Thursday, April 30, 2009

Chrysler and Uncle Sam

Today we are informed that the Government has added "Creditor Negotiator" to its rapidly expanding area of expertise. Accounts of the events surrounding the impending Chrysler bankruptcy would have been rejected by us as farcical, as recently as eighteen months ago. However, as discouraging as it is to admit, we were not surprised to learn that the Government had attempted to restructure Chrysler's debt via a broad brushed offer to all lenders, whether secured or not, of 29 cents on the dollar. With the Auto Maker's two biggest lenders, JP Morgan and Citi, currently on the Government till, it is likely that Uncle Sam thought he could compel the acceptance of these draconian terms in BOA/Merrill like fashion. Unfortunately for the "Auto Task Force", a sizable chunk of Chrysler debt is also held by a consortium of hedge funds that decided, possibly on principle alone, to reject USA's offer. Aside from the bit of satisfaction that can be derived from such an openly defiant measure against the US Government, nothing positive whatsoever can come from Government intervention taken to this extreme.

As we have attempted, to the best of our ability, to espouse on these pages, the deepest and most permanent damage that has been inflicted upon the United States during the current Recession is not financial loss itself, but rather the invalidation of previously sacred Rules of the Game. In order to effectuate the proper functioning of a free market society, the Government must set and enforce specific and unmalleable parameters, specifically with regards to the capital structure. With Chrysler, the Government has entered the fray as an unsecured creditor, and proceeded to dictate to other, Secured Debt holders, the terms by which they might avoid a bankruptcy.

Apart from these theory-based objections to the Government's actions, we would propose that they have single handily managed to ensure that Chrysler's stay in Chapter 11 will be longer than previously necessary, and wrought with competing legal actions and claims-the only beneficiary of which will be the hordes of attorneys that will descend upon the proceedings. We see this as the most likely outcome.
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Wednesday, April 29, 2009

Why Arlen Specter "Defected"

Senator Arlen Specter became a Democrat yesterday, for the purposes of saving his political career. The senior Senator from Pennsylvania was always forced to walk a fine line in the Republican party-appeasing his moderate to left leaning constituency while remaining loyal to the Party. However, eyeing his re-election year of 2010, and pondering the diminished status of the Republican Party in the state of Pennsylvania, Senator Specter realized that he could no longer walk that line as a Republican.

Consider the strategically superior position that the Senator has just assumed: Were he to run for re-election to the Senate as a Republican, he would have had to face off against a Pennsylvanian Democrat, likely supported in full by a DNC eager to regain that Blue State's Senate seat. Now however, he will run for Senate as the incumbent, senior Democrat, against a marginally popular Republican challenger. In fact, considering the brilliance of this strategy from a self-interested political perspective, we are surprised that it is not employed more often. That being said, we expect that as the tactical nuances of Senator Specter's little maneuver become more apparent, there will be other moderate Republican politicians from traditionally blue states to "defect" to the Democratic Party. It only makes sense.
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Monday, April 27, 2009

Federal Reserve Impotence

In mid-March, the Federal Reserve announced its intention to purchase $300Billion worth of US Treasuries, triggering an almost immediate 50 basis point decline in the 10 Year Treasury yield. At the time we proposed that the Market, being a force far superior to the Federal Reserve, would eventually counter-strike, much to the dismay of the Fed. We also stated that this initial $300Billion figure would be a mere drop in the bucket when compared to the volume of Treasuries ultimately purchased by the Fed. At present, approximately one month after the Federal Reserve officially embarked upon a program of Quantitative Easing, the Market has already counter struck, rendering the practical effect of the Fed's program useless. The yield on the 10 Year Treasury has returned to 3%, the same level it sat prior to the QE announcement.

The sheer speed at which the Market has assessed the Federal Reserve, formulated a counter strike, and implemented said strike is troubling at the least. The 10 Year is by the far the most important part of the Treasury Curve-its yield influences a vast spectrum of financial instruments, including but not limited to Mortgage Rates, the lowering of which has become a centerpiece of Government policy. That the Fed could only influence this rate by 50 basis points, for approximately one month, is a testament to that Institutions dwindling credibility and ability to manage the economy.

As for the Fed's next move, we are sticking with our assertion that Trillions more will need to be committed to the Treasury Market in order to keep the cost of capital sufficiently low throughout the economy. The alternative, allowing the Treasury Market to proceed unimpeded, would be the equivalent of dousing the purported "green shoots" with a solution comprised of 1/2 Raid and 1/2 Arsenic. We think the Fed's next move is quite clear.

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Friday, April 24, 2009

The First Bank of the United States

As pivotal decisions regarding the fate of a growing number of Industries are frequently being made from the oval office and floor of the Senate, one might immediately perceive the title of this post as an allusion towards the current de-facto nationalization of the American Banking System. Our intention however, is to discuss the First Bank of the United States and the spirited debate which preceded its charter in 1791.

In the aftermath of the Revolutionary War, the United States found itself victorious yet heavily indebted.  To aggravate matters, the former colonies lacked any sort of organized currency, instead relying on a patchwork system of bartering, localized currencies, and foreign coinage that had found its way into circulation. To counter these headwinds, the first Treasury Secretary of the United States, Alexander Hamilton, proposed the creation of a National Bank. This seemingly logical and necessary proposal was met with some resistance, particularly from Thomas Jefferson, who criticized the creation of a national bank on Constitutional grounds. 

Hamilton believed that the Federal Government had the ability to "make all laws which shall be necessary and proper"(US Constitution) in order for the Government to carry out those powers that had been specifically granted to the Federal Government by the Constitution. Jefferson however, held the view that the Federal Government possesses only those powers Specifically Enumerated in the Constitution. Obviously, this Constitutional debate is still occurring today, and because new eras inevitably give rise to new issues, we expect that the debate will never be definitively settled. Instead of arguing in favor of either man's position, we would merely like to provide two excerpts from Thomas Jefferson's statement of opposition to the creation of a national bank. Somehow, Jefferson's statements have managed to remain relevant to modern discourse, despite the fact that they were written over two hundred years ago.

I consider the foundation of the Constitution as laid on this ground: That " all powers not delegated to the United States, by the Constitution, nor prohibited by it to the States, are reserved to the States or to the people." (XIIth amendment.)To take a single step beyond the boundaries thus specially drawn around the powers of Congress, is to take possession of a boundless field of power, no longer susceptible of any definition.
-Thomas Jefferson

Can it be thought that the Constitution intended that for a shade or two of convenience, more or less, Congress should be authorized to break down the most ancient and fundamental laws of the several States;...Nothing but a necessity invincible by any other means, can justify such a prostitution of laws, which constitute the pillars of our whole system of jurisprudence.
-Thomas Jefferson

In the end, Hamilton's line of reasoning won the day, and in 1791 Congress chartered the First Bank of the United States. The repetitous nature of History is strange indeed.
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Wednesday, April 22, 2009

The New Economists and Inflation

One of the interesting side effects of the current recessionary environment is a newfound public attentiveness with regards to the economy, specifically within the realm of forecasting future events. Suddenly, a professional wedding cake maker(ice cream shop owner, florist, etc.)  is capable of forecasting annualized rates of inflation, and extrapolating the data out several years into the future. We would propose that this new legion of economic wizardry actually serve a distinct and useful purpose: They provide a readily accessible, highly reliable indicator from which one can apply a decidedly Contrarian strategy towards a number of predictions.

Typically, in order for the contrarian to feel confident about his inverse conclusions, there must exist a Strong Consensus about the future direction of the market price or economic statistic in question. Such a consensus, we believe, has developed within this new class of Economic Observers regarding the prospects for a severe inflation within the next year, two, or three. This sort of herd like thinking has proliferated for several reasons, namely logical foundations, media attention, and familiarity. To put it simply, it just seems logical to most folks that when Government spending measures top the $1Trillion mark, there must be some damage done to the currency, leading to inflation. Most significant we believe, is the average person's ignorance towards the concept of deflation, which serves to render his/her logical foundations utterly useless as he/she attempts to ponder the prospects for Inflation. Regardless of the basis for this conclusion however, we have detected a strong consensus in favor of an inevitable inflationary period. We however, will not be joining this crowd.
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Tuesday, April 21, 2009

Geithner's Quandary

Treasury Secretary Timothy Geithner has managed to create the most ridiculous quagmire of uncertainty that we have ever seen. None of this should really be a surprise however, given that he was exposed as a tax cheat and accused our largest creditor of manipulating its currency-all prior to his confirmation by the Senate. The main issue facing Mr. Geithner at present however, is how to prevent the complete stratification of the United States Banking System into a midieval caste system, where a well-capitalized nobility siphons increasingly greater resources from an insolvent peasantry.

To date, several smaller banks have returned their "bailout" money to the Treasury, thanking Mr. Geithner on the way out the door. Recently however, the calls have been growing louder from a select few of the Nation's largest financial institutions that they be allowed to prepay this onerous "loan". These initial requests have been met by Treasury with a certain amount of trepidation, as allowing the prepayments to occur would immediately create a de facto Bank Peasantry. The problem is, as time goes by, one can easily listen to the words of any given Bank Executive and discern, to some general degree, the overall health of that Bank. As the executives of the truly healthy insitutions continue to be angered by the useless interest payments that their Banks must remit to the Federal Government, their public statements have become definitive, proud, and bordering upon boastful. From the weak institutions however, silence is the Modus Operandi.

The question for Mr. Geithner then is "How do I stop this?". Unfortunately, this process can not be stopped. The Market has decided that, if Mr. Geithner's choice is inaction and lack of disclosure, it will discern for itself who are the fittest of the group. We are in the midst of a deleveraging process that can not be stopped by any amount of Government interference or balance sheet realignment. The question is rather how long the entire process will take, and how acutely the pain will be felt at any given moment in time. It appears that the Federal Government has chosen the path of a lost decade, albeit one without intense pain.
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Monday, April 20, 2009

Distinguishing the Banks

Against the backdrop of near constant speculation concerning the financial health of the Nation's largest financial institutions, we prepared the above chart, which should be useful insofar as determining the relative deterioration of these Bank's loan portfolios. The chart tracks "Provisions for Loan Losses", which is essentially an expense (deducted from earnings) based upon management's assumptions regarding impending loan loss amounts and subsequent regulatory capital requirements. There are obviously shortcomings involved in using this metric alone as a measure of Bank health: The figures are susceptible to management's discretion and they do not account for the many other ways that a Bank can lose money i.e derivatives, trading etc. There is however, a certain amount of insight that can be gleaned from the chart above. This should not be too difficult for the average reader of this site.
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Friday, April 17, 2009

Cuba: Sphere of Influence?

The Obama Administration's recent engagement with Cuba has provoked outrage by those who, accurately so, portrary the Castro Regime as an authoritarian dictatorship that has accomplished little aside from keeping its citizens equally impoverished. Numerous motivations have been attributed to President Obama's "outreach" to Havana, however, from a geopolitical perspective, the move clearly underscores the strategic chess match between the United States and the Russian Federation.

The principal observation we will make about the Russian people is that they have a strong yearning to achieve global significance and eventual SuperPower status. In fact, Vladimir Putin has built an entire political career around his knowledge of this one fact alone! Although many independent nations emerged from the fall of the Soviet Union, the Russian Government considers itself to still have "special privileged interests" over these former Soviet-bloc countries. This mindset has manifested into Russian foreign policy that tends to become more aggressive as the Motherland becomes more wealthy. We have seen Russia lash out militarily at its small neighbor Georgia, shut down natural gas pipelines to the Ukraine in the middle of the winter, attempt to interfere with US plans to install missile defense systems in the Czech Republic and Poland, and extend "strings attached" foreign aid to Armenia in a time of desperate need for that country.

We would propose that, while this concept of a regional sphere of influence has historically been the forte of Russian foreign policy, its attractiveness insofar as crafting a pragmatic approach to American foreign affairs is gaining appreciation. The fact is, Cuba's geographical location is strategically attractive for a wide array of military operations. More importantly, improved US-Cuban relations will symbolically expel Russia from a position of influence over the island.

Although the US and Russia have publicly "hit the reset button", behind the scenes there is geopolitical chess match taking place. We await the next move.
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Thursday, April 16, 2009

Can Optimism Alone Spur Recovery?

Let us begin by stating that there is a certain degree of truth to the layman's assertion that psychology plays a significant role in periods of economic contraction. Clearly, when consumers notice the early signs of a recession, they assess the likely threat to their job, standard of living, premium movie package, wine tasting club, Junior's college fund, etc., and adjust spending according to the perceived threat level. This collective consumer retrenchment has the potential to create a negative feedback loop whereby decreased consumer spending begets a weaker economy begets bad news begets further cuts to household spending. The most logical conclusion that can be derived from this sort of logic then, is that a dose of Happyspeak and a dollop of optimism can cure all ills. While this logic may have been valid during the infantile recession that ended in 2003, the situation at hand today is beyond the scope of what Optimism Alone is capable of repairing.

At present time we are in the midst of a balance sheet recession, characterized by the fact that the Total Liabilities of the financial system far exceed the dollar value of Total Assets. The scary thing is, we have only seen phase 1 of this grand and inevitable deleveraging process that must be completed prior to any sustainable recovery. Various other categories and breeds of poorly underwritten debt, whose combined value dwarfs the issues in subprime residential real estate, are currently lurking in the shadows of the Banking Sector's balance sheet. As evidenced by today's bankruptcy filing by the Nation's second largest mall owner/operator, commercial real estate has joined the deleveraging party. Next, consider the impending credit card debt debacle: At the exact moment that household incomes are being decimated by job losses and pay cuts, credit card issuers are aggressively slashing credit limits and ramping up interest rates. To invoke a suddenly relevant comment made several months ago by an acquaintance of ours "Are these guys suicidal?"

The primary point we would like to make is that optimism, regardless of its source, can only provoke households to spend a few extra dollars. Optimism will not, in any way shape or form, hasten the inevitable deleveraging process, nor will it reduce the Totality of Pain that comes as a result of the process.
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Wednesday, April 15, 2009

Tax Day: Merits and Misconceptions

The faux American protests of today, whereby the pouring of a jug of Arizona iced tea into a body of water is meant to be an act of protest against taxation, serve to highlight numerous misconceptions and hypocrisies inherent to this group of disgruntled taxpayers.

First of all, returning to a point that we have emphasized from time to time, the majority of these "protesters" are Baby Boomers who, while voiciferously bemoaning their perceived unjust tax burden, somehow fail to realize that it is the totality of their actions over the past quarter century which has necessitated said burden. The Boomers may not realize it, but what they are really saying is "We don't want to pay our share of tax. We would prefer that our children pick up this tab so that we may retire in peace".

Secondly, the concept of a progressive income tax is often deplored, ignorantly so, as "socialist" or "anti-capitalist". A brief review of historical literature however, tells us a different story. Within the Capitalist's Sacred Text itself, Adam Smith's The Wealth of Nations, lies the following passage:
"The subject of every State ought to contribute towards the support of the government, as nearly as possible, in proportion to their respective abilities; that is, in proportion to the revenue which they respectively enjoy under the protection of the State."

The last bit that we would like to clarify is in relation to the numerous Government bailout measures and concomitant assertions made by many individuals, usually in front of a television camera, that somehow "their" taxes are not being spent wisely. These people act as if the pittance removed from their bi-weekly paycheck is somehow sufficient to recapitalize the banking system. The appropriate statement, in our minds at least, is as follows: I am quite upset that my children's taxes will be used to pay the interest on this borrowed money that has been deployed so frivolously by a frightened Congress and a tax-evading Treasury Secretary.

Of course, such a statement could only be delivered by an individual who had taken a bit of time to research and understand the methods by which the United States of America funds its daily operations. Perhaps we are expecting too much.

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Tuesday, April 14, 2009

A Tale of Two Rallies

In early Fall of 1929, the Dow Jones Industrial Average reached an all time high of 386.10. Shortly thereafter, the Crash of 1929 occurred, driving the index down 49.4% to 195.35. The next page of this story contains a widely under reported detail, often ommitted from traditional stock market lore. This forgotten fact is none other than the magnificent stock market rally of 1930, a surge that lasted roughly four months and lifted the Index by 52.16% to 297.25. The ensuing two and a quarter years would not be so generous however, and by July of 1932, the Index had fallen 86.3% from the peak of that glorious bear market rally. It should be noted that between 1930 and 1932, there was never a dearth of happyspeak from Washington, most notably, Herbert Hoover's famous assertion that "Propserity is just around the corner!"

We are faced with a strikingly similar situation today. We can not predict just how long the current equity market rally will continue, as the market is obviously in possession of the ability to defy gravity itself for extended periods of time. However, we can, with some degree of confidence, assert that this economy's deteriorating fundamentals can not be ignored Ad Infinitum.

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Monday, April 13, 2009

Obligations Courtesy of the Baby Boom Generation

When considering the current Economic Predicament from a macro sociological/historical perspective, one can not ignore the integral role played by the Baby Boom generation. Specifically, we refer to this Generation's propensity for agglomerating vast amounts of debt, both in their personal lives, and through the Institutions that they have controlled for so many years. Essentially, a single generation of profligate spenders has saddled several future generations with an abundance of immoral obligations, accumulated during times of debt fueled prosperity. We now turn to Figure 1.

The early cusp of the Baby Boom generation is typically defined as a person born in the year 1946. This earliest Boomer Vintage began turning thirty in 1976, the age at which we can presumably say, an individual reaches a new plateau in terms of stake and influence within business and the community. In addition, by 1985, every member of the Baby Boom Generation was of legal voting age. As this all relates to the chart above, we can discern a sharp, noticeable Increase and Acceleration of the total national debt(right axis), beginning in the early 1980's. This trend continued to present, interrupted only by a brief period of windfall budget surpluses during the Clinton Administration. Now, the skeptics of national debt danger usually point to the chart's left axis and argue that, as a percentage of Gross Domestic Product, the national debt has been relatively higher at other times in history. This argument ignores the dual aspects of leverage, specifically the downside effect that we are currently experiencing, and fails to recognize that the debt agglomeration process created largely illusory growth that fostered a false sense of manageable debt levels.

As the Baby Boomers continue to age and withdraw from the workforce in increasing numbers, a particularly unsettling reality is beginning to take shape: Entire generations of Americans will be forced to assume the ill-accumulated obligations of the Baby Boomers for years to come. Boomers have virulently opposed higher taxes for almost three decades, while contemporaneously fostering entitlement programs such as Social Security and Medicare that will ensure them a well funded retirement. We are faced with perhaps one of the most immoral acts that one generation can impose upon another.

Fortunately for the Boomers, they have managed to gain control of the few media oligopolies that exist in present day. This will serve to distract and preoccupy the Debtor Generations for a given amount of time. How long this injustice can continue is yet to be seen.

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Friday, April 10, 2009

Important FDIC Announcement

This evening, the FDIC announced the failure of two financial institutions:

New Frontier Bank, of Greeley,CO

Cape Fear Bank, of Wilmington, NC

And so it continues. Sphere: Related Content

Thursday, April 9, 2009

Stress Tests: Who Will Take the Fall?

Early accounts of the results of the stress tests, apparently reaching the level of "fit to print" as determined by one news outlet in particular, are decidedly upbeat in nature. We are told that, in general, the nation's banks seem to be holding up quite well under the pressure of these tests. These rosy assertions are of course disclaimed by the caveat that the Banks "May Still Need Aid". Obviously, each Bank will possess a slightly different set of circumstances that correspond to a particular amount of additional capital needed by that Institution(at this one point in time). However, an analysis of the rhetoric that has emanated from Geithner and company would suggest that the Government's objective is to create at least one "fall guy" from the stress test process.

It has grown increasingly apparent that the motivation behind Treasury's stress tests is not to conduct a wholehearted investigation of the financial sector's future viability, but rather to instill confidence in the system in general. Granted, a small army of Bespectacled Bank Examiners are in fact sifting through the sewerage on Bank's balance sheets, proving that Geithner understands the need to provide this little exercise with the illusion of legitimacy.

Assuming that Mr. Geithner fully comprehends the need for a show of legitimacy(and we think he does), he in turn understands that some Bank(s) must take the fall for the good of the others. While we can assert with confidence that Goldman Sachs will NOT be one to take the fall, we are not able to say with certainty who exactly will. Likely, whichever Bank is least adept at behind the scenes chicanery will be punished accordingly. In any event, we expect these distinctions to materialize in short order. Sunday night has become an exceedingly popular time slot for this sort of announcement, however, we would be hesitant to put our money on any Government action these days.
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Wednesday, April 8, 2009

The Mark Sanford Fiasco

Mark Sanford, the Governor of South Carolina, has become quite a popular figure with the traditional media outlets(by popular we mean oft-discussed), largely due to his attempted refusal of federal stimulus money. The primary aggravating factor involved in this particular situation is the fact that, if Mr. Sanford succeeds in shunning the federal dollars, the necessity will arise for large cuts to the State's Education budget. Given that a wide swath of the population has a stake in the education of their children, the potential for said budget cuts has sparked a certain amount of anger. The Governor, in several cogently sound public justifications for his actions, has cited fiscal responsibility and the avoidance of addiction to federal money as his primary points of reasoning. Our purpose today however, is not to assess the merits of either side's argument, but rather to put forth an argument concerning politician's behavior in general.

We believe that, to a certain extent, the loathsome characteristics of our elected officials are no more than a reflection of the populus which they represent. "Hypocrite" is a common charge leveled against politicians, however consider the truth in the following: Everyone complains about wasteful government spending, especially spending on social programs that benefit a segment of the population that may live in a different neighborhood or be considered "less productive" as defined by income levels. However, that same Everyone will virulently oppose any spending cuts that they perceive may affect their/Everyone's life in any way. Who is really the hypocrite now? Furthermore, assuming that politicians are merely behaving in their own best interest, i.e to get Everyone's vote, then would their behavior not be a direct and exact reflection of the collective "Everyone"?

More than anything else, the public's reaction to Governor Sanford's decision is the exact reason why Government has and will continue to increase (never decrease) in size. Decreasing the size of Government involves making real decisions to end spending that someone or something has grown accustomed to. Breaking the dependence will always be met with an anger that causes the vast majority of politicians to cower in fear.

Disclaimer: We are extremely pro-education, in fact, we are so concerned about the current US educational system that we would go so far as to say that the future prosperity of the US is in grave danger due to the Quality Decay of our schools. Do not misinterpret this political expose as a repudiation of the concept of educational funding.
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Tuesday, April 7, 2009

The Insurance Industry and Collateral Damage

When the Government first began this journey towards a Brave New World, i.e direct intervention into every corner of the financial system and increasingly, the broader economy, the only thing we were sure of was the inevitability of unintended consequences. Of particular significance, we believe, is the rapid way in which the Insurance Industry has been affected by the actions of the Fed and Treasury, both of which were presumably acting with the best of intentions.

The first visible ramifications appeared soon after the Government's "loan" to American International Group, when complaints began to arise from AIG's competitors, alleging that the Company was offerring clients absurdly low premiums, across several lines of insurance, in order to retain business. Obviously, under normal conditions, under-cutting a competitor is as American as Living Beyond Your Means, however, the fact that Uncle Sam has annointed a Company with the title "Too Big To Fail", should not in itself provide a competitive advantage.

More recently, shares of Lincoln National Corporation have plunged following the Company's rescission of an application to participate in the Fed's commercial paper facility. Now, we understand that the Fed, likely the buyer of only resort in the commercial paper market, can not just pack up and leave that area of the financial system. However, by no means should inaccess to A Government Program ever put a perfectly healthy Company at risk in this way. We must assume that the Fed/Treasury have not fully investigated the massive policyholder liabilities that would be borne by State Guaranty Associations in the event of an Insurer collapse. Unfortunately, given that these same Institutions allowed Lehman Brothers to collapse, we can not be so sure that the Government has calculated anything more than half of a step ahead.
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Monday, April 6, 2009

The Government's Hand Forced

Geithner and company, having apparently gathered a sufficient amount of data to determine which of the nation's nineteen largest Banks are adequately capitalized, will reportedly convene this week in order to devise a plan of action. The new accounting rules, conveniently implemented just prior to this "meeting of the minds", will be taken into consideration during this decision making process. Given the crucial nature of these tests, along with the Catch-22 that the Government has created for itself, we expect Treasury to take some form of decisive action in the next two weeks.

For starters, we are told that Treasury has all intentions of keeping the results of the stress tests shrouded in secrecy, and away from the judgmental eyes of the Market. Realistically however, the sieve-like tendencies that pervade every level of Government will impair Mr. Geithner's ability to maintain 100% secrecy. The game then, is for Treasury to act upon the results before any Government Insider decides to feed his sense of self-importance by whispering into the ear of a journalist.

Given that the above assumption is correct, we would additionally propose that it is nearly impossible that all nineteen banks managed to "pass" the tests. Furthermore, it is highly probable that at least a few Institutions will be viewed by the stress tests as beyond the point of repair. This being the case, Treasury will be forced to move in and either nationalize or dismantle the most crippled bank(s). Now, due to the anti-nationalization rhetoric that has emanated from Washington, this new rescue effort will likely embody the full spirit of nationalization, while assigning some sort of euphemistic moniker to the action.

In any event, the conclusion of the stress tests has effectively forced the Government's hand. Every day that passes without action will only serve to fuel speculation as to the identity of the "weak links in the chain". This is our humble view.
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Saturday, April 4, 2009

The Latest Government Contrivance

The highly anticipated and editorialized changes to the Nation's accounting standards, implemented this week by the Financial Accounting Standards Board, will have the immediate effect of providing a boost to Bank's bottom line earnings. Additionally, the changes will at least delay the need for further Government Capital Injections, as the inevitable near term reduction in bank write-downs(possibly even write-ups for those feeling adventurous) will help provide the illusion of Capital Adequacy for the weaker institutions.

To use a wildlife analogy, think of the Banks as a herd of Antelope that are being stalked by a pride of Lions(the Market). Within the herd, many of the antelope are inflicted with a disease(bad paper) that has caused a noticeable deterioration and weakening of the horns(thin capital levels). The Lions, being savvy predators, have detected this "weak antelope" trait, and have selectively devoured this vulnerable segment of the herd. The Game Wardens(Government), having determined that the continuation of this process is not in the Savannah's best interest, devised a plan whereby they will rush in and attach fake yet healthy looking horns onto those Antelope deemed most "at-risk".

The question is, whether the Lions will be able to discern the difference between a legitimately healthy Antelope, and one that has been artificially aided by the Game Wardens? We think so.

We accept that, at this point, it may be more appropriate to value an illiquid asset based upon the present value of expected future cash flows, provided of course that reasonable assumptions are made concerning the impending permanent impairment to a portion of said cash flows. Unfortunately, we do not think that the Government possesses the ability to assess the present value of anything more complex than a plain vanilla Agency MBS. This reality will likely lead to attempts by financial institutions to grossly overstate the value of assets that are beyond the scope of the Government's evaluation ability. However, returning to a theme commonly espoused on these pages, the Markets are unlikely to be fooled for very long. We expect that the Market, in relatively short order, will digest the practical effects of the accounting rule changes, and judge the viability of financial institutions accordingly. The stronger Institutions will inevitably return their TARP money to Treasury, while the weakest of the herd will be exposed as both insolvent, and completely lacking that layer of the capital structure known as Common Equity. Owners of Bank Stocks beware. Sphere: Related Content

Friday, April 3, 2009

Big Subsidy

Given the Government and media's fixation upon referring to every industry with the prefix "Big", followed by a generalized word used to describe that industry's product (i.e Big Oil, Big Pharma), we thought it might be appropriate to coin a similar phrase of our own. As this article's title would suggest, the phrase we would like to introduce into the vernacular is "Big Subsidy", hereafter referred to as "BS"(not intentional). In addition to the fact that BS is entirely a creation of the Government, it can be distinguished from other major industries by pointing out that BS does not actually produce anything. Hence, the reason for insertion of "Subsidy" where in previous examples an actual product is described.  We will now move on to an industry profile.

The BS industry is comprised of every Government agency/entity/quasi-corporation ever created for the purposes of subsidizing the housing market. Several of these players, such as Fannie Mae and the FHA, emerged from the Depression, and the prevailing wisdom of that era. Others, such as Freddie Mac, were not spawned until the 1970's.

Lately, BS has found itself in quite a bit of trouble. Fannie and Freddie have been effectively nationalized and reduced to Wards of the State; there is nothing Quasi about them anymore. Standing next in line for a bailout is the Federal Housing Administration. The FHA's failure has become such a sure thing, that federal officials have eliminated their use of subterfuge when discussing the agency's prospects. In front of the Senate yesterday, the HUD Inspector General had the following to say regarding the FHA's potential bailout needs:
"Based on the numbers we're seeing, I think it's going in the wrong direction"
Of course, given that the FHA's purpose is to provide mortgage insurance on loans made to borrowers who can only pony up a 3.5% down payment, one might expect there to be some credit quality issues inherent in the agency's pool of insured mortgages as a whole.

We would hold that one of the greatest challenges the Government faces in the coming years is figuring out how to restructure/unwind the major BS players. In their present state, Fannie Mae and Freddie Mac are a mammoth strain upon the Federal Government. Keeping these entities on life support for an indefinite amount of time is not a viable solution. Unfortunately, as long as Congress remains panic-stricken by the collapse of the housing market, it is unlikely that the failed Quasi's will be unwound in an orderly fashion. We can only hope that Members of Congress, despite their Profound Obtuseness, are able to comprehend the long term consequences of allowing these bloated beasts to remain on Uncle Sam's balance sheet indefinitely.
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Thursday, April 2, 2009

Capitalism's Crisis: Is There a Precedent?

Consider the following headlines:

*China Sees a Dollar Crisis; Says U.S. Policy Fails
HONG KONG, Dec. 24 -- Last week's devaluation of the American dollar and the re-alignment of world currencies was depicted in Peking today as a manifestation of the crisis of capitalism and the decline of "United States imperialist hegemony."*
-The New York Times

*Russia Calls Oil Crisis a Failure of Capitalism
Foreign Minister Andrei A. Gromyko Thursday called the oil crisis more a failure of the capitalist system*
-The Los Angeles TImes

Can Capitalism Survive?
Increasingly, its supporters as well as its critics ask: Can capitalism survive?
-Time Magazine

Running in Blinkers
This election has been conducted without a vision of the future. It has been about the selection of a team to handle an immediate situation which the people have been told is a crisis although they have not been told very much about the exact nature or magnitude of that crisis. Out of this crisis, depending on the way it is handled and by whom, there could come an economic order and society markedly different...
-The UK Guardian

Black Revolt Against Capitalism "Inevitable"
Organized Revolution by blacks against the oppression of the capitalist system is inevitable.
-Daily Collegian

The Economy: Next 25 Years; Forecasters See Radical Potential
The flocking instinct among economists in the winter of the year is compelling. Like birds, the country's top analysts cluster to arrive as if by instinct at a consensus about the shape of the year to come. And so it is for XXXX. The forecasters-who performed dismally last year and the year before-have decided that the economy will get worse before it gets better. But itwill get better by the end of XXXX, they say.
-The New York Times

The Crisis of Authority
This town is alive these days with free advice. It is a time of economic and political instability, with a new President and a new Congress, and while everybody is vaguely confused, suddenly the air is full of demands about what somebody else should do to set things right.
-The New York Times

Amid the constant assertions from various world leaders, as well as from the usual media sources, that somehow the "blue-eyed capitalist model" has failed, we decided to conduct a bit of research concerning whether or not a precedent existed for this sort of talk. The twist here, of course, is that every headline above was written between 1970 and 1980, a period of time in which the headlines were eerily similar to those of today.

Because there have been enormous flaws inherent in every system of economic development that has been implemented by humans since the invention of the wheel, we are choosing to refrain from the advocacy of any specific mode of economic production. The above articles have been provided for the edification of those who may be unaware that the Current Strife does, in fact, have precedent in modern history.
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Wednesday, April 1, 2009

Japan and Lessons Not Learned

Taro Aso, Japan's prime minister, is emerging as one of the most vocal proponents of a continued Government spending spree. This stance has been taken via criticism of Europe's only responsible leader, Angela Merkel, and her resolve to limit the German Government's future stimulus/spending activities. The leader of the world's second largest economy points to the experiences of his own country, in the early 1990's, when the Government staged a wholesale intervention into the financial system. We would concede that the present day United States and the Japan of two decades past are/were both inflicted with a similar strain of economic contagion i.e the spectacular rise and fall of real estate values. However, we do not disagree with Taro Aso as to the premises of his argument, but rather as to the conclusion itself.

It is widely acknowledged that Japan suffered a "Lost Decade" ,characterized by a deflation of values across all asset classes, as well as stagnant, only interrupted by declining, growth in the overral economy. However, a brief assessment of the data concerning Japanese GDP growth, as well as real estate and stock values produces the inevitable conclusion that Japan did not just lose a single decade, but Japan Lost Two Consecutive Decades.

We can not possibly fathom why the leader of a country would voice support for the same policies that had already led to a two-decades long stagnation in his country. The Japanese Government, in the 1990's, rushed in and propped up every large and ailing financial insitution via capital injections. The Bank's, fearing a further deterioration of required regulatory capital, failed to lend the money. The Government injected more capital. This ongoing process succeeded only in producing a Zombie Banking System that was allowed to pretend that losses did not exist. Sound Familiar?
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