Merits (and Dangers) of Removing Rick Wagoner

The recent ousting of General Motor's CEO Rick Wagoner by the federal Government is an event that will likely be recorded in history books as a defining moment of the Obama Presidency. The removal of a CEO is obviously in stark contradistinction to the business-lenient Bush Administration, where Industry was allowed to evolve unfettered. For our part, we are tentatively in agreement with the President's decision, provided that the Administration treads carefully down the new path it has cleared for itself.

General Motors has been slowly deteriorating for upwards of twenty years, nine of which saw Mr. Wagoner at the helm. Following 9/11 and the ensuing mild-natured recession, GM embarked upon an aggressive financing campaign that incentivized millions of buyers to purchase a new car, despite the fact that the condition of his/her current vehicle did not actually warrant the purchase of a new one. The strategy, which Mr.Wagoner presided over, would have stymied demand for new cars even if the Great Recession hadn't hit. Our purpose is to illustrate the point that Mr.Wagoner, while not entirely responsible, does share some of the blame for the demise of GM.

In addition to removing a CEO with a history of inept management capability, Obama has also sent a message to the executives of other Corporations on the Government dole. The message is this: Floundering about on the brink of bankruptcy, and praying for an economic recovery is not an acceptable strategy in the eyes of your new creditor: Uncle Sam.

Of course, there are also competing dangers involved when a Government chooses to assert itself in this fashion. Namely, we have noticed that Government has a propensity towards the permanent retention of a newfound base of power. The implications for the economic preeminence of America would be devastating in the event that the Government takes an assertive and protracted role in the day to day operations of large multinational corporations. Unfortunately, such actions could easily become a reality given the fact that Government intervention always occurs through a set of lens known as the Best of Intentions.

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Announcement: Mortgage Broker Competition

On Friday, March 27th, Carneades penned an analysis entitled "Blame the Existence of Mortgage Brokers". Apparently, numerous individuals interpreted the piece to be highly derogatory in nature, as evidenced by the vitriol which emanated from various pseudo-sectors of the mortgage industry. The high volume of comments that we received certainly ran the gamut in terms of intellectual pedigree, logical soundness, and proper use of grammar/punctuation. Needless to say, we can not allow a handful of Rogue Commentators to desecrate these pages with ill-conceived and emotional comments. However, in the spirit of debate and fairness, we will allow users to submit their official rebuttals to the post dated March 27th. We will then select the best argument, based upon the criterion of intellectual pedigree, logical soundness and grammatical correctness, and post that argument to this site.We will not impose restrictions upon the number of words that you may submit. 

We will be posting submission instructions at the site www.brokeroutpost.com. Thank you Comrades, and good luck.

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Spanish Bank Bailout, More to Come?

On Sunday, the Spanish Government announced its first banking sector bailout measure of the current Crisis. Although this rescued institution is not a financial behemoth, it is still, relative to the size of the Spanish economy, a rather substantial "savings and loan insitution". Now, we have previously discussed the looming troubles in the Spanish economy and banking system, so the announcement regarding the necessity of a Government rescue scheme did not surprise us. What did pique our interest however, was the multitude of official assurances from the Spanish Government, characterizing this situation as an isolated event that was in no way indicative of greater financial system woes. Throughout this global financial crisis, Government forecasts and statements have, regardless of the country from which they emanated, served as a fairly reliable contrarian indicator. The situation in Spain should not be interpreted any differently from the plethora of inaccurate Government forecasts that have been proferred to date. The country is obviously on the brink of a massive banking sector consolidation process that will likely leave only a handful of large institutions intact. The lucky ones will be absorbed by the likes of a Banco Santander, while the unfortunate many will flounder about, eventually slipping into bankruptcy. So is how we anticipate it to be. Sphere: Related Content

Evaluation of Market Bottoming Evidence

The most recent chatter concerning evidence of a market bottoming pattern is widespread in nature, occurring in both financial and traditional media outlets. The impetus for this new found optimism was the release of several economic data points throughout the past week, and subsequent media analysis of the chart pattern formed by the inclusion of these data points. We will first offer an assessment of the data itself, followed by our observations concerning the individuals who are aggressively promoting this new economic storyline.

The two data points that are most widely cited as evidence of a market bottom are new orders for durable goods and existing home sales. The durable goods data is notoriously volatile, and thus we will not pass any judgment until at least four additional months of data are available. The trend in existing home sales however, has the ability to offer a bit of insight. More importantly than the headline data figure, we think, is the fact that approximately 40% of these sales involve a distressed property. This is actually to be expected, and provides evidence that the Market is working to clear the inventory of foreclosures, a prerequisite for any sustainable recovery. Sales of existing homes will likely continue to rise in the coming months, until at least, the Government's refinancing and foreclosure prevention efforts begin to work their way into the economic data. We expect these efforts to slow the intensity of foreclosures at any given point in time, although the total volume will remain relatively unchanged. Ultimately however, the level of existing home sales does not serve as an indicator as to the extent of deterioration in the underlying collateral of the securitized pools of mortgages that continue to rot the financial system from within.

As for the "pushers" of this new bottoming theory, we are not surprised to see that the chief proponents are none other than the usual Wall Street asset managers, who are unashamedly attempting to lure the public back into stock related investments. This is, and has always been, the Name of the Game. Sphere: Related Content

Government Debt Investors Revolt

The past 48 hours have brought interesting developments in both the US and UK Government bond markets. In the United States, a Treasury auction of $34Billion of five-year notes drew meager levels of support at the intitial yield offered by Treasury, forcing the Government to bribe investors with higher yields. In the United Kingdom, the Government lacked the ability to complete its most recent gilt auction altogether, resulting in an actual auction failure.

Now, in a world where Government policy Influencers could assess market developments in an apolitical, cogently sound fashion, the recent activity in the Government bond market could be construed as a good thing. The reason being, any honest observer would process the auction developments and conclude that, perhaps, a break should be taken from the Debt Agglomeration Rampage.

We interpret the happenings in the US market to be quite similar to when one feels his car sputter or stall for the first time. Often times, the internal cause of the first sputter will be readily identifiable. However, the human tendency is to avoid the inconvenience and expense of bringing the vehicle to a mechanic at first sign of trouble, and instead wait until the issue has become sufficiently problematic and presents the possibility of permanent damage.

Yesterday, the US Government's primary operation funding vehicle  experienced a very minor engine sputter. In the near term, such disruptions are likely to remain sporadic and isolated in nature. However, if the United States Government continues to travel down its current path, and delays the necessary engine repairs, the Consequences Will Be Severe.

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Russia Distinguished

As global economic disruptions have caused a collapse in oil prices, Russia has been exposed as having fooled itself into thinking that the past eight years of prosperity was the result of brilliant economic planning. With that veneer now stripped away, the reality is that Russia merely accessed many partially depleted Soviet-era oil wells, and watched gleefully as oil prices continued to rise. At the same time, one could question whether Vladimir Putin's immense popularity(until recently) was merely a reflection of ever increasing Russian living standards, enabled by oil wealth.

The above reality, we feel, is relevant when assessing the recent Chinese calls for a "global currency", and the supposed international support it is receiving for such calls. Cited by the media as supposedly pertinent to the Chinese comments is the fact that Russia also voiced these World Currency concerns just a week ago. First of all, we would dismiss the idea that any group of countries are about to unite under the noble and common goal of creating a global currency for the purpose of global stability. Clearly, the Governments of the world are only concerned about stability within their Specific country, and each has a specific reason to advocate a global currency. The Chinese are obviously upset that they have ignored the old adage "Don't put all your eggs in one basket", in addition to the fact that they see now as an opportunity to wield an increasing amount of influence concerning the restructuring of the global financial system. Russia however, is a different story.

Russia's situation is simple math. Where spending and oil revenue used to both equal 4X, revenue has now declined to 1.5X, but spending has remained the same. The country did have 7.5X saved, but has has to spend 2.5X to finance its deficits and support the flimsy ruble. Assuming oil prices remain relatively range bound(or don't fall further) the Russians will either have to cut Government spending significantly, or they will go bankrupt. The country is already allowing some of its smaller state supported entities default on their debt, and we don't think investors will lend money to the Motherland.

We believe that the above reality is already quite well known in the upper levels of Russian government, and that steep cuts to government spending are being planned. The Kremlin understands that the populus will not take kindly to sudden cuts in levels of service, and thus has decided to use the oldest trick in the book: the external enemy. We expect that anti-American/dollar rhetoric will emanate from the Kremlin at levels commensurate to that Government's inability to provide for its own citizens. The final stage, however, could very well involve Russia once again lashing out at a neighboring country, a la the Georgian incident.

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The(Newest) New Plan

The Plan we refer to is obviously the latest in the long procession of bailout schemes proferred forth by the Government's wizards over the past 18 months. As expected, and in contradistinction to previous bailout measures, this New Plan is largely predicated upon private sector support. Ironically, Mr. Geithner's grand unveiling occurred amidst one of the most intense populist, anti-bonus/reward/ excess-profit uproars in our memory. For that specific reason, we believe that, more likely than not, the Treasury's latest plan will be a failure.

The private sector's fear is that inevitably, the following will take place: Hedge Fund manager Johnny committs a certainl amount of capital to the Geithner Program. Treasury allows Johnny to lever himself substantially, potentially amplifying profits while limiting the downside. In the end, Johnny earns his Fund X amount of profits. As the manager, Johnny rips .2X for himself (We can assume that .2X is a hefty sum). CNN is alerted to some flagrant display of wealth that Johnny has made, and all of a sudden, everyone knows just how much .2X really is. The best case scenario at this point is that Johnny simply gives the money back, and fades quietly into the night. At worst, an angry mob holding signs bearing unintelligible scrawlings forms on his front lawn. Why subject oneself to this?

We are often critical of the Government, and for reasons that can be justified with relative ease. However, we also feel the need to expose the sad reality that is not recognized by the masses: Everything that you don't like about Washington happens because you permit it to happen. Very few voters have properly educated themselves with regard to each candidates stance on the issues. You instead choose to marinate your mind in the festering cesspool of reality television, emerging from a stupor only to bemoan the System. We have cowards and weasels(for the most part) in Washington because the populus has developed a voting pattern which favors the election of cowards and weasels. Should we really be surprised that, to date, no politician in Washington has accepted even an iota of responsibility for fostering the conditions necessary for our current Economic Predicament?

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The Great Confounder

The Great Confounder is, of course, the very Government that is supposedly "By the People, For the People". We have made a concerted effort, throughout the various stages of economic deterioration and amidst the daily din of traditional media, to provide an objective assessment of financial market happenings. The disheartening truth is that, at each stage of the Recession, the Government has acted in such a way so as to Confound the problems, and provoke a subsequent "leg down" in the real economy. First, the Government grossly underestimated the extent of Bank's losses tied to subprime securities, and stood idly by as the industry's balance sheets became increasingly gangrenous in nature. Next, the Fed misinterpreted the issue as being liquidity related, and responded by aggressively lowering the Federal Funds rate. A brutal commodity price spike ensued, causing significant damage to the average consumer's personal finances. Next up was Lehman Brothers, a systemically significant institution that, in an epically fatal decision by the Government to "draw a line in the sand" ,was allowed to fail. 3.3 million jobs lost later, the world is still reeling from the shockwaves that emanated from the Lehman bankruptcy.

At present, Congressional fixation upon the bonuses paid to a group of AIG traders has effectively annihilated the political will for additional Banking rescue efforts that might originate in the Congress. Future bailout schemes, such as the one to be announced Monday, will rely heavily upon private sector participation. Unfortunately, these are individuals who have been vilified and alienated by a Congress intent on capitalizing politically. We have continually asserted that, in order to garner substantial private sector support for any Program, the Government must provide a set of precise, immalleable Rules. A 90% ex post facto bonus tax does little to inspire investor confidence in dealing with the Government.

While we hope it not be the case, we are concerned that Government-led AIG furor may be a pivotal point in the Crisis. The Government has likely lost, for quite some time, the ability to engender private sector support for its rescue efforts. In a sense, a void has been created, one that will be quite difficult for Geithner et al to fill. Sphere: Related Content

GE's Disclosures In Perspective

When a large corporation feels compelled to make financial disclosures in addition to what is required of it, our interest is generally piqued. Thus began our journey into GE's 88 pages worth of disclosures related to GE Capital Corporation.

(Two side notes:

1) The pointless comments that are encircled by a cloud-like design: annoying.

2) Bullett point number one from the five point summary on page 84 reads "We Follow the Appropriate Accounting Guidelines". Great job.)

We found the disclosure, as a whole, to be relatively informative and feel that it probably answered many of the questions that investors have been wanting to know pertaining to the unit. For our part, we would like to look at GE's stress test results in conjunction with the relative quality of the Unit's mortgage and real estate portfolio.

From the looks of it, GE Capital is better positioned than the large commercial banks in terms of its exposure to the rapidly deteriorating commercial real estate market. First of all, of the Company's $81Billion commercial RE holdings, $33Billion is classified as "primarily 100% owned operating real estate". The debt holdings are slightly larger at $48Billion, consisting primarily of senior secured first positions, and well diversified across property types. In contrast, commercial banks poured money into CMBS saturated with office and retail properties, reaching an apex during the disaster vintage of 2007.

Despite these advantages, the Company still reported that, under "adverse" Fed economic assumptions, credit losses would equal $13.7Billion, and net income would be zero for the year. These assumptions involve US unemployment peaking at ~10%. We think this line of thinking should be labeled "optimistic". What then, can we infer regarding the liklihood of Banking Sector profitability for 2009? We understand that there are more problematic portions of GE's balance sheet such as consumer loans and Eastern European exposure. However, these issues exist across the board in the Banking Sector. What doesn't exist is the quality of the commercial portfolio described above, much less the accounting advantages GE enjoys as a "long term investor".

What should be noted, is that we have yet to see the results of the "stress tests" for the rest of the financial industry. For now, we will have to assume that this decision was made by the Authorities for fear of provoking some form of public alarm. In parting, please allow us to point out the glaring disparity between the latest disclosures from GE and Citigroup. While GE has provided investors with an 88 page document that forecasts earnings and credit losses based upon various economic assumptions, Citigroup has sent a one paragraph memo to its employees, claiming that profitability has returned.

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The Fed Follows Suit

Yesterday, the Federal Reserve announced that it will increase its purchases of Mortgage Backed Securities to a total of $1.25Trillion(yes, that's correct), and, more importantly we think, embark upon an aggressive Treasury purchase program worth at least $300Billion. We would like to note that while the Fed's actions "stunned" many an investor, those regular visitors to this page were warned of these Actions in advance. On March 7th, we posted an analysis titled "Bank of England Leading the Way?", in which we predicted the inevitability of aggressive Treasury security purchases by the Federal Reserve.

As is usually the case, the Economic Intelligentsia immediately put forth the usual faux-analysis on the subject. We are told that the Fed is trying to "force" investors out of Treasuries and into riskier asset classes, that the Fed's purchases will be relatively insignificant when compared to the total amount of planned Treasury issuance, and that the Fed's actions will help lower borrowing costs throughout the economy! In our opinion, a more reliable and profound statement arrived via the price and volume activity on the SPDR Gold Trust ETF (GLD) in the moments following the Fed announcement. At the risk of appearing cliche, "A chart is worth a thousand words".

Concerning the size of the Treasury purchase program relative to GDP,budgets, planned issuance,deficits, etc., we would counter that at this point, all such ratios are irrelevant. We say so for the following reason: The size of the program will not stop at $300Billion. For now at least, the headline figure of $300Billion has proved sufficient in lowering the yields at crucial points across the Treasury curve. Unfortunately for the Fed, the Market is no fool, and will undoubtedly begin to question the credit-worthiness of the United States Government. As has consistently been the case over the past 18 months, each Fed action has been met with a swift, shrewd Market counter-action.

We expect that as the Fed/Treasury/Congress continue down this path, the eventual consequence will be the loss of the United States Government's AAA credit rating. Our message to those who deny the veracity of this prediction: Just wait and see. Sphere: Related Content

Germany: Lone Voice of Responsibility

In the midst of a global political panic, evidenced by daily announcements of bailout and money creation schemes, Germany may be the only country still willing to act with some degree of prudence. As the largest European economy, Germany has repeatedly been called upon to lead a continent-wide bailout/stimulus measure. Predictably, the US Government has assumed a primary role as the world's "Urger of Further Bailouts". In the face of large internal and external pressures however, Chancellor Angela Merkel has consistently sounded the most sane with respect to the concept of a Government's fiscal responsibility. We would speculate that the German's attitude is derived from fundamental differences in the economies of Europe and the US, as well the German experience during the Weimar Republic.

The common criticism of the Western European economic model is that the relatively high tax rates tend to stifle economic growth. This is likely true to some degree, however, those higher taxes also create a set of "automatic shock absorbers" via the welfare state during an economic downturn. While the US has already unveiled a stimulus package in excess of $700Billion, it is clear from a quick assessment that the majority of the spending is directed towards items such as aid to states, extending unemployment insurance, and putting an extra $40 a month in everybody's pocket. Given this set of circumstances, we would not expect the Eurozone to announce a comparable stimulus measure, even though the economies of the US and Eurozone are very similar in size. As the leader of Europe's largest economy, Angela Merkel is obliged to act in accordance with this reality.

What we think the German's understand about the current situation is that a nation can not borrow unlimited sums of money. At some point, and as has already happened in the UK, the Central Bank's will have to embark upon a policy of money printing. Now, Germany has experienced a certain economic reality that the US has not: a hyperinflationary depression.

After World War 1, the Germans were forced to pay back a massive amount of war debt. The country had few resources to draw from following the war, so the Central Bank began printing money to repay the debts. The result: the Papiermark/Dollar exchange rate went from 4.2 to 1, to a level of 1,000,000 to 1.

We think it is likely that Berlin has retained some memory of the consequences of aggressive Central Bank money creation, and has thus become quite averse to heading down that path.

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Barney Frank: Owner

Politicians are quite adept at seizing upon the public's anger for no reason other than to score political points. Case in point, during the oil price run up in mid-2008, we noticed that politicians made a habit of mentioning the "pain at the pump". Eventually, hearings were even held on the subject. Notably absent was any politician able to proffer forth a legitimate solution(assuming one existed). In the end, of course, the politicians did nothing, which was probably for the better.

Today's situation however, is fueled by seemingly unprecedented public anger concerning $162 Million worth of bonuses paid to AIG executives. To be clear, we feel that in all of the history of modern corporations, it would be difficult to find one more poorly managed, and with more inept risk controls than AIG. Clearly, these men/women do not deserve to be rewarded for their role in the Debacle. However, we are concerned that the Politicians could go too far, essentially smothering any life the Company has left in it.

Now, it seems to us that it would be counterintuitive for the taxpayers to wish harm upon AIG. Apparently though, Barney Frank feels that he has a public mandate to "exercise our ownership rights". If the public's interest is in getting its principal back, plus interest, we would hold that allowing the Government to exert an undue amount of management control over the company is not in line with the public's best interest. Unfortunately, at this time, it feels good to be angry.

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Bernanke: Buy Gold

Despite the plethora of criticism that has emanated from these pages towards Dr. Bernanke, we must admit that he is a man who follows through with his promises. Long before ascending into the most powerful job in the world, during his time in the Ivory Tower, Bernanke penned many a paper regarding the Great Depression. In these writings, the Fed Chairman made clear that to combat a deflationary depression, a Central Bank must "print" as much money as is possible. Sure enough, throughout the current Predicament, Bernanke has remained true to his principles, and has now appeared on natinal television to espouse his views. The message we take from the interview is clear: The Fed has, and will continue to expand the money supply, at an exponential rate of increase if necessary.

The winners under this scenario are the Government, as well as certain recipients of Fed backing/funding. The losers, of course, are those who have saved their money, and the Government's creditors. We would speculate that the Chinese Premier's call for "assurance" from the US Government was purposely delivered on the eve of a public pronouncement from the Fed Chairman. Nevertheless, we hold that given the global currency risks that currently abound, Gold should maintain its status as Preserver of Wealth.

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The Next Leg Down: Sovereign Default

In case the title of this post does not clarify our position quite well enough, we would like to state, in definitive fashion, that the global economy is at best halfway through its deleveraging/bottoming process. The past week has brought with it a sharp increase in bullish sentiment, based upon the assumption that the negative economic data is slowing in the sheer intensity of decline. We are told that, historically, sharp drops are followed by sharp rebounds. Unfortunately for the professional prognosticators, the current downturn is unlike any economic reality in the post World War 2 period.

Within the current situation, there are several Countries that face a legitimate, imminent risk of collapse. We have seen this scenario unfold in Iceland, a relatively insignificant country that in this situation merely serves as a precursor for what is to come. The next leg down in the global economy will occur in conjunction with the collapse of one of the Countries that is currently at risk of collapse.We refer specifically to Hungary, Latvia, Ireland, Greece and Spain. We fully expect that two of the listed Countries will default on its sovereign debt and descend into a period of relative chaos. We have listed the Countries based upon the likelihood of a violent disruption in the Country's finances, ultimately resulting in the referenced sovereign default.

We are quite sure that the aforementioned issues are inevitable in nature, and will serve as a catalyst for a renewed sense of panic with respect to the state of the global economy. Sphere: Related Content

Chinese Warnings

Any coherent individual should, by now, be aware that Chinese Premier Wen Jiabo has issued a warning to the United States Government concerning the future level of Chinese participation in the US Treasury Market. Given China's status as the largest single holder of US Treasury debt, we were not surprised by the quick response from the White House.

Media accounts of the incident took a somewhat puzzled tone concerning the timing of the Premier's statements. For our part, we will not pretend to know the exact motivation behind the statement itself and the timing. However, we suspect that the Premier's comments are the first stage of a thoroughly calculated plan with regards to the the unfolding global Situation.

First of all, we expect that the Chinese economy will continue to deteriorate at a rather alarming pace. The large surplus that the Chinese Government has enjoyed for so many years will be reduced quite dramatically. Occurring concomitantly will be the necessity for a large Chinese stimulus package, one that will dwarf the faux-spending measures that have already been announced.

Secondly, the United States Government will continue to spend money as quickly as possible. President Obama will certainly request the additional $250B that exist in the Budget for shoring up Bank's balance sheets. Now, we have conducted a thorough assessment of the banking industry and the capital levels of Major Institutions, and in our best estimation can say that the US Banking Industry requires a minimum of an additional One Trillion Dollars to bring back some degree of solvency. In other words "We ain't seen nothin yet".

Obviously, the two situations above present conflicting realities for both China and the US. China will face rising internal pressures to spend its money domestically at a time when the US is attempting to borrow the money to recapitalize its insolvent banking system. We assume that history (of human civilization) will repeat itself, and the Debtor nation will ultimately choose to debase its currency as a means of managing its obligations. Then again, perhaps Mrs. Clinton will be able to talk our way out of it. Sphere: Related Content

Compensation Obsession

We are growing weary of the media's unhealthy obsession with employee compensation. The purpose, clearly, is to tap into the populist rage that festers just beneath the surface of so many Americans. Personally, we take a skeptical view of all "bosses" in general, and feel that oftentimes the "boss" is the least competent man(or woman) in the room. However, to use a favorite phrase of the Proles "It is what it is". Sphere: Related Content

The Evil Bondholders

We have observed a notable increase, in recent days, of Government (specifically Congressional) rhetoric that is quite anti-bondholder in nature. The call is growing increasingly louder for debt holders to "share the pain". These sorts of proclamations are recklessly foolish, even by Government standards. When statements such as this are made, we are forced to wonder whether our elected officials understand the crucial role that the bond markets play in a market based economy. For instance, we are told that Life Insurers own roughly 18% of all outstanding corporate debt. As we have noted before, the Government seems unaware of the potential Repercussions of it's actions.

First, a "sharing the pain" policy would wreak havoc upon the Life Insurers regulatory capital levels, bringing some to the precipice of collapse.

Second, and most importantly, we believe that an eminent domain like action against bondholders would cause a nearly irreversible "seizing-up" of the market for corporate debt. All of the Government's efforts to restore confidence to the System thus far would be wiped out in one fell swoop.

We are quite sure of it. Sphere: Related Content

Greenspan Tries Again

Ever since the US economy and housing market began deteriorating, we have noted with veiled amusement the apparent ubiquity of Alan Greenspan. In the face of ever increasing criticism of his tenure as Federal Reserve Chairman, the poor fellow has been doing all he can to preserve his legacy. For what it's worth, we would concur with Mr. Greenspan that the Fed did not, in and of itself, cause the housing bubble(Although Greenspan never argued, during the "good times", when he would receive credit for producing such a long, uninterrupted period of prosperity). There are, of course, innumberable causes for the "bubble", some of which we may never be able to identify as direct contributors.

What Mr. Greenspan doesn't seem to understand, however, is that no amount of editorial writing and speech making will ever be able to restore his reputation. First of all, the Proles tend to seek a simplified set of causes for every major event such as the Crisis of today. Greenspan's explanation involves events in far away lands that will be difficult for the workingman to fathom. For example, we know personally of an individual (who wields power over others in this world..apologies for lack of specificity) who proclaimed the Chinese effect on building material costs to be negligible in reality and "the biggest hoax of all time". This is an extreme example, but it serves to make the point. Secondly, every Crisis must have a scapegoat, and once that scapegoat is identified, it is impossible to reverse course. Mr. Greenspan, being a retired and elderly man, was an easy target for that scapegoat. Bankers have been thrown into the mix as well, since the Magnitude of this Crisis requires several scapegoats. 

Notably absent from the list of those Scapegoated are the Government officials whose job it is to regulate the banking industry and the marketplace. They have, of course, used the Bully Pulpit quite effectively.

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Causes of Credit Sector "Strains"

Media reports of the past several days have been replete with accounts of the "renewed concerns" within the credit markets, evidenced by widening yield spreads on even the highest rated investment grade debt. It appears that the brunt of the stress is concentrated within the financial sector, specifically in relation to the four "mega-banks". Now, given that the layer of the capital structure known as common equity does not actually even exist for these four banks,  the decision regarding outright purchase of their stock is an easy one. Debt however, has until recently been a different story.

Returning to a theme commonly cited on these pages, these recent levels of credit market distress are simply a reflection of a lack of investor confidence, based mostly upon erratic Government behavior. The Purchaser of debt issued by the four major banks is basically purchasing the hope that the Government does not wipe him/her out via concoction of a haphazard rescue scheme. Ironically, in the Government's frantic effort to rescue one industry, they have further endangered another, the Insurance industry. As major players in the Credit Markets, the Insurance Companies stand to be dealt enormous investment portfolio losses based upon bond holdings now trading at distressed levels. This is not surprising however, as the Government has proved thus far that it does not possesses the ability to read even a half-move ahead in any situation.

The sad thing is, credit market disruptions in September were a result of fear of institutional failure, while today, the Government has become the Ogre that the village fears.

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The GOP and Self Inflicted Wounds

In May of 2007, during a nationally televised Republican Presidential debate, three of the GOP's candidates indicated that they did not believe in evolution. At the time, we reckoned that it would be quite difficult to surpass this moment in terms of the level of embarrassment it inflicted upon a political party Since that time however, the GOP has obstructed every economic rescue effort(without offering an alternative), portrayed Rush Limbaugh as the face of the Party, and now has allowed Richard Shelby to go on national television and advocate that Bank's be allowed to collapse. 

Apparently, Senator Shelby is not familiar with the elementary school concept known as cause and effect. Now, we are quite certain that the Government's decision to allow Lehman Brothers to fail will come to be viewed as one of the most decisively poor decisions in American History. If the wise Senator thinks that market/economic conditions became strained following the Lehman debacle, he should know that a Citi failure would be immeasurably more destructive to the Global Economy.

Assuming that the Senator does understand the potential implications, and is simply trying to further relish in his own notoriety via continued talk show appearances, we would hold the behavior to be even more irresponsible. As we have said before, Investors need to know the Rules of the Game. Government actions thus far have provided no blueprint worth basing investment decisions upon. Furthermore, Investors have also been forced to digest the erratic pronouncements of politicians bent on making name for themselves. This, we feel, is not constructive insofar as the prospects for a Recovery are concerned.

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Bank of England Leading the Way?

Alas, the Bank of England has consigned itself to deploy the only remaining policy tool at its disposal: Quantitative Easing(QE). Now, preferring to call it like it we see it, we will refrain from using the term "quantitative easing", and instead refer to the Bank's actions in the colloquial, as Money Printing.

We are quite sure that a child as young as eight or so, having been provided with a clear explanation of Money Printing activities, would be able to conclude that this behavior could potentially be damaging to the value of said money. This is perhaps why Central Bank activities are shrouded in such esoteric terms as Quantitative Easing, the danger being a widespread realization, by the Proles, as to what the Bank's were doing to their already meager pittance.

Now, official statements from Dr. Bernanke would indicate a Fed resistance to embarking down the path of Money Printing via central bank purchases of Treasury securities. However, we have, on these pages, shown quite clearly that there is little to no credibility behind Fed statements, and fully expect the Federal Reserve to follow suit and launch an aggressive Treasury purchase program sometime this year. Whether this program is implemented sooner or later depends largely upon the breadth and ferocity of Treasury Market counter attacks. These attacks, which are a direct response to weeks upon weeks of record Treasury security issuance, have the side effect of increasing the Federal Government's borrowing costs at the most inconvenient of times. There will come a point in this process where the Fed/Treasury will realize that the only affordable way to finance the Government's spending activities is to allow the Fed to buy Treasuries with money created from thin air. We await with trepidity. Sphere: Related Content

Class Consciousness

With the release of The (Un)Employment Situation this morning, one might expect that 651,000 would be the most important number of the week. This is however, not the case, at least insofar as the world is viewed through our set of lenses. That ignoble distinction belongs to the number 31,800,000, which represents the number of Americans receiving food stamps in the past month. In case our readers are not sure, this is a record number of enrollment in the Program, and amounts to roughly 20% of the US workforce. The current economic situation, we believe, is deteriorating at a rate that endangers the foundation of the Capitalist System.

We would hold that the current Capitalist System within the United States, in general, relies upon two principals:
1) Maximizing the number of individuals who believe that devotion to the System will eventually lead to a spectacular financial reward OR will at least provide financial security in old age.
2) Minimizing the number of individuals who have lost hope in the System.

To clarify, those who have fallen into Category #2 generally do not pose a threat to the System unless they have developed what is known as Class Consciousness i.e an understanding of the predicament that they share with fellow workingmen. The Predicament can be best summarized by a passage from The Jungle, one of the great literary works in American history:
"It is all theirs-it comes to them, just as all the streams pour into streamlets, and the streamlets into rivers, and the rivers into the oceans-so, automatically and inevitably all the wealth of society comes to them The farmer tills the soil, the miner digs in the earth, the weaver tends the loom, the mason carves the stone, the clever man invents, the shrewd man directs, the wise man studies, the inspired man sings-and all the result, the products of the labor of brain and muscle, are gathered into one stupendous stream and poured into their laps!"

We would submit that Congressional/Fed/Treasury actions thus far have not been motivated by a desire to improve the condition of the average citizen for purposes of general happiness. The reason is simply that the news of half a million job losses per month terrifies the Government, for a certain portion of the unemployed will inevitably shift immediately into Category #2. Furthermore, the longer that a mass of peoples remain unemployed, the more are likely to develop Class Consciousness. For obvious reasons, the Government must avoid this mass realization at all costs. This is at least how we see it.
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On "Jump-Starting" Credit

We have again been bombarded in recent days with the announcement of a newly created Federal Reserve lending facility. This Program, we are told, will help "jump-start" consumer lending by providing the markets for securitization of auto, credit card etc. loans with up to $1 Trillion. Receiving secondary attention is the fact that hedge funds and private equity will now be allowed to draw from the Fed's till.

Instead of focusing on whether or not this program is likely to "work", we would simply pose the question of "Is it in anybody's best interest that this program work?". The current plight of the American consumer is well known, therefore we will refrain from listing the numerous reasons that said Consumer is in dire straits. We can however, make the generalization that the most prudent of consumers are in the process of strengthening their personal balance sheets via increased savings and paying down of debt. There are some however, who will never learn, and it is that segment of the population who will gleefully take advantage of any new credit availability. Unfortunately for the taxpayer (who is ultimately liable for losses under the new loan Facility), the Consumer who is still willing to seek and abuse the credit system is also willing to walk away from any newly created debt.

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AIG's Commercial Real Estate Losses Mount

Tucked deep within the details of AIG's $62B quarterly loss was a $5B write down on the value of the Company's commercial mortgage back securities portfolio(CMBS). AIG's vast losses that are attributable to credit default swaps, and the fact that it still has a net notional CDS exposure of ~$300B, mean that sometimes losses at the Company's other business segments are overshadowed. We have made our views on AIG quite clear, and so we point out the Company's CMBS losses not to lament the fall of AIG, but rather to speculate on the effect of this write-down on the rest of the banking industry.

Having been diminished to a "Ward of the State"-like status, we presume that AIG lacks the motivation to view its CMBS portfolio through a set of rose-colored lenses. The same can not be said for other financial institutions who, fearing even more Draconoian caps on compensation and executive perks, would very much like to avoid any sort of nationalization. Now, AIG values its CMBS portfolio, as of the end of 4Q '08, at $14.2B. Roughly 22% of the securities are of the 2007 vintage, and 64% of the total portfolio is either Office or Retail. Our point being, the characteristics of AIG's CMBS portfolio are very similar to a multitude of other market players, where 2007 marked the mountain top of total CMBS securitization, with a strong bias towards Office and Retail. It should be interesting to monitor the ongoing valuations that major financial institutions place on their CMBS holdings, especially in light of AIG's recent precedent, and the continued deterioration of that market.

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AIG Sues the Government

We were amused to learn this morning that American International Group has sued the Federal Government in response to a $306M squabble over the failed Insurer's tax liability. The dispute is evidently related to a certain arbitrage strategy that Washington has (just?) become wise towards. We do not wish today, to debate the merits or legality of AIG's tax maneuvers. Rather, we have chosen to discuss this development for the purposes of commending AIG for apparently having at least some life left in it. We had assumed that AIG, being the first institution to be nationalized during the Crisis, would have succumbed to its fate by this point. Unfortunately, we estimate close to a zero percent chance that AIG is able to emerge from its current state of purgatory and operate as a free corporation. Sphere: Related Content