Financial Center, is uncertainty. Despite the global upheaval in markets this morning (Asia and Europe were down 1-3%) most traders were confident that the bailout deal had been finalized and that the vote was merely a formality. I've been of the opinion that this bailout would have provided some cover for the system, but it would likely cost more than expected, be a behemoth to manage and was based on a series of overly optimistic assumptions.
I think the leaders of both parties underestimated the role that the upcoming elections would play in determining the voting on the bill. So there is plenty of blame to share for today's sell-off.
However, I think today's sell-off, while attention grabbing, may not have been tied entirely to the bailout bill failure. I think this article from Sunday foreshadowed much of Monday's market action.
"No one expects a wholesale flight from hedge funds. But even a modest outflow could reverberate through the financial markets. To pay back investors, some funds may be forced to dump investments at a time when the markets are already shaky.
The big worry is that a spate of hurried sales could unleash a vicious circle within the hedge fund industry, with the sales leading to more losses, and those losses leading to more withdrawals, and so on. A big test will come on Tuesday, when many funds are scheduled to accept withdrawal requests for the end of the year."
I think that the violent declines in hedge fund favorites like Google (down $40), Apple (down $22), Baidu (down $27), First Solar (down $28) and SunPower (down $10) indicate that a number of low-end hedge funds are bracing for a wave of redemptions in the very near future. These stocks are completely unrelated to the credit markets but they were sold consistently throughout the day.
Finally, for all of the gloom and doom in the media today there is a fairly consistent indicator of a near-term bottom in stocks. Without getting too technical there is a volatility Index (called the VIX) which has spiked into the 40's on a couple of occasions - 2002/2003 pre-Iraq war and 1998 during the Asian meltdown. We crossed above 45 today. Many, many professional investors follow the VIX as an indicator of fear by the small investor and use it as a contrarian signal that a bottom may be coming. With a ton of data coming out this week, it will be hard for the markets to find a bottom based on fundamentals, but if the charts tell big buyers to buy expect to hear more about the VIX.
Sunday, September 28, 2008
There was a kid-gloved analysis of what the bailout means to Joe Q. Public at Marketwatch.com - The five key areas where the bailout will hit home for consumers.
"Here are the five key areas of concern to consumers where the bailout will likely have an impact:
1. Mortgage rates
If you're shopping for a mortgage, the bailout might make a loan more available -- but higher interest rates might make it less affordable. "The prospect of an additional $700 billion in Treasury issuance is suggestive of higher Treasury yields and consequently higher mortgage rates," McBride said.
I couldn't agree more. It is very important to watch the 10 yr note this week, it climbed much of last week and mortgage rates moved up back over 6% on talk of a bailout.
2. On the job
Without the bailout, the unemployment rate could hit as high as 12%, said Brad DeLong, a professor of economics at the University of California at Berkeley. "A successful bailout could help keep the unemployment rate below 8% for the next year," he said.
Well, unemployment stats are notoriously bad, so I think that statement is fundamentally flawed. Perhaps, some companies looking to expand might be able to finance their expansion after the bailout, but the reality is that economic activity continues to weaken and that is going to be the biggest driver of higher unemployment.
3. Outlook for taxpayers? Depends who you ask
A major worry is that the rescue plan, depending on how it's structured, will cause a big tax hit down the road. But economists differ widely on the likely effects of this potential $700 billion outlay.
I continue to hear that this plan won't cost the taxpayers anything and we'll probably make money. That is a stunningly simplistic analysis even for Congress. The assumption that home prices are going to find a floor and somehow rebound to 2006 levels is beyond silly. It's like telling someone that bought Nortel in 2000 at a split adjusted $1,500/share that it's going rebound and then the taxpayer will make money (FYI - Nortel currently trades around $2.50). The assumption that this will not cost the taxpayer is also based on our ability to continue to access cheap capital from around the world (an assumption that seems to be challenged by the Chinese - see below).
4. Not helping homeowners?
Some say Washington's rescue plan does too little to help struggling homeowners -- a root cause of the economy's current problems. A proposal to change bankruptcy laws to enable judges to modify mortgages appears unlikely to make it into the final package.
Instead, the rescue plan may offer additional foreclosure assistance from the government, and help for borrowers to obtain better mortgages.
"There has been a lot of talk that if the government buys this stuff, they can make modifications. But that's really based on a misunderstanding -- the government is buying mortgage-backed securities. And the holders of mortgage-backed securities don't have the right to decide that mortgages are going to be modified," said Henry Sommer, president of the National Association of Consumer Bankruptcy Attorneys.
"Giving a lot of money to Wall Street is going to be helpful. But if you want to get to the root cause of the problem, you have to get in housing and mortgage relief," Leahey said.
Home prices remain too high, and with the economy weakening fewer people can afford these overpriced homes. This plan does nothing to change the death spiral of real estate.5. Betting on bankruptcy
Proponents of the proposal to change the bankruptcy laws note that court-supervised modifications could help borrowers with "piggyback" loans, which are second mortgages. Financial institutions who hold those second liens often won't allow loans to be modified without first being paid.
Yeah, it will become easier to go bankrupt!!! Everyone rejoice!!! If you were a bank would you suddenly start lending again to Joe Q. Public that is about to lose his house and job, knowing that it might be easier for him to file for bankruptcy? Of course not. This is why I expect the banks to move quickly to dump their toxic debt on the taxpayer and go into a lockdown mode of self-preservation.
Chinese Premier Wen Jiabao said Beijing was worried about the impact on its investments of U.S. financial market turmoil but now was the time to cooperate to calm markets.
'U.S. finance is closely connected with the Chinese finance,' Wen said in an interview aired on Sunday on CNN.
'If anything goes wrong in the U.S. financial sector then we are anxious about the safety and security of Chinese capital,' he said, but now was time to 'join hands' to deal with the crisis.
It sounds like the Chinese want to be a team player, but the timing of this message is clearly meant to send a message:
We're tired of being your ATM. Be careful or we're going to cut up your credit cards.
Your friends around the world.
Saturday, September 27, 2008
Thursday, September 25, 2008
"JPMorgan Chase & Co., the third- biggest U.S. bank by assets, agreed to acquire Washington Mutual Inc., the savings and loan facing $19 billion in mortgage- related losses whose market value halved in two weeks, the Office of Thrift Supervision said.
WaMu in March rebuffed a takeover offer from JPMorgan that WaMu valued at $4 a share. (that wasn't terribly bright in retrospect).
``JPMorgan is getting a steal compared with what they were going to pay,'' said Scott Adams, a pension and investment analyst at the American Federation of State, County and Municipal Employees in Oakland, California, which owns WaMu shares. ``It's very tragic.''
WaMu had about 2,300 branches and $182 billion of customer deposits at the end of June. Its $310 billion of assets dwarf those of Continental Illinois Corp., previously the largest failed bank, which had $40 billion ($83 billion in 2008 dollars) when it was taken over in 1984.
WaMu was the second-biggest provider of option ARMs, behind Wachovia, with $54 billion held in its portfolio in the first quarter, according to Inside Mortgage Finance. "
I think the comment from the analyst at the pension company is interesting. This is how the cycle completes itself -
* consumer A over pays for a home
* as rates adjust, consumer A can't make the payments
* the bank can't refinance it's failing portfolio containing consumer A's mortgage
* eventual the deposits are sold to JP Morgan
* Now consumer A is behind on his mortgage and your safe pension was invested in Washington Mutual shares that are now worthless.
It should be interesting watching Wachovia tomorrow.
Research In Motion (the maker of the Blackberry) reported a very weak outlook last night that should be a signal of weak corporate spending for the balance of 2008 and 2009. It's difficult to tell how much of this weakness is due to the iPhone and Google's new phone, but the concern that corporate America is putting the brakes on spending should cause alarm.
Media appearance -
I had the pleasure of appearing on the news at noon with our local CBS affiliate. The video's online - thanks for the opportunity.
As is the case most nights, there is news breaking late into the night and I'll update the stories as news flows in.
1) The Fate of the Bailout - I think it's become increasingly clear to Congress that this bailout's popularity is on par with a Cowboys fan in the Meadowlands. Calls to some Congressmen have been running 100 to 1 against this bill. My concerns with the bill remain that while it may grease the gears of capitalism it does nothing to address the underlying problems - home prices nationwide will continue to fall due to the weak economic backdrop.
There is talk of a new proposal from House Republicans, but there are a couple of scenarios that I see as viable:
a) The bailout fails and Congress delays any action. The markets are in for a really bumpy ride if this happens, but remember Goldman and Morgan Stanley took on this risk of their own accord. No one forced them to play in these markets.
b) A new bailout package is passed. The markets can explode upward but as the fundamentals of our economy are slowly revealed the markets can and will likely bleed lower.
2) Leading Economists on the Bailout - Economists in general are a dry, unexcitable lot. They are not prone to statements in black and white, they see the world in many shades of gray. However, it is for this reason that I find the following letter sent by 190 leading economists to the leaders of Congress particularly compelling:
"To the Speaker of the House of Representatives and the President pro tempore of the Senate:
As economists, we want to express to Congress our great concern for the plan proposed by Treasury Secretary Paulson to deal with the financial crisis. We are well aware of the difficulty of the current financial situation and we agree with the need for bold action to ensure that the financial system continues to function.
We see three fatal pitfalls in the currently proposed plan:
1) Its fairness. The plan is a subsidy to investors at taxpayers’ expense. Investors who took risks to earn profits must also bear the losses. Not every business failure carries systemic risk. The government can ensure a well-functioning financial industry, able to make new loans to creditworthy borrowers, without bailing out particular investors and institutions whose choices proved unwise.
2) Its ambiguity. Neither the mission of the new agency nor its oversight are clear. If taxpayers are to buy illiquid and opaque assets from troubled sellers, the terms, occasions, and methods of such purchases must be crystal clear ahead of time and carefully monitored afterwards.
3) Its long-term effects. If the plan is enacted, its effects will be with us for a generation. For all their recent troubles, America's dynamic and innovative private capital markets have brought the nation unparalleled prosperity. Fundamentally weakening those markets in order to calm short-run disruptions is desperately short-sighted. For these reasons we ask Congress not to rush, to hold appropriate hearings, and to carefully consider the right course of action, and to wisely determine the future of the financial industry and the U.S. economy for years to come." - emphasis mine.
We certainly live in interesting times.
Wednesday, September 24, 2008
I should start by saying that none of this is a surprise to those in the know. Many talented financial minds could see the dominoes lined up and all it would take is someone to push the first one over to start the calamity.
Without further adieu here's the 30 second run down on what went wrong.
1) The bubble in home prices was fueled by the availability of cheap credit which lead people to underestimate the risk of the US housing market.
***** Anyone with 2 firing synapses could see that the pace of housing price increases was unsustainable. However, there were bonus checks to be earned so no one stopped to ask if that condo in South Beach was really worth $400,000.
Who is to blame? Everyone that overpaid for a house that they can barely afford. If you paid more than 3 times your salary for a house, you overpaid and you're part of the problem.
2) Home prices peaked in 2006 and combined with poor lending standards (no doc loans, neg amortization loans, ridiculous amounts of home equity lines written) to push delinquencies and defaults on mortgages up.
*****Again, it was plain to see home prices had to fall and when they did it was going to create great pain for the marginal buyer.
Who is to blame? Mainly consumers buying beyond their means, but the realtors, bankers, appraisers and the housing propaganda industry that convinced everyone to put all of their eggs in one basket also played a role.
3) Okay here is where it gets sketchy. Wall street created investments that consisted of packages of loans that were to be repaid. A package of good credits would pay X%, a package of sketchy credits would pay x+1%, etc.
***** In theory there was nothing wrong with this process at first. Eventually, I think Wall Street understood that their prime credits were becoming less and less reliable, but they kept selling the debt instruments because bonus time was just around the corner.
Who is to blame? Wall Street, the rating agencies (S&P, Moody's), the SEC, and investors (for not doing their own due diligence).
4) Here is where it gets wacky. The big financial firms took the increased liabilities and issued “credit default swaps” contracts (CDS) that insured the packaged mortgages.
**** Again the theory was sound, but the products underlying them were problematic. The CDS's were set with triggers that forced the banks to pony up additional capital if their ratings were ever cut.
Who is to blame? This is principally on Wall Street - they should have seen that there was substantial risk to the system if they were ever downgraded. Their own hubris probably led Wall Street to ignore this risk.
5) When the losses in mortgage products started to hit Wall Street credit was curtailed. Now all of the dominoes were falling rapidly, highly leveraged lenders couldn't refinance their obligations, which led to more downgrades, which led to credit seizures, etc, etc.
**** This is where we are today. In the good old days of American Capitalism this scenario would have called for the banks to increase the rate of interest that they pay out to their customers. This would have increased the flow of funds to the distressed banks and they would have had lower earnings (maybe even losses), but they would have survived. In today's, Soviet-style version of American Capitalism the banks go to their friends in Washington (say a well placed former CEO as the Secretary of Treasury) and beg for a bailout.
Who is to blame? By now I hope that it's clear that there is no one person, firm or concept that led to this result. We all loved living beyond our means and now we're being asked to pay for the sins of the past 10 years.
As I said yesterday, this plan is going to lead to skyrocketing inflation and dramatically higher interest rates for the US Government because no one will want to lend to us. Bloomberg finally picked up on the concept today....
"Treasury Secretary Henry Paulson's $700 billion proposal to stabilize the banking system may push the national debt to the highest level since 1954, threatening an erosion of foreign appetite for U.S. bonds.
The plan, which asks Congress for funds to buy devalued securities from financial institutions, would drive the debt above 70 percent of gross domestic product and the annual budget gap to an all-time high, possibly exceeding $1 trillion next year, economists estimated.
At risk for the world's largest economy: a jump in interest rates prompted by the glut of additional Treasuries needed to finance the plan, and a diminished desire among international investors to add to their holdings. The dollar yesterday slid the most against the euro since the European currency's 1999 introduction."
The good news is that the Office season premier is tonight!
Tuesday, September 23, 2008
What is the bottom line for you - Mr. & Mrs. Taxpayer?
1) Savings, Smavings - This bailout punishes the smart, prudent, fiscal conservative consumer and rewards the knucklehead that paid 400% too much for their 3 bedroom ranch in Phoenix. The net result is that your hard earned and saved dollars are going to be worth less after this bailout.
2) Inflation - Remember six months ago when all of the talk at the water cooler was about the cost of groceries, gas and everything else skyrocketing? Well, despite the summer pullback in commodity prices most producers have held onto price increases implemented in the spring. The rapid return of oil inflation is going to give producers another excuse to push up prices again, get ready for the $6 12 ounce box of cereal.
3) Government Cutbacks - Cities and states are already starting to pullback their spending initiatives. The Federal Government is like a 400 ft supertanker. it's going to take some time to slow it down and turn it around, but spending is going to be cut despite what the candidates will say on Friday night.
4) Higher Taxes - No self-respecting politician will say they are raising taxes, but be aware that the portion of your gross income finding it's way to the government is going to go up. There is a small chance that this bailout could break-even, but I think it's less than a 20% chance. The more likely scenario is that the write down in assets is going to cost hundreds of billions of dollars financed at increasing interest rates which means your children will be paying for the mistakes of your parents when they overpaid for that condo in Boca in 2006.
5) ????????? - If anything was made clear today during the testimony before Congress it was that lawyers acting like accountants is a bad idea. Some the Senators (on the BANKING Committee no less) barely had any idea what the H%## they were talking about. Perhaps even more terrifying, I'm not sure Sec. Paulson clearly understands the nuts and bolts of the bailout. As another blogger observed today - Paulson and Bernanke have been wrong on EVERYTHING for about 14 months, why should we suddenly assume they know what they are doing now?
The late breaking news of the night is that Warren Buffett is making an investment in Goldman Sachs. The market will likely love this news and will read it as "Buffett to the Rescue" but let me assure you that the terms of this deal are very sweet and they assure Berkshire substantial protection in the event Goldman collapses.
****Update: The press is so predictable. From MSN Money:
Market Dispatches, 6:00 PM ET
Dow off 162; Buffett to the rescue
Warren Buffett's Berkshire Hathaway will invest $5 billion in Wall Street powerhouse Goldman Sachs. The move comes after stocks slump on fears that Congress won't pass a $700 billion proposal to shore up the nation's financial system.*******
Finally, this is perhaps the funniest thing I've ever seen. A sure sign of the cutbacks in our future...........
It's interesting to click through and see where your state ranks in different categories like extroversion, openness, and agreeableness.
I'd argue Upstate NY's personality is much more akin to that of Northern Vermont, but we're lumped together by state so NY ranks high in Neuroticism.
Perhaps my favorite statistic in the entire chart? Alaska's rankings.
Extroversion - 49
Agreeableness - 51
Neuroticism - 47
Openness - 49
Alaskans are apparently introverted, ill-natured, and a closed-minded people. It must be the weather up there.
Monday, September 22, 2008
Sunday, September 21, 2008
Side note - I find more than a little irony in the fact that Mr. Paulson was quick to let the market decide the fate of Lehman Brothers, but when Goldman Sachs was threatened - the firm where he served as the Chairman and CEO from 1999-2006 - there was suddenly a risk to the entire fate of the US economy.
The NY Times published the draft of the bailout document on Sunday.
The most troubling items within the text:
1) The Secretary’s authority to purchase mortgage-related assets under this Act shall be limited to $700,000,000,000 outstanding at any one time.
So, if the government buys $700bil in bad debt and determines that some of the debt can be resold at cost, the government can replace that debt with MORE BAD DEBT. In effect, this can be a permanent dumping spot for bad loans. This might ENCOURAGE more of the same activities that got us here in the first place.
Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.
WHAT? You are asking the American taxpayers for $700 billion and you want your authority to be non-reviewable and not to be reviewed by any court of law or agency? Where can I get a deal like that? Both political parties need to work together to strike this from any bailout package.
3) Foreign Banks
This is going be a political hot potato, but given the nature of the global financial system a number of foreign banks (HSBC, UBS, etc) can be expected to ask to be part of any bailout. Their argument is simple, we made the same bad loans to the same foolish US consumers, so if you're bailing out Citibank and Goldman, you should bail us out too.
Their argument is sound, but in an election year I wouldn't go near this issue. "Let's send US taxpayer dollars to save foreign banks" would not be a popular campaign slogan.
So, now in the post bailout era, how's business?
In a nutshell - awful. There will be pockets of light this quarter but companies will start reporting earnings in the next 3 weeks and I think the numbers will be startlingly bad. The weakness of the US consumer will finally start to show through and we might retest our lows in early October.
Friday, September 19, 2008
Thursday, September 18, 2008
1) It is way too early to start talking about a resolution trust. Home prices are only about 1/3rd of the way down to where they need to be. Bailing out the foolish US consumer and Wall Street with my daughter's future tax dollars is insanity. This is the sort of thing that has me shopping for real estate in China and India.
2) The cost is obscene - $400 billion on the low side. We need to start seriously looking at these costs, $400 billion --- are you serious? I've mentioned before that we need $60 billion to build a new national electric grid that could produce 1/2 of our energy needs via windmills in the Dakotas. That investment is deemed as too expensive, but somehow throwing another $400 billion of your dollars out the window to save some knucklehead in Vegas that paid $400k for a 2bdrm ranch, is just wrong.
For a little perspective if you took $400 billion in $1 bills and stacked them in a single stack, you'd have a stack about 26,000 miles tall.
3) The media is in a tizzy over hedge funds right now. They are specifically targeting the hedge funds that are short. This is silly. Anyone ever heard of puts? A smart fund will just buy puts and stock and evade this rule. Right now, if I was a hedge fund I'd sell and go home for the week.
* UPDATE * Late last night the SEC leaked news that they were considering an outright ban of short-selling. Unbelievable, our leaders apparently are comfortable with the concept of free markets as long as those free markets lead to stocks going higher. This is the ultimate level of government interference in free markets and will do a number of things:
A) Produce a crazy, insane rally that could start tomorrow (China's up 9%).
B) We will lose all credibility as a global investment platform.
C) This is clear market manipulation on a scale that we've not seen in our lifetimes.
D) When this rally unwinds (and it will unwind) - buy hard assets (gold and oil) and invest in a farmable plot, because the next leg down is going to be the big one - the real big one.
When it was clear that the market was going to make a run on Goldman and Morgan Stanley the SEC decided to pull out it's Nuclear Option - banning short-selling. 9/15-9/19/08 a week that will live in infamy.
Like I said, use bear market rallies to adjust your portfolio (update - tomorrow could be the mother of all bear market rallies).
Good night and good luck!
Wednesday, September 17, 2008
First, AIG, Merrill, Bear Stearns, Fannie, Freddie, now Morgan Stanley and Goldman Sachs are in the cross-hairs. There are so many moving parts here that it's hard adequately summarize the events, but here are some of the big issues facing us right now:
1) AIG - The AIG rescue was probably necessary but it didn't do anything to stop the financial bleeding. If ever there is a company that was too big to fail, AIG was that company. The terms of the deal are slowly leaking out and it is clear that the Government views this as a very risky endeavor. I think the principal grows by 2% every month that it is not repaid - roughly 24% interest. That's like a really bad store credit card.
2) Look Out Below Comrade - Russia is in the midst of a complete financial meltdown. They closed their stock market for a second day after another 10% decline. Russia is coming apart at the seams because of seizure of the credit market and oil's collapse. The geopolitical impacts of their stock market falling coupled with events in Venezuela (what you didn't hear about this?) and Georgia make this a very delicate time to deal with the Russians.
3) Oil's En feugo! At least for today. Again, I'm of the opinion that people are eventually going to sell US dollars and buy commodities (Oil and Gold - up $87/ounce as a I write this) to fight the inflation bug that is coming. I'm not sure when this trade occurs but since the analysts are starting to lower their target price for oil, it's a pretty sure sign that we're near a near-term bottom in oil and the price could reverse quickly. Separately, there is a lot of bad info coming out of the Gulf on refineries and wells. Rumors plus scared investors equals irrational moves.
Things to look for - sharp bear market rallies, hedge funds blowing up, rinse, lather, repeat.
Tuesday, September 16, 2008
1. Check that your bank accounts are federally insured. The Federal Deposit Insurance Corporation (FDIC) guarantees deposits up to $100,000 per person. If you have to hold more than that, spread it across multiple banks.
* This is a no-brainer, just watch your kids accounts that have your social security number - they can easily push you over the $100,000 limit.
2. Make sure your brokerage accounts are federally insured, too. The Securities Investor Protection Corporation (SIPC) guarantees you at places like Lehman Brothers, Merrill Lynch, E-Trade and the like up to $500,000, including $100,000 worth of cash.
* This is a little confusing - they don't guarantee the value, just insure that someone can't fold up and take your securities with them.
3. Put money in thy purse. If this market and this economy get any tougher, cash is king. The easiest way to make or find a buck is to save it. So take an axe to those family budgets. The restaurant meals. The Super Duper Everything Cable package.
* It shouldn't take a financial crisis to do this - every 6 mths step back and look where your money is going - you'll be stunned what you spend on latte's.
4. Set up a home equity line of credit while you still can. I usually don't like advising people to take on more debt, but if access to ready cash might be a life saver it's best to line it up. That's especially true if you are worried about your job. Credit is already tight, and it may get a lot tighter still.
* It's tough to even dignify this with a response. Let me try - Hey dummy, Home Equity lines are a big part of the problem right now. Asking people to go get another line is crazy talk. If you really want to tap that equity in your house, sell your 4,000 sq ft McMansion and move into a smaller place.
5. Refinance your mortgage. The panic on Wall Street just caused a collapse in the interest rate on long-term US Treasury bonds, as lots of investors rushed there for safety.
*This is amazing but true. Rates are down and if you can get refinanced and you plan on staying in your house for 7+ years maybe you should refinance. I'm stunned that despite our financial turmoil US government debts are viewed as a flight to safety. This will change at some point in the near future.
6. Stop pulling a Monty Python when it comes to your worst investments. If you ever saw John Cleese and Michael Palin perform their famous skit about the dead parrot, you know exactly what I mean. No, your Fannie Mae shares aren't "resting." They're lying at the bottom of the cage with their feet in the air. What more do you need to know? So stop waiting for them to "recover" before sorting out your portfolio.
* If you're a long-term value investor there might be opportunities to bottom feed on some great companies, but for most investments in Lehman, Fannie, Freddie it's true that you should liquidate.
7. Don't panic. Journalists, like markets, tend to move in herds. And by the nature of their jobs they write about the plane that crashes instead of the thousands that land safely.
* Hmmm, sounds like something that was said to the musicians on the Titantic. Nothing to see here - keep playing - don't panic - move along. This could be the beginning of the great financial calamity of our time and a little bit of panic might be a good thing.
8. When it comes to your short-term money needs, nothing has changed. Any money you might need within the next year or two should be held in cash or equivalents. That was true two years ago and it is true now. The stock market is no home for money you may need urgently. It could fall 30% or jump 30%. Nobody knows. You can get a one year CD paying 5% right now, and it's federally guaranteed.
* Agreed, but look at the 10 year chart on the Dow or S&P and you will see that stocks have gone virtually nowhere for 10 years. That's not a good thing if you're a long-term investor. I've said for some time that we are in the midst of a Japanese like recession that could hold US stocks in check for 10 to 25 years.
9. If you are investing for five years or more, buy some stock. The investment outlook is much, much better today than it has been for several years, because shares are much cheaper. World markets overall have fallen 27% from last year's peak. They're not a steal at current levels but they are not particularly expensive either.
* Agreed - Invest globally, but start slow and because world stock markets are going lower from here be prepared for declines.
10. If you want to worry about anything, worry about your taxes. The worse this crisis gets, the more they will end up putting the taxpayer on the hook to prevent a meltdown. Taxes are going up sooner or later anyway, no matter who wins the election, because of our gigantic federal deficits.
* I don't think worry, is the right word, but it's true - taxes are going to go up or spending has to go down sharply, or more likely a combination of both. It's not the popular thing to say, but like Randy Pausch said - Tell the Truth, All the Time. Wouldn't it be nice if politicians could do the same instead promising more silly tax cuts.
A) AIG is in serious trouble as a result of liquidity issues. They have lost nearly $180 BILLION of market cap as result of the recent sell off. AIG was the biggest company that you had never heard of. They are the largest commercial insurer in the world, the largest aircraft leasing company, an enormous re-insurer, etc, etc. AIG had the best minds in creative financing in the world and they were rewarded handsomely as a result.
Hank Greenberg was just on CNBC and that caused a 25% run in the stock (from $2 to $2.45) but this name is going to be in play all day.
* Full Disclosure - I worked for AIG in the mid-90's and was always impressed by the firm.
B) It seemed like only a matter of time until Goldman was put on the spot and today seems to be the day. The stock is off $13 and with a price still over $120, it seems like there will be lots of trading around this name.
C) The best news out there is the complete collapse of oil prices. Lehman and other financial firms had a number of commodity related trades that had to be sold this week. As a result oil is absolutely collapsing - down to $91/barrel (remember in JULY! it was $147 so we're down $57/barrel!!). The collapse of oil has lead to other more margin calls and more sales, so oil is falling for the same reasons it rose in the spring - more financial selling than buying. For an idea of what this means globally - Russia's stock market is down about 12% right now on the day (after falling more than 20% initially). The Russians and sovereign wealth funds have been sources of liquidity for the US. As this money dries up, it could lead to another leg down.
This saga continues....
Sunday, September 14, 2008
1) Lehman to file for bankruptcy protection
Lehman, like Bear before it, continued to claim that they had adequate capital, that they'd liquidate non-core assets and they'd be fine. Once again, not so much. Personally, I'm deeply pained by the collapse of Lehman because they were the firm that gave me a shot and afforded me the opportunity to have a career on Wall Street.
Unfortunately, this is not likely to be the last independent Broker/Dealer to go down in flames.
2) Bank of America to buy Merrill
This is perhaps even more stunning than the Lehman news. First for the price - $29/share - which could be about $28.75 too high, and second that Bank of America didn't learn anything from their rescue buyout of Countrywide (remember that?). If, and it's a big if, Merrill is still in tack than perhaps this is a steal, but it's not likely.
3) Oil under $100
Despite the run up in gas due to refiner cut backs caused by Hurricane Ike, the writing is on the wall and oil continues it's march into the double digits. I don't foresee a change of trend until traders start to sniff inflation again.
4) Who is next?
This is going to be the big game on Wall Street today. Look for huge option activity in Goldman, Bank of America, Morgan Stanley, AIG, etc.
5) Impact on NYS
Let's not forget the dramatic impact that this is all going to have on NYS. As I've noted before, up to 20% of NY State's Tax Revenues are tied directly to Wall Street. As Wall Street collapses upon itself look for dramatic effects on Main St., Anytown, NY. The tax base is going to undergo a historic contraction and without a similar cut in services, employees, and other costs NYS is going to be in serious trouble.
On a happier note, my fantasy football team looks pretty good going into Monday Night :)
Thursday, September 11, 2008
Apparently, because no one in the Auto industry could have ever foreseen a day when consumers might actually want a fuel efficient vehicle, the Big Three are asking the US Government to finance a $60 billion "retooling" of factories to speed the move to small, more fuel efficient cars.
This is the slippery slope that the US Government has started down. Save one bank to save the industry, then another, and another, and another. Now, the Big three say that without this money they run the risk of failure and the big car companies are viewed as too big to fail.
I call BS!! The reality is that Michigan is an important potential swing state and the big car companies are leveraging that fact to take advantage of you and I.
"Congress has already given the auto industry $US30 billion in low interest loans gradually over a period of 12 years, but with the big three in dire straits because of plummeting sales in trucks and four-wheel drives, and with credit drying up and fears one of the three might go bankrupt, Congress is being asked for five times that amount and to make it available almost immediately.
The three carmakers are in a hurry to get a deal. They want congressional agreement before November's election because a new president and new Congress could delay access to the loans."
Someone has to stop this nonsense. The carmakers made their bed when they continued to deliver poor performing, gas guzzlers for two decades. The US carmakers have lost at least a generation of buyers. Practically no one between the ages of 20 and 40 wants to drive a US car and no bailout is going to change that fact. The message to the carmakers should be this - make a safe, reliable, affordable sedan that gets 40mpg or else plan to join the ranks of PAN-AM.
Unfortunately, in today's age of political pandering this loan will probably go through and you and I will end up paying for it in many ways.
How exactly? Well, the value of the US dollar is a function of the stability of the US Government and our ability to meet our future debt obligations. The more bailouts we offer, the weaker our long-term prospects, and the weaker our dollar. Since so many commodities are priced in US dollars, everything gets more expensive when when the US dollar falls. There, now you know more about global economics than 88% of the people running for Congress.
On a lighter note - this is clearly the funniest real estate ad ever....
I absolutely love the fact that the Christmas Decorations are included.
Wednesday, September 10, 2008
"Developers have built one billion square feet of retail space in the 54 largest U.S. markets since the start of 2000, 25% more than what they built during the same period of the 1990s, according to Property & Portfolio Research Inc. of Boston. U.S. retail space now amounts to 38 square feet for every person in those 54 markets, up from 29 square feet in 1983, the firm says."
"For the first time since the 1990-91 recession, occupied retail space in major U.S. markets is expected to decline this year, falling by 1.2 million square feet, projects Property & Portfolio Research. Last year, occupied space grew nearly 61 million square feet, the firm says. Retailers that helped drive the building boom -- Wal-Mart Stores Inc., Home Depot Inc. and Starbucks Corp. among them -- have nearly saturated the U.S. Earlier this year, Home Depot said it would close 15 unprofitable stores and cancel 50 proposed ones, throttling back its store-growth ambitions to a meager 1.5% a year."
How the Home Depot in Watertown avoided the chopping block is beyond me. For all of the building on Arsenal Street in Watertown it is important to note the very low occupancy rates of some of the newest strip malls. There is simply too much space to match the limited demand in Watertown. When coupled with new commercial development closer to Fort Drum it could make for Watertown a ghost town for commercial real estate in a couple of years.
Enough with the local chatter - Lehman Brothers looks like the next big broker to fail. It seems 50/50 that Lehman could survive, but it's never going to be the same firm that it was a powerhouse in it's heyday. Lehman might make a nice division for a large foreign bank, but it's going to take a CEO with a gambler mentality to pull the trigger. Lehman and Washington Mutual - another stunning fall from grace - seem to be the major games in town right now.
Tuesday, September 09, 2008
Unfortunately, as you drive around Northern NY you'll notice most prices are down just 10-12% (in fact this is consistent around the country), so what gives?
Well, the unfortunate fact is that we're paying now for the privilege of paying just $4/gallon of gas this summer. Historically, there has been a fairly consistent ratio between the price of gas and the price of a gallon oil Gas has typically cost roughly 2 to 3 times the price of gallon of oil (for the math freaks out there - there are 42 gallons of oil in a barrel). So when oil peaked at $147/barrel or $3.50/gallon if gas prices had stuck to historical norms we would have been paying $7.00 to $10.50/gallon for unleaded this summer. Even with oil at $105/barrel, gas should cost almost $5/gallon if these historical trends held.
However, the demand destruction that would have occurred at those levels would have had dire global economic consequences, so the commodity represented a greater portion of the cost of a gallon of gas and each participant in the gas food chain - refiners, wholesalers, gas stations, etc - saw their profit margins shrink dramatically. The cost of oil, state taxes and federal taxes represented 85%-90% of the cost of a gallon of gas at the peak. The refiners, distributors and retailers divided up the last 10%.
Refiners have seen their profit margins sharply cut during 2008 as a result of an in ability to pass through any higher prices.
However, given that US demand only slipped slightly with gas at $4/gallon, refiners see the current drop in oil prices as an opportunity to recoup some losses and improve their margins.
So, while the news remains good on the oil front for the very immediate future (I think we could touch $90/barrel before some people put an inflation trade on) don't look for much relief at the pump.
While it's easy to try to blame some one or a policy for the pain at the pump, the realities are that the complex and nuanced nature of the oil industry makes simple analysis difficult.
Monday, September 08, 2008
1) Why should you care about the bailout? One quote says it all - "In the end, the ultimate cost to the taxpayer will depend on the business results of the GSEs going forward." I think you and I are on the hook for multiple hundreds of billions of dollars if real estate doesn't snap back sharply (highly unlikely). At the end of the day, our government implied that the debt of Fannie and Freddie was backed by our government. The Chinese and other foreign investors bought their paper, like US Government debt and the result was that we risked a global meltdown without this move.
2) Can this fix housing and financials? Not so much. Housing might get a little pick up if rates dip a bit (but it doesn't change the fact that Joe consumer can't get financed b/c his salary is stagnate, his job is at risk, and credit standards have become more stringent), but financials are beautifully set up for the big shorts. Financials are rallying like crazy, but their July and August results are going to be disastrous. Any moves up 10% or so will be very attractive to the big hedge funds and the shorts will be back.
3) The Great Hope - The number of major financial pundits today saying that "We hope this will stop the losses" is stunning. Hoping for a fix, isn't exactly smart financial planning.
4) Dollar/Oil/Commodities - The US dollar has been insanely strong as of late. Once, we get through this current rally, I think you could see another repeat of the Spring 2008 trade - long oil and other commodities and short the $ because of rising inflation fears. Just when you were getting used to the joy of paying $3.92/gallon for gas, it could start climbing again (not due to demand but b/c of financial investment in commodities).
Given the rapid fire trading nature of the market this rally should last for sometime (technically, it looks good up here) but in the next two weeks we are going to start getting concerned about Q3 and that will likely take us back down to our previous July/Sept lows.
I'm still a little long here, but I'll put stop-losses in and look for Nov/Dec/Jan puts on the big indexes.
Note again the new address - http://www.grindstonefinancial.com/
Sunday, September 07, 2008
How much confidence should you have in this plan offered up my Secretary Paulson? Consider this photo as a reminder of the compentency of some Federal Employees...
Friday, September 05, 2008
A series of rumors have shaken the traders in the market. Unfortunately for people that are long equities, most of the market is moved by these traders. SocGen put out an alert yesterday calling for an imminent collapse in global equities. These sort of calls usually go unnoticed, but in today's nervous market it was enough to shake people's conviction.
Continued rumors about this hedge fund closing or that hedge fund blowing up are everywhere. Some of this is true and due to the continued collapse in commodities. However, there is another side to this story. If you're a hedge fund that's down 10% this year, you'd love to see a sharp 5% drop (like we've had this week) so you can load up your long positions for a false bear rally. This might allow you to meet your goals in the face of a weak market. You can threaten hedge funds with regulation but if you threaten their overnight billionaire status you might create some desperate moves.
Interestingly, not a rumor was Goldman cutting Merrill Lynch to sell. As unbelievable as it seems, we could see the day in 2009 or 2010 that Lehman, Bear Stearns and Merrill Lynch (and maybe even Citi) are all gone as independent entities. Since Financial Services was the last great industry where the US was a true global leader, this will be a sad changing of the guard.
B) Housing Prices - A note made the rounds last night highlighting an interview with Robert Shiller of the Case/Shiller home index and he had some rather dire forecasts:
* Home price declines are already approaching those in the Great Depression, when they plunged 30% during the 1930s. With prices already down almost 20%, it's not a stretch to think we might exceed that drop this time around.
*There are about 10 million homeowners whose debt is higher than their home value, which has broad implications for how Americans feel about their wealth and spending habits (read: more pressure on consumer spending).
*The current hopeful consensus -- that house prices will bottom soon and then begin to recover -- is most likely a dream. Housing markets don't usually have "V-shaped" recoveries. And even if house prices stabilize in nominal terms, after adjusting for inflation, most homeowners will continue to lose money.
1) Prices in some parts of the country will fall more than 30% simply because the financing math will change. In 2005, you could buy a 4 bedroom house in SoCal for $2,700/mth with no money down, a neg-am mortgage and a 40 yr payback. That same house with a traditional 30 yr mortgage might cost $4,000/mth if prices were stable. Since no one wants to pay more solely b/c the structure of the financing has changed, prices must fall. This is the big difference between today and the Great Depression. The Great Depression caused prices to fall due to supply/demand issues, the Great Credit Crunch is going to push prices lower just because access to financing has dried up.
2) I don't know where he gets the number that 10 million people owe more than their house is worth, but if that is the case we're in deep, deep trouble. Have you ever been underwater on a car, where you owe more than it's worth? Well amplify that feeling by 50 and you'll get some sense of the panic we could have on our hands if 10 million homeowners suddenly realize their home has shifted on their personal balance sheet from an asset to net liability.
3) I can't agree that home prices won't spike again after we bottom. Did we learn anything from the tech bubble? Not really, stocks ran fast and furiously from 2004 to 2007. Much the same could happen in housing, but it's probably a 2012-2015 story.
C) Microsoft ad
Some time ago I posted a comment on Microsoft's plan to recapture their cool mojo with a series of ads from Jerry Seinfeld. Well, the first of them debuted last night and it was cute, but it's not enough to slow the Apple/Google juggernaut. Google's new browser is fast winning fans and like all things Google, it's easy, clean and free.
Note - I finally changed the website address - I now have the blog hosted at www.grindstonefinancial.com - so note it in your bookmarks.
Thursday, September 04, 2008
Negative Amortization mortgages gained in popularity from 2004 to 2007 as a way to give fringe borrowers a chance at finally owning a home. In essence, with a Neg-Am mortgage you pay a monthly payment that is less than the sum of your principal and interest with the balance that you owe added each month to the principal.
So, assume you bought $500k house with zero down. In a traditional 30yr fixed rate mortgage your monthly payment might have been about $3,000. However, with a neg-am mortgage and a 40 yr payback period your payment could be as low as $2,000. Your monthly payment falls b/c you're paying the loan back over 40 years!!! instead of 30, and the difference between your payment ($2,000) and you're actual obligation ($2,600) was simply added to your principal balance each month. So at the end of year 1, you would have paid $12,000 toward your house, but in fact you would now owe $507,200 (at the end of yr 2 $515k, yr 3 $523k, etc). This is essentially credit card financing for your house.
However, most of these mortgages put a 110% principal cap in their fine print (in our example the mortgage can't exceed $550,000). When coupled with the fact that most people chose to pay the bear minimum on their mortgage it has led to a rapid escalation of "recasts". Recasts are provisions built into the loan to charge a higher rate and require principal reductions.
"Though recent declines in the 12-month Treasury average rates have mitigated some risks, the majority of option ARM borrowers have elected to make the monthly minimum payment over the past 24 months,” Fitch said in the report. “As a result, a large number of these loans, especially those with 40-year amortization and 110% principal caps are expected to reach their recasts before the end of the five-year mark.”
The result? Fitch said it expects 90-day plus delinquencies — already ranging from 10 percent to 24 percent, depending on vintage — to more than double after recast for 2004-2007 vintage loans. It gets worse: Fitch also estimated that the potential average payment increase on the re-casting loans to be 63 percent, representing on average an additional $1,053 due each month."
For many homeowners that are already on the brink an extra $1,050/mth is simply too steep and unfortunately this means up to another 500,000 people are at risk to losing their homes in the next 2 years. These loans were particularly popular in Florida, Las Vegas and California, so the pain in those real estate markets will persist.
Market update - Stocks continue to get battered as I expected. Falling oil and a stronger dollar are doing nothing to stop the bloodletting. Hedge funds are in a tough spot b/c they have to make their number in Q3, but they run the risk of falling another 10% and getting shutdown. I'd look for a little bounce here (I'm starting to get long a little at a time -- just for a trade) but the long-term downtrend remains intact.
I'll use any real strength to build long-term short positions.
Wednesday, September 03, 2008
"Ospraie Management LLC, the investment firm run by Dwight Anderson, will close its biggest hedge fund after slumping 38.6 percent this year because of bad bets on commodity stocks.
The New York-based Ospraie Fund fell 26.7 percent in August after a ``substantial sell-off'' in energy, mining and resource equity investments, Anderson said in a letter to investors yesterday."
The perils of hedge funds are many, but this fund was managed by someone with all of the right pedigree (experience at Tiger and Tudor) but perhaps a weak understanding of fundamentals in my opinion. To have fallen 27% in August alone the fund had to have been levered to the gills near the top in the commodities market in mid-July. Demand for commodities is strong as a result of emerging markets but the price of oil and other commodities in mid-July was unsustainable.
Sidenote - Never invest in a hedge fund with a cute, mispelled animal name.
The Financial Times reports that Manhattan real estate is showing it's first cracks.
"As the US housing slump deepened over the past three years, Manhattan’s real estate market seemed immune. Instead of crumbling with the rest of the nation, prices continued to rocket. Sales surged and new condominiums found multiple bidders. For a long while, Manhattan property was in an orbit all of its own.
But there are growing signs that this last bastion may be giving way. New York City, the seemingly indestructible foundation of the nation’s luxury property market, has this year begun to shown signs of strain. In the second quarter, traditionally the hottest property season, sales slumped 38 per cent to a five-year low, according to the Corcoran Group, the city’s largest residential real estate group."
Basic economics says slack demand and stable supply should lead to lower prices, but slack demand and soaring supply should really impact prices. As I've said a number of times, asking prices for homes are ridiculously sticky. People always remember what Bob down the street got for his 3 bdrm ranch in 2005 and they want 20% above that price. Eventually, prices begin to slip and when they do, the drop can be sharp and painful.
"According to Miller Samuel, a New York residential real estate appraisal company, some 6,869 apartments were for sale in Manhattan in the second quarter. That is 11 per cent more than the first quarter – and a full 31 per cent more than the second quarter of last year."
Again, this speaks to the potential weakness of the NYS economy and the long-term impacts on Upstate NY.
Tuesday, September 02, 2008
Today's move in the market is a perfect encapsulation of the major money managers on Wall Street. Gustav turns out to be a bust so oil collapses (oops, maybe I should have stayed short oil) and stocks rally almost 2%. But like every bear market rally before it, there was no conviction in this rally and it's faded very quickly. Most money managers are acting like day traders, trying to squeeze a 1/4% out of the market every day so they can still get paid at the end of the year.
Daytrading was a suckers bet for the common man in 1999 and it's an equally disastrous methodology for mutual funds and hedge funds in 2008. True investing should be done without consideration for the market. If you can buy stock XYZ for 10x earnings in a growth industry and get a decent dividend - do it. Forget about when you'll get liquidity, the stock will reward you by making a smart investment in a good company. Most "investors" today seem fixated on only their liquidity event. When can I sell and how much will I make? Buffett once said that he thought you should be comfortable with your portfolio if they stopped trading stocks for 5 years. Can you imagine the panic that would cause if you told the average RIMM or APPL shareholder there wouldn't be a quote on their stock for 5 years?
Chase the market at your own peril.
Outlook - I added some market short positions this am in the rally and I'll look for additional rallies as entry points on the short side. Earnings this quarter should be fairly weak again.