My Last, Final, Very Last Post for 2008

Bugger Thy Neighbor

One of the links I had yesterday noted the importance of global coordination for fixing our finacial global mess. Well, that is a nice goal but reality is likely quite different. The EU cannot even agree on a response within its ranks, so the likelihood of a coordinated global response is rather slim, to say the least.

Beyond coordination, there is the real prospect of international trade friction escalating. As Yves at Naked Capitalism points out, every country is trying to boost exports to salvage their failing economies. Only problem is there is no country anxious to be the importer. As much as the U.S. government is trying to get the U.S. consumers to return to their over-spending, debt-laden, ways, consumers (out of choice or otherwise) are not spending. They are deleveraging, which is what they need to do. Meanwhile, their deleveraging is causing some pain to countries like China, addicted to our spending ways. These countries are taking steps to alter this and expand their exports again, but this is just folly in today's economy. In any event, imbalances are developing fast. Countries are pursuing the wrong remedies and will hopefully realize this in time to avoid a prolonged global recession. I, for one, am planning on no such realization. Hunker down; this will be long and nasty.

http://www.nakedcapitalism.com/2008/12/groundwork-for-trade-conflict-being.html

Bearfund Comment

Some of my posts are occassionally posted on Seeking Alpha, where I am a contributing author. One of my more recent posts published there resulted in a rather lucid, and worth mentioning, comment from "Bearfund." I quote it here in full:

" 'A third way to benefit stockholders is for the company to do a good job, spend its capital wisely, invest in prudent growth, avoid complicated financial instruments that no one understands and make a profit. Having excess capital sitting around is not a bad thing after all...'

"Doing fine right up until the end there. In fact, having excess capital sitting around is definitely a bad thing. When I buy a business, I want the returns from that business and only from that business. I do not want exposure to arbitrary other assets. When a company builds up excess capital, it usually does so in its home currency or in one of the world's major reserve currencies (dollars, yen, euros). These assets typically earn very little yield, dragging down the company's return on equity.

Compare with dividends: the company retains enough of its earnings to pay off any debt and operate normally through a recession, and pays the remainder of its earnings to its shareholders. They can, in turn, put those earnings to use in whatever fashion they like. If you want to own, say, 3 units of exposure to AAPL's business and 1 unit of US Treasury bills, you're free to do so by taking the dividends AAPL should be paying you but isn't and buying your T-bills with them. If you would rather own 3 units of exposure to AAPL's business and 1 unit of gold, you could do that too. And, if the managers really have a great idea for growing the company, they can sell shares in the new company on the open market and use the proceeds to fund it. If the existing shareholders want to own the new venture, they can benefit from a European-style rights issue in the new shares, or they can agree to suspend the dividend to fund the new business line as an integrated unit.

AAPL is of course only one particularly egregious example, but the point is clear: give the shareholders the flexibility to decide how to save, invest, or reinvest the profits from their holdings. Don't try to turn business managers into asset managers; most of them are not very good at the latter and will consistently underperform.

In the time period of interest, you are correct that holding excess capital was profitable. But these are relatively unusual times: there has been a short squeeze in money of zero maturity; despite plentiful supply, the size of the short positions outstanding simply became too large and forced covering resulted. Under such circumstances, those T-bills did pretty well (though not, I should mention, as well as much more leveraged instruments like the Long Bond, or - curiously - the base unit of stored value, gold). If you as an investor chose to buy assets like Treasuries or gold with your earnings, good for you. If you chose to buy more shares, not so good for you. But your choice shouldn't have been made by management or the board of directors. You should have been handed a dividend check and told to fend for yourself.

Buybacks, funded by debt or not, deserve only a brief mention: most publicly traded companies provide their senior managers with most of their compensation in the form of restricted stock and/or stock options. Under such circumstances, buybacks should be strictly prohibited, especially if any senior manager also serves as a director. The main reason for buybacks is the incestuous nature of boards of directors, which usually consist of executives from other companies. Doing buybacks simply allows them to feather one anothers' nests at the expense of shareholders.

It is true that paying out substantially all earnings every year will expose marginal businesses to severe pressure during downturns, because they will mostly be forced to take on tremendous debt to provide an adequate return on equity. The solution to this is not to limit dividends but to limit debt, and encourage marginal businesses - especially mature ones in decline - to shut down. The result will be a smaller economy in notional terms, but one which is far less volatile and allows investors much greater freedom to start new enterprises (since their capital will not be tied up on the balance sheets of poor-performing companies). In short, the economy would be much more dynamic, with fewer zombie companies and more new ventures. If the money is sound as well (i.e., it is gold or silver and no central bank is on the scene) then interest rates will be low all the time (no need for an inflation premium since there's no inflation, and little demand since debt is used sparingly) and the speed of money will be high as paid-out earnings are forced to search for returns.

Who can lenders trust? A tough question to be sure. But maybe the answer, as I've outlined it here, is that it shouldn't matter so much. A more dynamic, less leveraged economy would offer all of us quite a lot - except, ironically, those who take, and introduce, only systemic risks: the large-scale leveraged borrowers operating underperforming businesses and the lenders who enable them with the help of a flood of money from the ever-devaluing central banks."

I have no qualms with Bearfund's comment. What I need to do is add a caveat to my own. When I wrote my pience I had in mind companies like Berkshire Hathaway, who do in some respects act like asset managers. They make their money investing moreso that through a typical business model. Berkshire stored away over $50 billion in capital during the bubble to take advantage of this crash. And while not all companies are oriented to investing like this, I do think most should have a CFO who is looking at the economy, determining whether a bubble might pop soon, and deciding how to perhaps build capital and take advantage of it. Even if you are of the school that this bubble was not predictable - despite dozens of very vocal voices predicting it - you might at least subscribe to the Taleb Black Swan principle and put some bucks away for the completely unpredictable. Putting something aside to take advantage of once-in-a-lifetime events can lead to once-in-a-lifetime gains. Gains that might be unthinkable otherwise. And I am not just talking gains in profit, but gains in market share, taking over competitors, and the like. Right now there are companies out there just sitting on piles of cash and they will come out of these "relatively unusual times" with opportunities unheard of in usual times. They can achieve gains on the competition that would take decades otherwise.

So Bearfund, I hear what you are saying and agree that what you have to say is sage advice, but if you have not read Taleb's book on Black Swans, I recommend it. It opens a new door to investing - the preparing for the unexpected events side - that is worthwhile exploring. Your advice is well grounded in usual times, but my comment on maintaining excess capital (which was admittedly not properly stated) is oriented to those that migh like to take advantage of less than usual times, which we can expect for some time to come.

Disclosures: None

Top 10 2008

As I suggested yesterday, here are some top 10 lists to end the year. If you find others of interest, please leave a comment and I will be happy to link them.

Top 10 Stupid Moves That Created This Mess

1. Securitized Debt. Call it mortgage backed securities, CDOs, CDOs squared, CDOs cubed, CDOs quadrillionthed or whatever, but the process of those underwriting the risk not keeping the risk led to, well, lots of risk. All was fine and well while housing continued to climb, or at least appeared to be fine and well. You know the rest of the story.
2. Rating Agencies. The rating agencies were being paid to rate the securitized debt and when you are paid handsomely to do something you do it. Seems the money making aspect of the process was perhaps the driver for some ratings that, at least in retrospect, were foolish at best. I don't care what tranch you are talking about, subprime mortgages, like liar loans and 100% LTV loans, never deserved triple A ratings or anything close.
3. Credit Default Swaps. Credit default swaps are to blame for AIG's demise. Otherwise they have not been the biggest player in creating the mess but may be the biggest player in cleaning it up. It would be nice to be able to let some of these players fold in an orderly fashion and support just those that survive. The problem is that the folding process will undoubtedly trigger some of the CDS contracts, which may result in taking down other entities in the process. With what was once estimated to be $62 trillion in CDS contracts in play, this is no small problem.
4. Commodity Futures Modernization Act. Try saying that five times real fast. While the act, which was enacted in 2000 in the final days of Clinton's presidency with no debate in either the House or the Senate, did various things, the key thing it did was legalize CDSs, which arguably were illegal before then. To the extent someone bought a CDS to protect them on a bond, for example, that was insurance and should have been regulated as such. To the extent the person buying the CDS had no interest to protect, they were simply betting that a company would default, which is gambling. The Commodity Furtures Modernization Act made sure CDSs did not get treated as insurance or gambling.
5. SEC. In 1975 a regulation was passed that limited the leverage certain financial institutions could take on, in relation to capital, to a 12-to-1 ratio. A few years ago the SEC provided an exemption to a handful of institutions, including Lehman Brothers, Bear Stearns, Merrill Lynch and Goldman Sachs, allowing them to go up to 40-to-1. Oops.
6. Liar loans, 100% LTV loans, option ARMS and the like. Closely tied to the securitization issue was the scope of mortgage products being made available. People could get mortgages with no or minimal documentation, with no money down, with payments that did not even keep up with interest accrual and with poor credit ratings. If you could fog a mirror, you could get a loan. Those taking out these foolish loans, on the expectation that prices would continue to rise, are as much to blame as anyone.
7. The Fed. The Fed, under Greenspan, kept interest rates too low for too long following the dot com bubble bursting. It also was a staunch advocate for deregulation and free market principles. Greenspan spoke openly on how CDSs for example, were good for the economy because the reduced risk. Having $62 trillion in obligations out there waiting for the shoes to drop is not my version of reducing risk, but to each his own.
8. Special Purpose Entities. These are orphan companies set up by a company, such as a bank of financial institution, that keeps certain assets and/or risks off of the sponsoring entity's balance sheet. Financial institutions have been able to hide a great deal of loss this way. Enron is a prime example of how these off-balance sheet entities can be abused.
9. Ben and Henry. They downplayed the problems for far too long and when they did react their plans were poorly conceived and executed. We seem to be following the Japanese play book and everyone can see how well that worked out. Throwing money at the institutions that created the problem is not helping anyone but those institutions. We would be better off to stand in their shoes and lend the money instead of giving it to them and hoping they will lend (which of course they are not doing).
10. The Shadow Banking System. You know who they are. Some of them are gone and some have had to merge. Some have now agreed to change their form and be regulated. These entities went unregulated and self-supervised for way too long and we are all paying the price. Some of the problem here is their compensation scheme that handsomely rewards large profits, even when they are earned at the expense of future stability. These behemoths should be dismantled, but instead we are supporting their attempts to become bigger. Iceland learned what happens when financial institutions get to big to fail and too big to save, but we never learn.

This is by no means a complete list but it is a nice start. Feel free to make suggestions.

Top 10 Records Set in 2008

Setting records can be a good thing or a bad thing, it depends on the record. As you might have guessed, this is a list of the not-so-nice records of 2008.

1. $30 trillion in market valuation losses. This is a very big and painful number. For the U.S. it comes at a time when baby boomers are getting ready to retire, so the timing is terrible (as if there ever is a good time for this to happen). While some of this will eventually reverse itself once the recession ends, it could take well over a decade for valuations to return overall, and certainly for many companies they never will. http://www.bloomberg.com/apps/news?pid=20601109&sid=ataVotdLreS0&refer=home
2. $50 billion Ponzi scheme. The biggest and perhaps longest running Ponzi scheme, engineered by Madoff, has come to an end, and the impacts are far and wide. This one does not even have three degrees of separation from Kevin Bacon. http://www.bloomberg.com/apps/news?pid=newsarchive&sid=asjgOZK87JDI
3. Highest number of foreclosures ever. I hope 2008 will be the peak, but expect foreclosure activity to be high throughout 2009 and into 2010. They will be shifting from subprime to Alt-A and prime, but they will continue as housing prices decline, jobless claims rise and credit remains tight. http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aRhcv8yIAheo
4. Record 18% decline in home prices. It is what it is, though this is through October, so it may not be a record for the calendar year once we know the year-end data. Still bad by any standard. http://www.monkeybusinessblog.com/mbb_weblog/2008/12/caseshiller-housing-index-decline-sets-another-record.html
5. $700+ billion in financial company write-downs and still counting. Most have predicted this will eventually exceed a trillion and some say two trillion. A trillion here and a trillion there and this starts to add up to some big money. http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aRhcv8yIAheo
6. Largest bankruptcy ever. Lehman Brothers bankruptcy filing, with $613 billion in debt, was the largest ever. The 158-year-old-firm had survived the Great Depression but it could not survive 40+-to-1 debt to capital ratios.
7. Record redemptions from hedge funds. Not a biggie here except that this will impact stock prices as hedge funds have to liquidate further next year. http://www.ft.com/cms/s/7b886520-d6a2-11dd-9bf7-000077b07658,Authorised=false.html?_i_location=http%3A%2F%2Fwww.ft.com%2Fcms%2Fs%2F0%2F7b886520-d6a2-11dd-9bf7-000077b07658.html&_i_referer=http%3A%2F%2Fwww.nakedcapitalism.com%2F
8. Record Oil Prices and Record Decline. Oil hit $147 a barrel earlier this year only to be followed by its biggest price drop ever. Kinda like following the bouncing ball.
9. Largest nationalization. The U.S. increased its debt load by about $5 trillion when it nationalized Fannie Mae and Freddie Mac. The irony of the bastion of capitalism doing the largest nationalization ever is not lost on the taxpayers.
10. Three-month Treasury yields below 0%. Not even during the Great Depression did rates go this low. We are effectively paying the government to keep our money. Now that spells panic.

There you have it. Not a pretty picture. For those interested, here is a nice piece by Fortune on the 21 Dumbest Moments in Business for 2008.

http://money.cnn.com/galleries/2008/fortune/0812/gallery.dumbest_moments_2009.fortune/index.html

Disclosures: None

Evening Edition

All I can say is this is bad news, as far as I am concerned. Purchasing half a billion in mortgage backed securities from those that brought us here is not inspirational, even if you have some smart people managing the process. And if you believe the line about "minimal" risk, then you have to ask yourself, if there were truly minimal risk then why? Why relieve these companies of good securities? Does that help them? Of course not. So we continue this charade. Moreover, we seem to be trying to lower interest rates. Heeelllloooo! Too much lending got us into this mess. I can see helping some people reduce their rates to make current loans affordable and reduce foreclosures, but doing anything to foster more debt at the moment is foolish. When houses get to where they can be affordable at reasonable rates or people's incomes can get to where they can afford them, then we have achieved a bottom. Until then, artificial supports are doomed to failure, in my opinion.

http://www.bloomberg.com/apps/news?pid=20601087&sid=a160y41WSJvk&refer=home

What really gets my goat about the actions to date by the Fed and Paulson are they are seeking to help the worst of the bunch. They are propping up those that foolishly created the mess in the first place. Moral hazard is totally out the window, but that aside, what about all the companies, large and small, suffering from a situation not of their own making. Where is the government support for the small businesses. It is truly lacking and that has my panties in a bunch.

This is one aspect of Obama's plan I like. Instead of throwing money at the culprits, we are spending money on things we need, like infrastructure, alternative energy and education. Perhaps this will not help the ecomony at all, or minimally, but it will have the good side-effect of a getting something done that is positive. If you can say that about the $152 billion we wasted on AIG, I am all ears. If you can say that about the tens of billions we gave away to financial companies under TARP, well the ears are still here. I think not. So doing something that solves the problem - or at least tries to - from the bottom up instead of the top down is a positive in my book.

Michael Panzner and Charles Smith do a nice couple of posts on how helping the big corporations is missing the boat as the backbone of our society is small business, not large, and they are in a whole lot of hurt at the moment. Think of how many can be helped by the money we have wasted on the financial sector alone.

http://www.financialarmageddon.com/2008/12/not-seeing-that-small-is-bigand-hurting.html

Year-End Edition

To end the year right tomorrow, I would like to do a top-ten list or two. I am open to suggestions here, so feel free to comment. Here are a few thoughts:

1. Top 10 list of stupid things done during the 2007 bubble.
2. Top 10 list of stupid things done in response to the bubble bursting.
3. Top 10 predictions of the stupid things the government will do next year in response to the bubble bursting.
4. Top 10 reasons to sell everything and move to some remote island where they cannot even spell recession.
5. Top 10 reasons to not have a top 10 reasons for anything.

Your thoughts/comments are more than welcome. I am looking for thoughts on additional categories. I am also looking for your contributions/votes on what qualifies for the top 10 lists above. Have fun!!

Who Can You Trust?

That is the question of the day when it comes to lending activity. What Buffett once referred to as financial weapons of mass destruction seem to have a very long half life. Right up there with uranium. Until the derivaties mess has played out and companies know what is on their books, credit will continue to only be available and/or affordable for the best of companies.

This is why GE and the few other remaining AAA rated financial companies are trying so desperately to maintain their rating. Once upon a time the interest rate charged a AAA company only varied a few basis points from that charged a AA- company (three steps lower), so the financial impact in terms of interest charges was relatively minimal. Well, that time is long gone and the difference now is a whopping 112 basis points (a basis point is .01 percent). For companies using massive amounts of debt, that difference can be tens of millions of dollars a year.

http://www.bloomberg.com/apps/news?pid=20601087&sid=a59gngOiy2c8&refer=home

So why such a spread today? That trust thingy explains a lot. Those still willing to lend need to be sure they will get repaid because there is virtually no secondary market for securitizing the loan. In other words, banks actually have to do some underwriting for a change because the loan will remain on their books. Accordingly, any variance from a perfect rating will cause lenders to charge a premium. There is also the supply/demand aspect to consider. Not a lot of lenders out there willing to lend at a time when there are a host of companies desperately needing to borrow. Those lenders still lending can afford to be picky and charge a premium for the privilege.

One reason banks are not lending money despite the hundreds of billions thrown to them by the U.S. is that they do not fully know how much they will need to use themselves to survive. As I have noted before, their business model is broken. All those fees they used to generate on complex financial transactions are now gone at a time when they are continuing to have building losses on loans, derivatives, credit cards and the like. If you are not making money and your losses are mounting you are not about to lend what you have to other companies that may not be able to repay you. Instead you hoard what you have until you are sure you will not need it, which could be years from now. Keep in mind that a lot of this money from the Fed is given to them as a loan that, absent them folding, will have to eventually be repaid to the Fed, so even when they do get back on their feet, they will have numerous lean years while they repay the loans. Don't look for banks to be posting good profits for some time to come.

http://www.nakedcapitalism.com/2008/12/banking-industry-sinking-faster-than.html

2009

I hope to post tomorrow some more thoughts on what 2009 holds for us. Not a pretty picture at the moment. Here are some thoughts from Wolfgang Munchau, at Financial Times, on what we should be doing in 2009. I agree with most of his thoughts (though not all of them as I do think spending on infrastructure and education makes sense). One particular point I like is that the financial industry is too large and we cannot and should not support it in its current form. Some of it needs to be broken up and wound down in an orderly fashion. I know this will have some unintended consequences, like in the CDS world, but we cannot support it all and need to use our money more wisely.

He also has a warning on things that might happen in 2009 to make matters much worse. Some of these are well within the realm of possibilities:

"It is not difficult to construct a plausible scenario of an economic catastrophe. Pick some of the following and you could end up with a depression that beats every modern record: a rise in global protectionism; competitive currency devaluations; a sterling crisis; social unrest in China, leading to political instability; a well-timed terrorist attack; continued refusal by eurozone leaders to co-ordinate; a payment default by a large sovereign in the eurozone; an acute emerging market crisis; continued lack of synchronisation of monetary policies, or a collapse of the CDS market. Obviously, the insolvency of a large global bank or the annihilation of the hedge fund industry would not go unnoticed either."

http://www.ft.com/cms/s/0/af4e7e40-d507-11dd-b967-000077b07658.html

You Can't Make This Stuff Up

Companies have variuos ways of financially benefiting their shareholders. One way is to pay dividends. The problem with dividends is that when you start paying them the expectation is that they should continue and never get reduced. Some companies this year are proving that expectation to be wrong, while others are struggling to maintain it.

Another way to benefit shareholders is through stock buybacks. Rather than just handing the money over to shareholders and building a dividend expectation in the future, some companies in good times will use some of the excess cash to rebuy shares, which should have the effect of increasing the share price for those remaining shares on the market. Note I emphasize excess cash as it makes no sense to buy back shares if you do not have the cash.

There is a good bit of controversy over share buybacks and whether they really make good sense for the company. While the logic of a buyback may be debatable generally, I think most would agree that using debt to finance a share buyback is right up there with subprime mortgages on the "ten stupidest things I did during the bubble" list. Seriously folks, how do you add value for shareholders by taking out a loan - on which you pay interest - to artificially inflate the share price with a buyback? I am sure some CFO got a nice bonus for coming up with that idea.

http://www.bloomberg.com/apps/news?pid=20601087&sid=aOW9ACek2RRg&refer=home

A third way to benefit stockholders is for the company to do a good job, spend its capital wisely, invest in prudent growth, avoid complicated financial instruments that no one understands and make a profit. Having excess capital sitting around is not a bad thing after all; just ask the companies that are now struggling to pay down debt. Indeed, those with a lot of capital now will undoubtedly get a host of investment opportunities over the coming months as competitors fail and sell assets at fire sale prices. Guess I am a bit old fashion here, but I like companies that benefit shareholders by being well run and prudent. Not all that exciting, I know, but if you want exciting you should go to an amusement park.

By the way, there is another reason why a company might do a share buyback that is worth noting. Buybacks can be done to cause a short squeeze. Just ask those that were shorting Volkswagen in late October when Porsche decided to execute on some options and increase its stake to 75%. The stock shot up 93% and the company for a while was worth more than Exxon. Talk about a squeeze.

http://benbittrolff.blogspot.com/2008/10/volkswagen-short-squeeze-hedgies.html

We Only Lost 38%!!

You know times are tough when a well run mutual fund that is closing in on the record for the most consecutive years for beating the S&P can boast that it only lost 38% this year. And, yes, that is a bit better than the S&P so far. I doubt this fact is being touted in their advertising materials but it is being touted by Bloomberg. I should note that my daughter's piggy bank is nicely beating the S&P this year, so if any Bloomberg writers are reading this, she does give interviews.

http://www.bloomberg.com/apps/news?pid=20601087&sid=aELpuqQko.Xg&refer=home

Go Figure?

Home prices in 20 major cities tracked by the S&P/Case-Shiller index dropped at a record rate, 18%, in the 12 months to October. All told, down 23% from the 2006 peak and still falling. The combination of tight credit, job losses and foreclosure sales will continue to pressure prices through 2009 and perhaps into 2010. Most predictions I have read by those that seem to be in the know are expecting the housing prices to drop 35-40% in total before all is said and done, so we still have another 12-17% or so to go. At the current pace, that is another 8-12 months before reaching bottom. We will see.

Another record also set today was in the consumer confidence index. Down to 38, which is the lowest since records began in 1967. Seems that people are realizing this recession is going to wear on for a while. There is also a lot of concern about jobs and unemployment, which is to be expected. In a word, it is dismal out there and the holiday retail numbers will reflect just how dismal.

So how does the market react to all this dismal news? Up nicely at the moment. Go figure? I guess some dismal news is already worked into the market at the moment, but we will see during the year-end reporting season coming up just how much. I still expect new market lows next year. The question is, how low?

http://www.bloomberg.com/apps/news?pid=20601087&sid=aquICb64DYOc&refer=home

http://www.bloomberg.com/apps/news?pid=20601087&sid=a1sbaSrZJxO8&refer=home

Rules To Live By

Robert Farrell, a long time analyst at Merrill Lynch (I bet they wish they had him back), developed a number of rules for guiding investment strategy. Some of these, like reversion to mean, I have discussed in some detail here. They are along the lines of my two-plus-two approach. Sooner or later we come out at four. I think these rules are all worth some consideration in these troubling times. The Big Picture recounts the 10 Rules here, with some good comments. Numbers 2, 5 and 8 are particularly worth noting at the moment.

http://bigpicture.typepad.com/comments/2008/08/bob-farrells-10.html

CRA Blame Game

Some people are seeking to blame the Community Reinvestment Act for the subprime crises. Now I know there is a logical and valid debate on whether the CRA has actually achieved its goal of ending a lending practice of redlining, i.e. not lending in poor areas, but to blame it for the current crises is ridiculous. The act itself calls for "sound" business practices and in no way, shape or form required banks to do liar loans, option ARMs, no money down or other junk loans that they were doing. Moreover, the CRA has been on the books for three decades but the current mess has largely been developing for less than a decade. Folks, there are plenty of scapegoats out there for this mess, but I hardly think the CRA qualifies. If anything the impact of the CRA has lessened under the current administration where agencies such as the OTS did little to enforce it.

http://baselinescenario.com/2008/12/16/community-reinvestment-act-housing-crisis-aei/

Here is a nice piece from the Washington Post (the first two of a three part series) on the arm of AIG that took it down, AIG Financial Services. Let me summarize what happened to AIG as best I can: GREED.

http://www.washingtonpost.com/wp-dyn/content/article/2008/12/28/AR2008122801916_pf.html

http://www.washingtonpost.com/wp-dyn/content/article/2008/12/29/AR2008122902670.html?hpid=topnews

Rick Rule Interview

Here is an interesting interview with Rick Rule (hat tip John), someone who knows commodities much better than your's truly. The part I find of interest is his discussion on oil. I noted yesterday I do not see oil prices escalating to any significant degree next year, and I am sticking with that (for now), but his point on where they might be in five years is well worth the read. He points out that a lot of the oil supply today comes from national oil companies, i.e. government owned. The governments running these operations are, generally speaking, running them into the ground. They are stripping the profits for social causes and/or their own use and not properly investing in new production or maintaining operations. This could lead to the destruction of 25% of today's supply in the years ahead. You might also have some tar-sands operations shut down, at least for now, as oil is well below where these operations are profitable. Ramping them back up could take some time. All things considered, $4 a gallon gas could sound rather cheap five years from now.

http://www.growthstockwire.com/interview/20081029_rickrule.asp

Disclosures: None

Thin Week

This is a thin week on many fronts due to the holidays and the new year, so it is wise not to read too much into any news. Stocks being down a smidge is an example. With trading volume low it does not take as much to swing things. January and February will be another tale. Despite the slim trading, the news remains dismal on the retail front, as Bloomberg reports. Not a surprise, just an affirmation.

http://www.bloomberg.com/apps/news?pid=20601087&sid=aOVg4pkw229o&refer=home

Unintended Consequences by the 800 Pound Gorilla

The 800 pound gorilla here would be the U.S. and other developed countires We are borrowing at an alarming rate. Still, people are flooding to Treasuries as a safe haven - for now, anyway. The question not asked much before is where would those dollars flow otherwise. After all, we are borrowing trillions of dollars, soaking up global capital like a desperate sponge, with little thought to the other players looking to secure some of those dollars. Well, it would seem that developing countries will once again take the brunt of our indiscretion. Their credit is drying up just as they need it most and in no small part to the larger players being on a borrowing spree. If this does not correct in time, more issues will face the global economy that will be hard to fix in short order.

http://www.nakedcapitalism.com/2008/12/emerging-economies-risk-being-crowded.html

And if you believe that, I have a bridge to sell you...

Apparently, you too can soon own a bridge, or highway, or lottery or other state assets, either full out or at least for a time. Yes, it is true, state governments are in desperate need for cash and desperate times require desperate measures. So states left and right are looking at some ways to sell, or at least lease, some of their crown jewels in terms of reveune generation in order to quickly raise some needed mula. Form your own opinion on this. To me, at least a limited term lease to make ends meet makes sense, but selling off long-term income generating assets - likely at fire sale prices - is a bit short-sighted. But then again, I am not facing a multi-billion dollar deficit, so what do I know.

http://www.financialarmageddon.com/2008/12/more-bad-choices.html

Almost Heaven

As noted yesterday, I spent the holidays with family in West Virginia. Some people have thoughts about my home state that are not too positive. Yet, I love the state and have some points to note in its defense:

1. WVU won its bowl game this year and its quarterback, Pat White, after throwing for 332 yards, won his fourth bowl game as a quarterback to set a record. This is in addition to being the NCAA all time record holder for rushing as a quarterback, not to mention having the most touchdowns of any college quarterback.
2. WVU beat the pants off Ohio State in basketball this past Saturday.
3. WV is the only state in the country that did not have an increase in unemployment between November 2007 and November 2008. And their unemployment rate, at 4.6%, is well below the national average.
4. Did I mention that it is an absolutely beautiful state?

Despite some not-so-nice comments I have heard over the years, WV is a great place and I am proud to be a mountaineer.

http://www.bls.gov/web/laumstch.htm

Not on any list!!

My first year of blogging and I have escaped all the lists of worst predictions. Now I could say this is due to making no clearly wrong predictions. Or it could be because the few dozen people who follow my blog did not write these lists. Either way, good not to be on them. Still, these list are some good reading. Some people went way off the mark and paid the price (or at least those that listened to them paid the price). One reason I give no advice. For those Hogan's Heroes fans, I am the Shultz of the blog-sphere: I hear nothing, see nothing, know nothing. Yet here you are, reading what I have to say. All I can say is thanks.

http://www.ritholtz.com/blog/2008/12/worst-predictions-for-2008/

DOW DOWN

For once I am not talking about the Dow Jones Industrial Average. This time it is about Dow Chemical. Its deal with Rohm and Haas appears over as Kuwait is drawing in the purse strings. Let's speculate that Kuwiat, like the rest of the Middle East, is feeling the pinch of low oil prices. Otherwise, they no longer saw the wisdom to the deal. Either way, Dow Chemical is being down graded and the stock is down big time today, as is Rohm and Haas. Will we need chemicals tomorrow, sure, but not as much as we needed a year ago. This demand will eventually return to some extent, but the question today is whether Dow Chemical will be here to enjoy the bounce?

http://www.bloomberg.com/apps/news?pid=20601087&sid=aEOpmCv.eKSE&refer=home

The Big Oil Rebound

I have noted here repeatedly that I despise analysts predictions as most cannot tell their predictions from a hole in the ground. In other words, they put the anal in analysts. Yet I feel compelled to report on their latest prediction. They predict $60 a barrel oil by next year. While I have little doubt it might hit that mark, I must say I disagree with any prediction that keeps oil on average that high next year. Mind you, "that high" is very low by recent standards, but I still disagree with these predictions, at least for 2009. If I am correct in my anticipation that the global economy, and especially China, will suffer big time in 2009, I think the dampered demand will, on average, keep oil in the$50 a barrel range or lower. OR - I could be wrong!!

http://www.bloomberg.com/apps/news?pid=20601087&sid=abtq_Q4RkQJQ&refer=home

Disclosures: None - other than I am from West Virginia.

I'mmmmmmmm Baaaaaack!!

Well, six houses, seven gift openings, 1300+ miles, ten dogs, dozens of relatives and a partridge in a pear tree later, I return. It is good to be home. I sit here watching the Miami/Jets game, hoping the Jets can pull it out (update, they did not do so). New England's future likely depends upon it. Oh well, like the stock market, watching it will not make a difference.

Two Months

Yesterday was the official two month anniversary of my blog. I would have liked to blog but I was on the road nearly the whole day and landed in a location where I did not have internet access. Nice break, however, after a long drive. Anyhoot, two months in and, apparently, picking up speed. Seeking Alpha posted my first contributing article today. You can either click on the Seeking Alpha certified label on this blog or go here to see it.

http://seekingalpha.com/sector/retail?source=refreshed

Quite the honor for your's truly. I will try to continue to live up to their standards. But now, on with the good stuff, what little there is:

Latvian Prostitutes

Okay, I must confess that I do not fully understand the Latvian economy or the price of hookers within it. Indeed, "not fully understand" is a vast understatement as I would be hard pressed to find Latvia on a globe, much less discuss the plight of it hookers. Thus, I refer you to Bronte Capital for more detail.

Let me be a bit clearer here, as Bronte Capital talks more about currency devaluation, monetary policy and the like moreso than the prostitution trade in Latvia, though he links an older post that I read when it came out that is more intensive on the prostitution side of things. I will not seek to fully understand or explain his musings. The only thing I can say is that the pain is obviously geographically and economically widespread. And all occupations, including the oldest, seem to be impacted. Moreover, U.S. prostitutes beware!!

http://brontecapital.blogspot.com/2008/12/hookers-that-still-cost-too-much-some.html

UPS - Social Upheaval

I will be the first to admit that I am making a mountain out of a mole hill here, but it plays well with various comments I have made here, so I am running with it. A UPS driver apparently signed in a turban wearing customer as a "terrorist." The attached article addresses the rampant racism in this act and deals well with the facts, so I will not go there.

http://consumerist.com/5119125/sikh-signs-for-package-ups-driver-enters-his-name-as-terrorist

Where I will go is the social unrest caused by economic recession or, perhaps, depression. I was thinking about this today on the long drive home so I have stretched the UPS article to fit in my thoughts. Let me begin with a quote from Time magazine when it made Hitler the Time Magazine "Man of the Year" for 1938:

"Most cruel joke of all, however, has been played by Hitler & Co. on those German capitalists and small businessmen who once backed National Socialism as a means of saving Germany's bourgeois economic structure from radicalism. The Nazi credo that the individual belongs to the state also applies to business. Some businesses have been confiscated outright, on other what amounts to a capital tax has been levied. Profits have been strictly controlled. Some idea of the increasing Governmental control and interference in business could be deduced from the fact that 80% of all building and 50% of all industrial orders in Germany originated last year with the Government. Hard-pressed for food- stuffs as well as funds, the Nazi regime has taken over large estates and in many instances collectivized agriculture, a procedure fundamentally similar to Russian Communism."

I do not pretend to understand Hitler or WWII, but as I understand it Hitler's rise to power was in part due to economic strife in Germany and a promise of economic austerity. The present times, I fear, are leading to an arena where such rhetoric can again gain a foothold. People are looking for scapegoats to execute or to explain or excuse their pain. It is this environment that on an international scale can lead to those with the wrong message being believed. Those wanting to stir the pot can stir the pot.

I hope these words ring hollow and the world comes together to fight our current economic plight. But I fear that these times will lead to enough desperartion that we will see over the next decade more political and military turmoil than we have in a long time.

I realize this is a bit off the mark from my usual fare, but the political/military/war arena impacts all others, so it needs to be considered. If I am right, I will not say I told you so. If I am wrong, I will be very happy to say so. Watch though, as things are beginning to percholate a bit around the world.

Yield Curve - No Where to Go

Those that follow the yield curve may think the worst is behind us. Well, that ignores that the Fed has taken the Treasury rate down to 0%, effectively negative, so this means nothing. Don't believe me, Krugman says it better than I can.

http://krugman.blogs.nytimes.com/2008/12/27/the-yield-curve-wonkish/

No Safe Haven (or very few)

I report here often on U.S. spending being low. Well, we are not the only ones. Britian is sucking wind as well. Not a lot to add here except to note again that the decoupling theory was just that, a theory. Sometimes theories do not hold water. And if this was your theory, well, can I hand you a sponge?

http://www.guardian.co.uk/business/2008/dec/26/creditcrunch-consumerpages

History Books

A lot will be reported about the current financial crisis as time passes. This will fill chapters in economic texts in the future. I fear it will all be reported as the dire consequences to those who could not foresee this coming, as opposed to focusing on those that anticipated it coming. I would like to be considered in the latter crowd, but I was late to the game, not joining that bandwagon until late 2007, which turned out to be in the nick of time but still a bit late. Many others saw it coming far in advance. As one comment I saw mentioned, however, some saw it coming too soon. If you predict a bubble too soon, you can miss out on massive gains. If you get out too late, you have massive losses from your earlier massive gains. If you are in the middle, Goldilocks will be happy. In the end, it is best to probably be somewhere in the middle. Early or middle, however, and the history books will forget you.

http://www.theglobeandmail.com/servlet/story/RTGAM.20081226.wmeltdown1227/BNStory/National/?page=rss&id=RTGAM.20081226.wmeltdown1227

Disclosures: I work for a subsidiary of Fairfax Financial and own stock in that company through my employee stock owernership program.

Post-Christmas: The Recovery

Well I have been through five gift openings at four locations so far and just two more to go. The last will be back home when we finally return. I do not remember all this house-to-house gift opening as a child, but, then again, I don't remember this many gifts either. Any hoot, it will be nice to get home. I enjoy seeing family, but there is a lot to be said for home-sweet-home.

Santa Scrooge

Despite all the gifts I saw, it appears that this was a rather slow season for retailers. Despite massive discounts, the customers were just not coming in the doors. I know this is bad news for retailers, but they will have to get used to lean times for some time to come. Those that can survive it will do well in the long run, those that cannot, well, cannot, which apparently explains some predictions for massive bankruptcies in 2009 and 2010 in the retail sector. If you have returns to do, the sooner the better as January is a big month for retailers filing bankruptcy. Undoubtedly they wait to see if a good holiday season helps to bail them out. Well, this year it ain't, so get ready.

http://www.calculatedriskblog.com/2008/12/wsj-retailers-brace-for-major-change.html

The good news is that at least some U.S. comsumers are hunkering down and doing some deleveraging. Consumer debt reached an all time high a few months back in relation to income and we must, I repeat must, stay within our incomes. Americans need to pay down personal debt and increase savings. Doing so will be a painful exercise for both the consumer and retailer, but it is a necessary evil.

Now I am not saying all these consumers suddenly woke up and learned how to be frugal overnight. I suspect most simply are at a point where they are given no choice. Credit card limits are being reduced, home equity lines are gone and incomes are being reduced. Without credit or cash you are really given no choice but to spend less. Some day folks may thank the credit card companies for reducing their lines or their mortgage company for eliminating the home equity line. That may be hard to imgine now, but some day they will be better off because of it. Until then, most will have a few choice words for their banks.

http://www.bloomberg.com/apps/news?pid=20601087&sid=asEhz._blSwg&refer=home

Then again, the market was up today, so go figure. Bloomberg attributes it in part to GMAC qualifying as a bank and, accordingly, qualifying for government aid. Given the very thin trading volume today, I would try to avoid reading too much into this either way.

http://www.bloomberg.com/apps/news?pid=20601087&sid=a9CgUozSEpmw&refer=home

Burning Calories

A doctor in California (where else) reportedly was taking the fat from liposuctions and using it to make diesel fuel for his SUV and his girlfriend's SUV. Apparently some legislator with good foresight already had a law on the books prohibiting the use of human waste for fuel - go figure - so the good doc is on the lamb doing charitable work at clinics in South America. Just think, he can do the liposuction and power the generator for the clinic all in one transaction.

http://www.ktla.com/landing_topstories/?Doc-Busted-for-Using-Human-Fat-to-Fuel-C=1&blockID=171088&feedID=1198

Glad it is Not My Tax Dollars

A study in Japan has determined, and I quote, that "teens who skipped breakfast began having sex earlier than teens who ate breakfast." Aside from the fact that teens who skipped breakfast get out of the house sooner and, thus, got a head start, I fail to see the connection. Still, I didn't pay for the study, so I appreciate it's entertainment value. I hear there is a lobby being lead by Kellog to keep this study from becoming public (Not). Nonetheless, had I only known that all those bowls of cereal were holding me back as a teen . . .

http://www.ktla.com/content_landing_page/?Study-Teens-Who-Skip-Breakfast-Have-Sex-=1&blockID=171017&feedID=1080

Thin trading, thin news, thin post. Night all.

Disclosures: None.

Santa Edition

Well, somewhere in the world Santa is spreading his joy and in other parts, well, not so much. But we can still hope.

My daughter finally seems down for the eight count so I thought I might sneek in a post before the jolly old soul arrives. And talk about jolly old souls; it seems Asian stocks are up a good bit this evening on news that consumer spending only slowed .6% in November in the U.S. versus the anticipated .7%. Woohoo, let's party!!

http://www.bloomberg.com/apps/news?pid=20601087&sid=ab.yi64ezPkY&refer=home

Before you pop that cork, however, it looks like December may not fare quite as well. The weekend before Christmas - you know the retail big mama - fell 24% over last year in what Bloomberg says may be the worst holiday retail season in four decades. Sorry, you cannot put the cork back in the bottle and return it, but if you use one of those pressurized corks you may be able to make it last to new year's eve.

http://www.bloomberg.com/apps/news?pid=20601087&sid=agdeTeaKJuGU&refer=home

Oh, and did I mention, that first time jobless claims rose to 586,000?

http://www.bloomberg.com/apps/news?pid=20601087&sid=audHmQcYVBxY&refer=home

When markets rise simply because the bad news is not quite as terrible - on some fronts - as anticipated, then it is a bit hard to get a sustained rally I would think.

More Dong for Your Bong

I admit that this is not a big deal but I had to go there for the heading. How often do you have a link to a devalued dong. I hear that happens when you get older, but I am not going there.

http://www.bloomberg.com/apps/news?pid=20601087&sid=avuMNO_SNRjo&refer=home

All I Can Say is Staggering

How can one state have a two-year budget shortfall of $42 billion? I realize that California was one of the hardest hit by the real estate bubble bursting, but there are an enormous number of wealthy people living in California that may need to be tapped to fill that void. Big void indeed, but big state indeed. Their problem is that they all get to vote on whether they want to pay taxes. And I thought we elected officials to tell us what to do?

http://www.bloomberg.com/apps/news?pid=20601109&sid=a5GbgGwA7BKM&refer=home

So How Have The Really Smart People Done?

Not so well, apparently. According to this calculation, Harvard through the Harvard Management Corporation has lost up to 50% in this down-turn. I sure am glad I am not nearly that smart. I would be in pretty bad shape if I had done what they did. Really, though, this is a good lesson. A lot of what is now considered a toxic investment was extremely complex but, for a while, very profitable. So much so that it seems no one really understood the risk. Well folks, when you cannot understand the risk, by definition it is to risky for you. But try telling that to someone from Harvard.

http://www.huffingtonpost.com/ed-epstein/how-much-has-harvard-real_b_152711.html

I know it is a bit light tonight, but tis' the season! So let me end with something not as light.

China

No catchy heading, no big lead in, just the bottom line. Some are predicting growth to go to zero or even negative in 2009, which for a country needing 5% to break-even this is a drastic recession. Moreover, even when it recovers, some are predicting it will never return to the growth rates of late (I agree) and will be in a difficult economic situation for years if not decades to come.

http://www.nakedcapitalism.com/2008/12/guest-post-how-can-no-one-see-imminent_23.html

Think about the knock on effects here. First you have the social and political problems, which I have discussed. It is kinda like a big panda bear with a hangover; not much is needed to piss it off. Second, think about the short to medium term impacts on various commodities. China was an increasingly major consumer of metals, oil and a variety of other commodities. If its growth rate goes to negative in the short term and single digits in the medium term, this is a major pressure valve letting the steam off of commodity prices. If accurate, commodity prices could well languish for some time. This helps the U.S. by making things more affordable, but it hinders other countries dependent on these commodity exports, which will lead to more instability in those countries. Remember the balance thingy I mentioned yesterday? Well this is an area where that is needed.

All-in-all, China sneezing is not a good thing.

http://www.nakedcapitalism.com/2008/12/guest-post-how-can-no-one-see-imminent_23.html

Disclosures: None

Happy Holidays!!

There is a chance that this will be my last post until after Christmas. Whether you celebrate Christmas or something else, happy holidays (or at least days off)!! I know I will probably get bored and sneak back on tonight after all are tucked away in bed, with visions of sugarplums dancing in their heads. I hope Santa does not consider me naughty for doing so. Later!

The Joys of the Mountains

Well, we had a nice strong wi-fi signal last night but I could not connect to the internet. Must have been a server down somewhere. I need to be brief as we are preparing for company, but I wanted to respond to a comment by Midnight. He/she notes some homebuilders will likely be going down in 2009 and can be expected to seek their own bailouts. Well, some already are going under or are already under, especially the small shops. The guy that built my house, for example, gave up and moved to Florida to do odd jobs. And those big ones still around are already asking the government to be included in the bailout. I do not have the link right now but I read about this happening just last week. So Midnight, you are dead on.

I suspect the relief will come more in the form of some homeowner related relief than direct support to home builders. They have already shed their employees so supporting them is not avoiding job losses. Moreover, we probably have too many home builders out there at the moment and shedding a few makes sense. From an investor perspective, figuring out those with the capital and credit to survive is key. Not that housing is going to come roaring back anytime soon, but if you are interested in that sector the key at the moment is avoiding those destined for bankruptcy.

Madoff Contagion

It seems Bernie Madoff is having repurcussions far and wide. From one reported suicide of someone who invested client funds with Madoff, to litigation flying left and right. I mentioned one fund-of-funds (FoF) last week, Fairfield Greenwich, that was likely to be sued. Well, it is being sued. Imagine that. Now NYU is in the game too, suing those that managed some of its money. And by "manage," NYU alleges they just handed it over to Madoff. Some "management?" Well, I suppose they earned a nice fee for this "management." It is nice to be middle man, at least until the crap hits the fan.

http://www.bloomberg.com/apps/news?pid=20601087&sid=a.vf3pTm9hlQ&refer=home

Disclosures: None

Hate It When I Am Right

literally. I am no big fan of doom and gloom and am hoping for a bright spot to show up soon. But I read the cards as I see them and lately not getting many good cards. I like to play blackjack in Vegas, though I have not been there in some time. Those that gamble know you have hot streaks and then some that are, let's say, not so hot. The former is what keeps people coming back and the latter is what prohibits them from coming back more often. Well, we are in the latter right now, from what I can tell.

In a word - housing

Another dismal performance by the housing sector. As Bloomberg reports:

"Sales of single-family houses in the U.S. dropped in November by the most in two decades and resale prices collapsed at a pace reminiscent of the Great Depression, dashing speculation the market was close to a bottom."

Now I am not going to say I told you so, but heck, why not. I told you so!
This is not tea leaves, it is just two-plus-two.

Another key point here is that foreclosures and short sales accounted for 45% of the sales, according to Bloomberg. Not a pretty sight. Actually, I beg to differ. I think it is a pretty sight.

We need to get there and the faster the better. We especially need to do so before the government tries some stupid tricks to prop up mortgages or prevent foreclosures. I have friends and family on the verge but that does not change the fact that the pain is inevitable.

This reminds me of a child with a splinter. They would rather live with the pain of it for days to avoid the minor immediate pain associated with removal. They know eventually it has to come out, but they try to avoid that day of reckoning as long as possible. Well, in my book, the sooner the better, so the dismal housing report is a good thing, believe it or not. How is that for a silver-lining?

http://www.bloomberg.com/apps/news?pid=20601087&sid=adkUcqYlJVRA&refer=home

I will post more later after everyone goes to bed but the wife is complaining about the "financial guru" (she does not mean this) doing his blog on vacation while dinner is being prepared.

Disclosures: None

In-Laws Day Three

Surviving fairly well. Only a few minor meltdowns so far, and none of them by me. It is early yet, so we shall see how the week moves along.

Bail-out Smail-Out

Apparently the Bush (temporary) loan/bailout of the U.S. auto manufacturers is not making the rating agencies all warm and fuzzy. GM and Ford both got downgrades today, from S&P and Moody's, respectively. They are both several grades below investment grade so in some respects it is relative. Either way, neither is about to attract anyone's money until folks have faith that they will survive. Until then, Uncle Sam continues to be the lender of only resort (other than Canada, which gave their Canadian subs a few billion). Not big news, but the fact that this follows the supposed bailout is telling on whether this is a turning point.

http://www.bloomberg.com/apps/news?pid=20601087&sid=aeb9Jow5oXNY&refer=home

Stocks Down

Again, hardly a surprise. Not a particularly big drop. I mention it because I expect to see more of the same over the next two to three months. First, as we approach year end, you will have mutual funds and others realigning their portfolios and dropping some duds so that they do not have to report them in their year end books. Second, I believe there will be more hedge fund quarterly redemptions, which will create more pressure in January and beyond as they have 90 days to pay up, typically. Third, the fourth quarter and year end results will be horrendous, so this will put pressure on the markets throughout February and March. Just my take. Let's revisit in three months to see if I guessed right. And by the way, that is all it is - a guess.


http://www.bloomberg.com/apps/news?pid=20601087&sid=aEcUjf7SQK60&refer=home

Back to "Normal"

I have spoken here often about how the economy is not about to return to where it was in 2007 any time soon, nor should it, as we were at artificially inflated - or you might say abnormal - levels of credit, debt, consumption and everything else that builds a bubble. These were all things that in time simply revert to mean. The problem is in defining mean. Mean has been in a process of distortion for years, well over a decade, and mean itself may need to revert to mean. So what is normal? I suspect over the next 2-5 years we will all find out.

Here in a piece by Cassandra, she talks about what is normal and how recent past has distorted expectations in this regard. It is a common theme here. We are going to have a new world after this recession. Then again, you may view it as a very old world, depending on your perspective. Either way, we have all been spoiled and now they are taking the punch bowl away. Get used to it.

It will be boring or even down right depressing for a while living this way. Then again, all this fiscal stimulus could succeed in building yet another bubble to help us escape the current mess, which should truly make the next bubble prick most spectacular! Only time will tell. I just hope to have my retirement under my mattress before the next one pops, if that is what happens. The alternative I fear is a long recession followed by a slow and unexciting recovery. Not rosy either way.

http://nihoncassandra.blogspot.com/2008/12/if-you-cant-tell-who-sucker-is.html

Wage Deflation

It is what it is and it is happening left and right. Those that still have jobs are seeing wage deflation. This does not always need to take the form of smaller per hour wages. It more often takes the form of shortened work weeks, unpaid vacations, lessened benefits, brief shut downs and the like. Wage deflation is not terribly upsetting when there is commensurate price deflation to match it, but that is hard to expect across the board. Sure, we are seeing gas down, for now, and retail sales are providing bargains, as are lower housing prices, but certain things are not going down. Food prices and fixed rate mortgages for two. By fixed rate mortgages, I do not mean new mortgages, which are going down. Rather, I am talking about the millions of people like me who have them already. If you have one and your pay goes down, the bank still wants the same monthly payment. And other prices will either hold steady or increase in price in due order. This too will cause this recession to drag on.

http://www.nakedcapitalism.com/2008/12/wage-deflation-underway.html

Gettin' Down With The OTS

Quiz question, when is supervision not supervision? Answer, when it is supervision in name only, which has been the case with the Office of Thrift Supervision for quite some time. They were seen as the more "flexible" regulator, so banks preferred them. It is hard to say any regulator was exactly breathing down the necks of those they regulated this past decade, so when banks seek yet an even more flexible regulator that means something is afoot that really needs regulating. Looks like the OTS needed supervision itself. It is now accused of letting those it supervised commit fraud through backdating. In "normal" times I would be shocked. Hopefully some day stuff like this will shock everyone again.

http://www.calculatedriskblog.com/2008/12/ots-official-accused-of-backdating.html


Credit Watch

Calculated Risk does a nice daily take on a variety of credit indicators. Right now it is quite a mixed bag. The one that optimistically has my attention at the moment is the three month LIBOR, which is down significantly off its peak. Still a bit high, but down nicely. Between that and three month treasuries at 0%, you will have many adjustable rate mortgages that could reset lower over the next 12-18 months. Not all of them mind you. Some homeowners, for example, have option ARMs that allowed them to pick among payment options. They could have picked an interest only option such that they have paid no principal for a few years and now must amortize it all over shorter period. There were even even loans that allowed you to pay even less and increase the principal. So while the low rates are promising and they might help us reach a bottom sooner, they will be little help the most foolish of the fools, who will likely still see increased payments..

Even those who are helped by lower payments are well advised to find refinancing and lock in a fixed rate if the can. If the flooding of the economy with fiscal stimulus does have the desired effect over the short or medium term and that results in inflation, do not expect these rates to stay low forever. Over the short term deflation may drive them even lower (below 0%, however, is going to be tough), but eventually (like yesterday) you will wish you had locked in a rate sooner.

http://www.calculatedriskblog.com/2008/12/credit-crisis-indicators_22.html

Wait, look, it seems people are already looking to lock in those new lower rates and refinance. Refinancing applications are up sharply. Now all these applicants have to do is pray their homes appraise above water, their credit is not too low and their employer does not confess to the bank how shaky their job situation truly is at this point in time. Maybe, just maybe, some of these refinancings will be approved and housing starts to reach a bottom. The problem for me if I am a lender, I know fiscal stimulus can, and eventually probably will, lead to vicious inflation, so how many really low rate loans am I looking to lock in and who am I interested in lending to? The answers - not many and only to those with the best credit, i.e. those that probably really do not need to refinance. Those on the edge needing to refinance before their rate resets may not get what they are looking for. If they do, I will be pleasantly surprised.

http://www.minyanville.com/articles/bac-Fed-Federal-Reserve-tbt/index/a/20419

Disclosures: None

On Balance - We Need Balance

Here is a genuine fear heading into the times ahead - overregulation. The pendulum most definitely swang too far to the deregulation side of things (though some that I follow say our problems are still due to too much regulation, which I will discuss at the end of this piece), so the natural counter is to swing it back the other way, with a vengence. I certainly agree that deregulation was taken too far. Corporations were given far too much say in how to value their books, the nature and amount of debt they took on, and how they were allowed to report things. Aided, mind you, by ratings agencies willing to give a AAA rating to me securitizing a loan from my dog - she is good for it, honest. And now when the house of cards caves, it is time to fix the problem. My concern is that we may over fix the problem.

One problem may show its head in trade protectionist activities. Bailing the auto companies might be viewed as such. Another problem, and one likely more imminent, is replacing lax to no regulation and oversight to overly burdensome regulation and oversight. Moreover, government risks throwing the baby out with the bath water. Not every American corporation was a bad player here. Indeed, a good case can be made that the vast majority of American corporations were trying to do the right thing for their shareholders but have now been caught up in a recession and credit crunch not of their own making. Many may have gotten a bit addicted to credit, but it can be hard to resist when banks are throwing it at you with low rates. Still, most bear little blame for our current mess, and Congress needs to do what it can not to overburden them, especially when they are on the edge already, with costly over regulaiton.

The balance we need to achieve going forward will be quite difficult in this environment but someone (hopefully Obama) needs to keep a cool head and push for more, yet moderate, regulation. I am a big fan for doing enough but not too much. Keep the process simple and inexpensive as you can, but some regulation and oversight is absolutely necessary. Let's do away with some things that are welcoming trouble, like 40-1 debt to equity ratios, Level 3 assets, CDSs and the like and force corporations to be a bit more boring. You know, like cockroaches. Profits will not soar absent a truly great innovation or product - such as an efficient and economical alternative energy source, but that is a good thing. As it turns out, few (other than over-paid CEOs) benefit from make-believe profits. Yet to get there, we need government to work toward the right balance. With the social unrest building, pressure will be on to do more, but we need to move cautiously and deliberately in these times. Time will tell if we achieve the right balance.

http://www.bloomberg.com/apps/news?pid=20601087&sid=avJ43XHySeVs&refer=home

I mentioned that some still think that we have too much regulation, and government in general, and that is the problem, not the lack of regulation. One of them is Mish, who I follow. He can make a convincing case for doing away with the Fed, with Fannie Mae and Freddie Mac, with the alphabet soup of Fed facilities and with a lot of other government programs, much of which I agree with. I have ranted here against what the Fed is doing, the TARP, about pushing Fannie and Freddie to take on more junk, but there is a world of difference in my opinion between doing the wrong thing and doing nothing at all. The SEC did virtually nothing and we have the collapse of Lehman, Merrill Lynch and Bear Stearns to thank for it, not to mention Madoff. We do need to carefully consider our moves before doing them. That has been one of the major problems with the TARP; it was not well thought out to begin with and it keeps changing approaches, which does not inspire confidence. So Mish, I must disagree with you on being totally free-market oriented, though I agree with you on a lot.

http://globaleconomicanalysis.blogspot.com/

Disclosure: None

Blogging West Virginia Style

I sit here about a mile from any road with no cell service, with my wife pasting our faces onto elf bodies that will soon dance on her blog site. Life doesn't get any better than this! But I do have internet access. Bless my mother-in-law for getting wi-fi. There is a Santa Claus!!

Social Unrest

No, I am not talking about that feeling that sets in after two days cooped up with the in-laws. That does not start until day four of five usually. I am instead talking about on the larger scale. I have discussed some social unrest taking place in China. The people there do not have the channels we have for addressing their outrage. They cannot contact their Congress men and women and rant, only to receive back a standardized email. They cannot take out their feelings by their vote. All they can do is protest, and that is difficult too.

Well, China is not alone in social unrest. Unrest in Greece has been on the news and tied to the police shooting a 15 year old. Well, it could have deeper roots than this. And it could be - and become - far more widespread, as Michael Panzner reports. Could this youthful outrage start up here across the pond? If things get worse and the government continues with bone-head moves, I would think so. For now, however, I believe youth here are happy to see Obama elected and will bite their tongues for a while to see what he is able to accomplish. If he does not readily bring the change he said he would . . . well . . . did I mention Canada is a nice place to live.

http://www.economicroadmap.com/2008/12/spreading-far-and-wide.html

Who Wants To Be A Cockroach

I recommend this piece because, if for no other reason, it is very well written. It likens hedge funds to furu (have to read it to understand) and long term stodgy investors to cockroaches. I especially like the line about how cockroaches never take over the world, they just inherit it. Truly is a good read. Point of the article, or at least one of them, is to point out that many corporations today are also like furu, very specialized. Does not take too much of a change in economics to destroy their business model and their profit.

http://ultimibarbarorum.com/2008/12/18/i-want-to-be-a-cockroach/

The Blame Game

This will go one for decades to come, so it will certainly be worth mentioning every now and then. Who is to blame for our current mess? A lot of people start their list with Greenspan. Some with Clinton. Some with Gramm. But probably most start with a single letter - W. Mind you, there is plenty of blame to pass around and all the people on the list get a their fair share, but I suspect W is as guilty a player as any and guiltier than most.

Barry Ritholtz did a nice piece commenting on the NY Times, which did not do as good a piece, placing the blame on dear old George. I am posting it because I agree with it. I do sometimes post things I do not wholly agree with, but not everyone can be as right as me.

http://www.ritholtz.com/blog/2008/12/nyt-blaming-bush-for-the-wrong-things/

No %$^& Sherlock

Two things about this article get me irked. First they title it "New figures show that recession is deepening," but then all they report on is economists' predictions for the upcoming week. Now part of me says this is the UK, so what do I care, but "news" outlets on both sides of the pond do this regularly, which leads to my second irk; the economist have been wrong and behind the curve on this for a long time, generally speaking. Sure you can point to a few with their heads on straight. Those looking at the two-plus-two facts I discussed the other day. But many of these experts seem to ignore the data and predict rosy seas ahead.

The attached notes that economists, finally, are getting gloomier about the outlook. Boy I wish I had seen that coming. I could have protected my portfolio better with that knowledge.

http://business.timesonline.co.uk/tol/business/economics/article5375480.ece

You Ponzi

Some of us build fame and fortune in different ways. A few, like Madoff, start with fortune (for many), which leads to fame (for him), and then lose fortune (for many), which leads to even more fame (for him). The fame is, unfortunately, especially long lasting when it is based on misconduct.

Well, they keep calling the Madoff scheme a Ponzi scheme, so it would seem that Bernie's ability to get the most fame out of this is preempted. It already has a name thanks to Charles Ponzi. Madoff seems to have perfected it a bit better, making it last an unbelievably long time, but Ponzi still gets his name pinned to it. If you are unfamiliar with Charles Ponzi, here is a nice article on the financial magic he performed in all sorts of investments.

http://timesonline.typepad.com/timesarchive/2008/12/charles-ponzi-a.html#more

As the derivatives market has shown us, we are all Ponzis now!

Disclosures: None

Parting Shot

Hectic day to say the least, but I am taking a break from it to return for a while to my second job, my blog. You know, the one that does not pay. But as I have always said, it is the work that does not pay that pays the most. You can quote me on that and you can pass it on to the few financial heads who are going without pay or bonus.

Auto Bailout?

Not so much a bailout as a short term lifeline. The government is throwing GM and Chrysler $13.4 billion in aid. This should allow GM and Chrysler to survive a few months though getting continuing aid after that will depend on the companies and their bondholders and union employees making some rather dramatic changes/concessions. I like it generally. It is certainly short term and it passes the buck to the next administration, but I would have done the same thing in W's shoes. I truly hate saying I would do the same thing as W, but I would in this case.

http://www.bloomberg.com/apps/news?pid=20601087&sid=a5s6IaFfulhM&refer=home

I will not begin to try to summarize this blog from Yves as there is too much to it (and I need to load bags in the car for attempting to travel tommorrow in a foot of snow). But the premise here is so very nice. News organizations, and their supporters, from both ends of the spectrum hate the TARP (count me in) and news outlets for both are looking to get to the bottom of it. And both are getting rebuffed. Go figure. Yves take is well worth the read. I especially like the J. Edgar Hoover line.

http://www.nakedcapitalism.com/2008/12/mirabile-dictu-fox-news-is-suing.html

Again, Good And Bad News

Oil down to $33 a barrel. This means pump prices should soon approach a dollar a gallon. While this is incredible, it will be only a medium term happening. Given the world-wide recession, it could last for a while, but sooner or later oil producing companies will do significant cuts in production realizing that it makes more sense to leave that Texas tea in the ground. Either way, oil this low spells out financial instability for Russia, so do not go popping the cork just yet. Their instability is our pain, eventuall.

Executive Pay(ola)

Here is a class assignment. Look for companies that seem to have done very well over time, including in the current financial crisis, and look at what their executives are paid in salary and bonus. I suspect that a lot of them will not be in the class of multi-million dollar salaries or bonuses paid to the failed financial company executives. Personally, I think they should be sued, but I am an attorney and that may be my natural tendencies taking over.

Nonetheless, these are people that should only do well in the long term when their companies do well in the long term.

Here is an idea. Let's set up shareholder meetings where the shareholders, much like the voters in California, can vote on resolutions about their executive pay. Now these executives have few more attractive options these days, so they are probably will just be happy to have a job. And here is another idea, do a resolution where most of the money each year is only paid if the company, and its stock price, continues to do well five or even ten years out. Heck, put in a claw back provision where the company can demand back past bonus payments. Easier yet, pay them bonus in stock options that can only be used after they retire. These are just suggestions, but the point is that we need to stop these insane salaries for executives because they simply try to pump up short term profit to inflate their own salaries.

We need to insure executives have a very long term horizon. Otherwise, just look for companies doing well where the executives are already taking reasonable pay and tying their fortune to their companies and invest in them.

Disclosure: None

Looks like S&P agrees with my discussion yesterday on financial institutions having a broken business model and on Greenspan's prediction of them rebounding in 6-12 months being wrong. It has lowered its rating or outlook on a dozen of them citing "significant pressure." Perhaps the rating agencies are starting to do what they are supposed to do and not just sell ratings.

Sorry for the short post. Getting ready to travel. Happy Holidays!

Not Surprising

Oh Ben Ben Ben, what are we going to do with you? You seem to never learn, or perhaps you don't want to learn. Either way, why do we continue to let you repeat your mistakes of the past. So, what did he do now, you ask.

If you fill a room with the culprits that got us in this mess (a very large room indeed) you would need to most certainly have the major rating agencies in it. After all, these were the companies that generated nice fees for themselves by giving top marks to $3.2 trillion in toxic subprime backed securities. I am not saying that the conflict of interest had anything to do with these lala ratings but . . .. These rating agencies also, by the way, maintained AAA ratings on mono-line insurers MBIA and Ambac long after both companies no longer deserved them. Indeed, a plausible argument exists that any company that is reliant on its triple A rating to survive does not truly deserve a triple A rating in the first place. But hey, what do I know. All things considered, however, they have not shown a great deal of ability to accurately rate anything.

Any hoot, helicopter Ben is relying on these same rating agencies to tell him what debt is safe to lend against. Go ahead and feel free to reread that last sentence slowly to let it sink in. Jaw dropping, isn't it!

If I were a cynic, I might start thinking something nefarious was happening. You know, like Ben going through the steps of getting bogus ratings so he can appease the public and Congress about the quality of the junk he is accepting, all the while knowing it is a load of crap, but he needs to get this crap off the bank books of banks to help out his buds. Naaa, not Ben. He would never do that, would he?

On a connected point, I have not seen anyone talking about this too much, so let me throw it out there to see if it makes sense. The various facilities set up by the Fed for the most part simply provide loans to the financial institutions and take on these toxic securities as collateral. If these financial institutions do survive - which we seem hell bent on making sure they do - then they need to repay the loans eventually and take the toxic debt back. Exactly how on Earth does this help them?

It may give them time but it does not really give them liquidity.
Think about it. They really cannot loan out the money they have from the Fed as they know at some point, a point that they hope is far away but they cannot guarantee, they will have to repay it. Their business model is not working too well right now, so they cannot assume they will generate new cash to repay the hundreds of billions (I believe over $600 billion) in loans they have taken on. And if they do survive they get the wonderful benefit of taking these toxic assets back from the Fed. So all it really does is buy them time to try to devise some new ridiculous scheme to make money.

Oh,I forgot, they already have the new plan in place. They call it TARP and it works quite well for them. They do nothing and are given money by their other friend Paulson with no strings attached. Now this money does not need to be repayed, so they are free to lend it. But who can they lend it to. Certainly not any of the other characters that drank at Uncle Ben's trough. They have all that debt to the Fed too and will be getting toxic securities back. Can't lend much to corporate America as we are in a recession and too many companies are on the brink. Guess they just have to spend it on acquisitions to make sure they are too big for Uncle Sam to let them fail. It is so nice having a couple of rich uncles around in these times of trouble.

Long story short, the day will come when the survivors do indeed have to repay the Fed and by then the collateral will undoubtedly be close to worthless. They may beg and plead then to have the debt forgiven, but let's not go there. Meanwhile the money we loaned to them really cannot be used by them for much more than insuring their own solvency because they continue to lose money. Some of them are undoubtedly already insolvent, but can mask that fact with the loan proceeds. Just kicking the can down the road in my opinion.

http://www.bloomberg.com/apps/news?pid=20601109&sid=af32G4ayfLQY&refer=home

X Rated

While we are on the topic of credit agencies, it does seem they are not hesitating to downgrade some companies. GE was put on negative watch today, which some say caused the market drop, and Citigroup's debt was lowered two grades by Moody's. In the process Moody's said Citigroup will not generate significant retained earnings through 2010. Kinda makes it hard for them to pay back the loans from the Fed, don't it. Of course Citigroup retorted noting its "strong" cash box. I didn't know they kept it in a box. Whose bed is that under?

http://www.bloomberg.com/apps/news?pid=20601087&sid=av3u3ANbl5nY&refer=home

We Are Definitely In Trouble Now

Greenspan says financial markets will rebound in the next six to twelve months as housing bottoms and confidence rebounds. Guess Alan has not been reading my blog. And here I thought he might be my one Follower, Loose Tool. Darn!

Well if you read what I have to say and think it makes sense, do you think Greenspan's estimate is correct? Don' hesitate here, I can take it. Just what I thought. Thanks for the support. Let's list a few reasons why he may be just a tad off:

• If you look at the blog entries above, that is a nice start. With loads of debt and bad assets, why would confidence restore any time soon?
• Housing ain't going to bottom in six months. Sorry Charlie, er, I mean Alan, but adjustable ARMs are about to hit the proverbial fan and I am getting out of the way. Builders are cutting way back, which will help, but foreclosure sales will continue to push down prices well beyond six months from now.
• The economy is in a deep recession that I expect to last a long time. Job losses are mounting and will continue to do so through 2009 and beyond, and that does not bode well for housing.
• The business base of these financial institutions is not going back to what it was. Let's see, no loans, no M&A, limited brokerage, no securitizations, etc. Their business model is broken and they will perhaps never return to the unsupported profit levels of the past few years. Add this to all the toxic mess on their books and I don't see confidence returning too soon.
• As noted here last week, financial insitutions are adding hundreds of billions of assets to Level 3. Remeber my Lala Land post and what I said there? Increasing Level 3 - rather drastically - kills confidence and trust, not the other way around, and this will not change back quickly.

I have more reasons, but this is enough to chew on right now. If you want more, leave a comment and I will be happy to oblige.

http://www.bloomberg.com/apps/news?pid=20601087&sid=aJ0kdydwOmVc&refer=home

Just The Facts, Ma'am

Any Dragnet fans here. For those college level followers, and I know there is at least one (hat tip Cody), it was a TV show way way back in the days when TV broadcasts were in black and white. The black-out here in New Hampshire harked me back to simpler times. I started telling my five year old daughter about all the things we did not have when I was her age, like color TV, computers, DVD players, microwaves, digital cameras, etc. etc. She asked me if we had "arms." She is such a little smarty and I knew she was teasing me. I also know she was not talking about adjustable rate mortgages.

This is not about a big retro thing, however, as I am cluing you into my investment philosophy. This year I have really looked far and wide for facts. Sure I like the discussion blogs that make sense of these facts, but the facts are critical. For example, knowing that a very significant number of adjustable rate mortgages are resetting next year is a nice fact to know if you are trying to judge when housing will bottom or foreclosure rates will slow down. Knowing that financial institutions just moved over $600 billion of assets to Level 3 is a nice fact to know too. Knowing that even when their business models start to recover the financial institutions still have a bunch of debt to repay, is a good fact to know. And most of these facts have relatively obvious consequences.

Two plus two equals four. In matters financial, I have found that it does not always equal four. Sometimes it might migrate up to five or five and a half or down to three or two and a half, but eventually it migrates back to the right answer, as in reversion to mean.

So what I do in trying to anticipate what is happening on a macro level is read a lot and collect together as many pertinent facts as possible. I then try to make sense of them or find someone who does that for me. And if I am happy with what I have found, I try to pass it on here. Truly, knowledge is power. It does not take an MBA to understand some of two plus two situations. For some of them it helps, but I try to bring you those that I can understand, so I suspect anyone can.

Radio Silence

I am leaving Saturday for vacation for a week. I likely will try to do a post or two but I will be in a place where I very well may have no available internet connection. I will definitely be hyperventilating a bit, but probably a good thing.

Slowly We Creap, Step-By-Step

I have been posting for all of, I believe, 52 days, and today I should reach the 1000 page impressions level (I am at 995 right now). No, not per day, but total. Still I think that is respectable. Whether it is or not I am happy with it and thank you for your support.

Did I Mention Greed

I am not going to summarize this as it is too disgusting to give it short shrift. Please read it yourself. It is about how the financial institution officers and head people looted their companies and shareholders, as well as taxpayers. This is revolting and it still continues. I truly hope these people get sued for every cent they have and hopefully get put in jail. They have caused more harm and pain to so many in this country that they should all be in jail. Few have done as much harm to so many in our country's history - all in the name of greed.

The original article was forwarded to me earlier today and is in the New York Times (hat tip Chris) but I like Yves' expansion on the original piece better. This is closely related to a topic I have not seen mentioned lately, which is moral hazard. When these idiots get saved by the government and are allowed to keep their jobs, we the people are simply supporting their idiotic and potentially illegal ways. They now have government incentives - as do others who might immulate them - to continue this short term bonus, risky, looting behavior. This is why, for the first time in a long time, I wrote my Senators and Congress people imploring them to vote against the TARP. Some did and some did not. One that did leaves office next year, so I get some satisfaction.

Any event, this has me upset enough that I am having a hard time keeping this post PG. Folks, if you are not mad, stop reading and go elsewhere. Then again, read the attached and then come back. Then, if you are not outraged you are welcome to go elsewhere. And think about how we are throwing money at these #%^holes to keep them in business.

Okay, I need to try to calm down and get to bed so I need to stop now. You know where I stand.

Disclosures: None