Saturday, May 30, 2009

May2009: Summary of Developments Relevant to Investment Decisions

This post will be part of an ongoing series. The primary objective is to take a step back from daily market gyrations and the noise created by the constant barrage of headlines, and objectively assess the major developments of the month.

US Equity Markets
The major stock indices continued their impressive rally which began on March 9th, albeit at a more constrained rate of increase than in March or April. The S&P500 began the month at 872.81, and ended at 919.14- an increase of 46.33 points or 5.3%. This corresponds to to an annualized rate of increase of 86%, which is likely unsustainable.

US Treasury Market
The most profound development in the market for US Government debt occurred at the 10-Year portion of the curve. The yield on the 10-Year note began the month at 3.1%. By the midpoint of the month, the yield was little changed. However, from May 20th to May 27th, the yield on the 10-Year increased by nearly 50 basis points to a month-high of ~3.7%. A variety of justifications have been offered by the investment community concerning the underlying causes of the downward price pressure. We reside firmly in the camp that sees the movements as the Market's skepticism towards the ability of the United States to service vast amounts of newly acquired debt. We expect this trend to continue until the Fed decides to step in and defend the 10-Year. We do not know the exact point that this will occur, but we suspect that the Fed will be loathe to allow the 10-Year to push average mortgage rates into the 6% territory. There are several planned Treasury auctions in early June- the outcome of which will likely dictate future Fed actions in the arena of quantitative easing.

Geopolitical Developments
North Korea: The isolated dictatorship has continued to test the Obama Administration's willingness to forcibly curtail its nuclear ambitions. At some point, China is likely to exert its influence over North Korea and compel the "Great Leader" to cease and desist. It is in China's interest to allow this chirade to continue at the moment, because it highlights Washington's relative inability to exert power over the region. However, North Korean actions that could potentially stymie a global recovery and induce world panic are certainly not in China's interest. That being said, further escalations of rhetoric between Washington and Pyongyang could have the effect of provoking short term volatility spikes in US and other equity markets.

Pakistan: The Pakistani army's advancement into the Swat Valley has continued to displace residents, creating a humanitarian nightmare. Recent pronouncements from the US military indicate that the Obama Administration is laying the necessary groundwork to justify a military intervention in Pakistan. We expect that this will not occur, as the Pakistani military is fully capable of extinguishing the Taliban resistance. However, a drawn out conflict in that country could have the effect of inducing further upward pressure on oil prices. This would obviously not bode well for the sprouting of further "green shoots".

Final Observations
We note that public sentiment concerning the liklihood of a recovery was slightly diminished during the month of May. The optimism spurred by the appearance of the "green shoots" and concomitant equity market rally has been partially displaced by the realization that there is no true catalyst for a sustained recovery. Disaster appears to have been averted, however job losses, foreclosure/delinquency rates, rising fuel costs, and continued bank failures have served as a sobering reminder to the public that we are not "out of the woods" yet. The emergence of frugality as a popular concept should continue to affect consumer spending, which, as we recall, represents some ~70% of the US economy. Our venue of choice for gleaning insight into this trend are the earnings, statements, and behavior of Procter and Gamble(the company that owns every brand of household necessity that you see on the store shelf). At an investor conference last week, the CEO of P&G, A.G. Lafley, made the following statement:

"In every recession there are hosts of compensating consumer behaviors as they manage a more modest budget. We have to expand our portfolios to serve the needs of those consumers. I think a lot of that is going to last"

P&G is one of the fortunate ones-their products are actually Needed by consumers, and they have a broad enough product mix to emphasize "trade down" products in a recessionary environment. Even they are not immune however, as the Company's most recent 10-Q indicates that Q1 earnings were bolstered largely through cost cutting and lower interest expense-a direct result of subdued Treasury yields. While cost cutting is necessary and helpful, it is doubtful whether this strategy can be successful indefinitely.

We expect that Q2 earnings season will bring with it a host of dissapointments, especially if Treasury yields continue to march upwards, and the consumer continues to embrace frugality as a way of life. Sphere: Related Content

Taxpayers Buy Rep. William Jefferson a New Laptop

Not to be outdone by their British counterparts, it appears that members of the US Congress have been engaging in their own little brand of "perk expensing". According to documents reviewed by the Wall Street Journal, the last weeks of 2008 saw a parabolic spike in the dollar amount of Congressional expense reimbursement statements. Apparently, each member of Congress is given an exorbitantly high expense budget each year so that they will not have to face undue financial burdens, and thus can focus on the task of making this country's laws. The catch is, unused yet budgeted expense money can not be rolled over to the next calendar year, incentivizing members of Congress to "spend it or lose it".That the practice is legal does not mean it is acceptable. We have grown tired of members of Congress standing at the lectern and micro-lambasting every aspect of American business.(Not that it doesn't deserve to be micro-lambasted, the previous point was delivered in the spirit of "don't throw glass stones in a glass house")

Most egregious of all, in our opinion, were the actions of former Rep.William Jefferson (D-LA). According to official documents, the taxpayer has purchased Mr. Jefferson a $2793 Toshiba Toughbook laptop. Now, we are all for technological literacy within Congress( we don't think much exists currently), but seriously, this is the same man who was caught with $90,000 of cash in his freezer. How in the world can a member of Congress be caught with that kind of money in his freezer(of all places), and still retain the audacity to charge the taxpayer for an overpriced "Toughbook" that isn't even designed for old men in Congress?

The consensus of historians as to the reason for the fall of the Roman Empire, is that Rome was not overwhelmed by external enemies, but rather that it crumbled from within. Sphere: Related Content

Friday, May 29, 2009

David Einhorn Disparages Moody's

Yesterday, the founder of Greenlight Capital, David Einhorn, publicly accosted Moody's Investor Service. His scathing remarks were as follows:

"If your product is a stamp of approval where your highest rating is a curse to those who receive it, and is shunned by those who are supposed to use it, you have problems"

In this situation, Einhorn is simply playing the role of being the first person to say publicly what others have long said privately. Some may choose to criticize the ratings agencies by citing specific examples of incompetence (AIG, MBIA etc.), while others will go to the lengths of proving, quantitatively, that these entities are no more than lagging market reactors. For the sake of our assessments however, simply understanding the manner by which the ratings firms are compensated is enough to deter us from ever using them for anything more than an ancillary opinion. The fact is, Moody's et al are compensated by the firm whose debt they are supposed to objectively rate. It doesn't take too much experience in the business world to understand the typical relationship between a Client and a Service Provider. The relationship is rarely, if ever, a balanced and objective exchange between two parties whose goals are perfectly aligned. Need we go further?

Sphere: Related Content

Commercial Real Estate's Funding Dilemma

The prevailing conventional wisdom, for the past 6-8 months or so, has been that commercial real estate would suffer a residential-like implosion. While we did acknowledge that the key economic ingredients were in place for a decline in the sector, we remained a bit wary of the overwhelming consensus that had developed. In terms of financial markets and the economy, the stronger the consensus, the more likely that the herd is dead wrong. Our approach has been one of cautious assessor, avoiding a conclusion until more material evidence of a deterioration, or possibility thereof, arose with respect to commercial real estate. We believe now to have that evidence in hand.

We refer specifically to the not so subtle foreshadowing by Standard & Poors, that a vast swatch of CMBS now stands on the precipice of a downgrade. In fact, if we are to fully believe the extent of the sabre rattling, a full 90% of all AAA rated CMBS issued in 2007 stands to be downgraded. This is important for several reasons. First, 2007 represents the time just before the peak of CMBS issuance. It also represents, arguably, the most poorly underwritten vintage active today. Second, the US Government has just announced that its TALF program could only be utilized for the purchase of AAA CMBS securities. Meaning: the CMBS vintage most in need of removal from bank's balance sheets has just been disqualified from TALF.

The CMBS market is quite important for the functioning of a healthy commercial real estate sector, as it provides financing for approximately 25% of mortgages on commercial property. As evidenced by the attached chart, it may be difficult to conjure an adequately grim description of what has happened to CMBS issuance thus far in 2009. As long as the ratings agencies continue to apply heightened standards to the credit quality of CMBS,  we don't expect any change to the current trend. Additionally, now that rapidly deteriorating CMBS will have to remain on the balance sheets of financial institutions, the availability of financing for new commercial real estate projects will be greatly reduced.

The pending S&P ratings downgrades will stymie all major outlets for the financing of commercial real estate projects, and serve as a catalyst for the further deterioration of the sector.

Sphere: Related Content

Thursday, May 28, 2009

Time Warner to Rid Itself of AOL

Today, Time Warner's board finally voted to excommunicate AOL. This much needed move has actually come a bit late, to the point that, if we were shareholders of Time Warner, we might be quite concerned right now. Seeing this bit of news come across the wire, we began to ponder the question "What does AOL do exactly...what service do they provide?". Until several minutes ago, the only service we could identify is that AOL brings ridicule to any individual whose email address bears the name of the company. Having noted in the wire article that AOL is supposedly valued between 3 and 5 billion dollars, we set out to investigate the company's operations. The results are mortifying: AOL is still offering dial-up internet service. They do try to trick the consumer by providing an option called "AOL High Speed Essentials". Sadly, there is nothing high speed about this option, as it really amounts to nothing more than 10 hours of "back-up" dial up time and some security software. The most disconcerting aspect of our entire investigation was the realization that there must be a substantial number of Americans who are still paying AOL every month for the right to have an email address. Sphere: Related Content

The Irrelevant Aspects of US Mortgage Woes

In its quarterly status report,  released today, the Mortgage Bankers Association presented data that, as expected, points to a continued deterioration in the quality of US mortgages. According to the Association, this report set all time records (to the beginning of record keeping for this sort of data) in the following categories:
  • The percentage of first mortgages to have foreclosure proceedings initiated
  • Quarter to quarter increase, in basis points, of percentage of first mortgages to have foreclosure proceedings initiated.
  • The non-seasonally adjusted delinquency rate for mortgage loans on one to four unit residential properties.
  • The combined percentage of loans in foreclosure and at least one payment past due.
  • The percentage of loans in the foreclosure process.
Clearly, mortgages in the United States are performing poorly in virtually every aspect that it is possible for the instrument to fail. This information is all relevant insofar as assessments of future economic activity are concerned. What is quite irrelevant, in our opinion, is the fact that 46% of foreclosure starts are concentrated in a handful of states including Florida and California. Our reasoning is as follows: The nation does not exist in a vaccuum. We get the distinct impression that, when the MBA continually asserts the regional specificity of mortgage delinquincies/foreclosures/late payments, they are considering this aspect to be a mitigating factor within the carnage. This attitude belies certain realities.

First, California and Florida are major population centers within the United States-the two states together represent nearly 25% of the United States population. Hundreds of thousands of people migrate to and from these areas each year-under normal economic conditions. Housing markets across the country are adversely affected by the diminished pool of potential buyers that is the result of CA and FL residents being unable to sell their own home, or no longer credit worthy enough to receive financing.

Second, and obviously, woes within one region of the country can damage the ability of a financial institution, that is national in scope, to provide credit. Whether or not these bad loans are all located in one state, or evenly spread across the country, the majority of all loans are concentrated within a handful of financial institutions, rendering the actual loan location irrelevant. 

Perhaps the location of the mortgage meltdown epicenters is continually contained in these reports as a mere bit of trivia. Unfortunately, we feel that it is often cited as a means of assuring those lesser-affected states that everything will be allright.

Sphere: Related Content

Wednesday, May 27, 2009

Treasury Market Rebellion

Although we are typically not alarmed by short term market movements, we feel compelled to comment on today's developments in the Treasury market. As of the time of this writing, the yield on the 10-Year Treasury note has just surpassed 3.7%. Consequently, the average interest rate for a 30-Year fixed mortgage has climbed firmly above 5%, threatening to undermine a host of Government rescue schemes. We have been both surprised and impressed by the speed at which the yield on the 10-Year has been driven upwards-Surprised because we thought the process would take considerably longer to play out, and impressed at the Market's power in the face of a Federal Reserve intent on lowering the yield.

During the period of time in which the world financial system was supposedly on the brink of disaster, we were told that government intervention was required "at any cost". Well, it appears that catastrophe has been averted, but at what cost? Clearly, we think, the Market is judging (quite ruthlessly) the creditworthiness of the United States in the context of its ability to repay the obligations that it accrued, at an exponential pace, over the past six months.
Sphere: Related Content

Monday, May 25, 2009

The Stock Market: Expensive or Not?

The attractiveness of the stock market, from the perspective of an individual investor, is largely based upon the determination as to whether or not stocks are "cheaply" valued. Unfortunately however, it can be difficult for the average individual to properly assess current market valuations. First of all, stocks do not adhere to the everyday concept which tells us lower prices are synonymous with cheapness. This misunderstanding has been prominently displayed by many of our acquaintances who have proudly announced the purchase of a stock(usually in a social setting, usually drinking is involved)  based upon the assumption that it is cheap. These folks have made decisions based upon a perceived cheapness, relative to some price anchor that they have established for the stock in question. For example, a stock that traded in the $30 range only two years ago, and is now but a $5 stock, will be purchased on the assumption that it will inevitably return to $30. Secondly, there are numerous valuation metrics from which to choose from, most of which provide seemingly contradictory signals. For instance, a stock might look cheap based upon the ratio of price to as-reported, undiluted earnings, but appear expensive when subjected to a discounted cash flow analysis. Obviously, there is plenty of gray area in all of this.

As far as this current equity market is concerned, we have been told repeatedly that stocks are "in the bargain bin". We will now look to the available data for the S&P500 index and attempt, in an impartial and straighforward manner, to either verify or refute that claim.

Index-wide earnings for the S&P500 are reported in the two separate ways below:
Operating Earnings- Income from the sale of goods and services
As-Reported Earnings- Income from continuing operations as defined by Generally Accepted Accounting Principles (GAAP)

Our earnings figure of choice will be "As-Reported Earnings". This decision stems from a couple of grievances we have with the "Operating Earnings" figure. First of all, we are wary of the fact that these numbers are not standardized according to GAAP. While standardized accounting principles are not perfect, we ardently prefer a slightly flawed yet standardized measure over the inconsistency that is inherent to earnings designations made outside of the GAAP framework. Most suspect, we believe, is the fact that Operating Earnings exclude what is known as "unusual items". Essentially, a company has characterized a particular charge to earnings as "unusual" and thus can pretend that it did not really happen. Unfortunately, the world is defined by events and occurrences that would be largely considered unusual. Unusual things happen, and they matter. That being said, we will still provide the data for both earnings figures if for no other reason than to appease those who suffer from chronic delusions. Below are the quarterly, aggregate earnings per share for the S&P500, as reported by Standard and Poors:

Operating Earnings As Reported Earnings

Q1 2009 $10.07                  $7.57
Q4 2008 -$0.09                   -$23.25
Q3 2008 $15.96                   $9.73
Q2 2008 $17.02                    $12.86

At the time of this writing, the S&P500 index stands at 883.24. Given the current annualized index-wide earnings rate of $40.28(Operating) and $30.28(As Reported), the S&P500 is trading at earnings multiples of 21.92 or 29.16, depending on your method of earnings calculation. Furthermore, since 1988, the index has traded at an average P/E of 19.27 and 23.16 respectively. Typically, the index has overshot its valuation average, to the upside during the final stages of economic expansion, and to the downside during economic contractions, recessions, depressions or whatever your title of choice may be. When assessing this all in the entirety, we must conclude that the S&P500 is currently somewhat expensive. Granted, the market is anticipating a bounce in earnings over the next several quarters. Should this happen, now would be, in hindsight, a great buying opportunity. However, we would strongly caution individual investors against wading into the current market, unless however, you are extremely comfortable and familiar with the use of option contracts as risk management tools. That is but all the wisdom we currently have to offer.
Sphere: Related Content

Friday, May 22, 2009

Is Uncle Sam Creditworthy?

This is a somewhat difficult question to answer, as it is questionable whether any truly objective means of evaluating the creditworthiness of an individual/corporation/nation even exists. However, given that the investment community tends to rely upon a letter based rating system, developed and implemented by a small group of "ratings agencies", we will comment on Uncle Sam from this pseudo-objective standpoint.

Many of the inquisitive minds who frequent this site will remember a declaration that we made on March 19, 2009 in a post entitled The Fed Follows Suit ,forecasting the eventual loss of the United States Government's AAA credit rating. At the time, we were lambasted as a bit "out in left field" for making such a preposterous prognostication. Now however, the idea is starting to gain traction, and has even managed to "earn" a bit of discussion time on the popular stock market "investment" shows. As usual though, the producers of these programs either lack the will or the ability to deliver any content other than the latest pre-packaged storyline from Wall Street.

This story in general began gaining traction yesterday, when the US's feeble associate, the United Kingdom, was warned by Standard & Poor's about the country's ever growing public debt as a percentage of GDP, and put on alert that a AAA rating is a privilege earned, not a right given at birth(or in Britain's case, through conquest). Instead of diverting attention away from Uncle Sam, this announcement served to increase investor scrutiny concerning, to put it simply, just what kind of ship is the US running?

The future of the US's AAA credit rating is quite uncertain, however, we would be willing to speculate, in general terms, just how we see this all "going down". The situation in the coming months, we think, will be quite analogous to that of General Electric-another American entity that had likely come to take its AAA rating for granted. As most of you remember, GE was stripped of its AAA rating by all three agencies quite recently. The official downgrade announcement however, came absent any sort of fanfare, panic, or surprise. The reason: The Market told us all about the looming downgrade long before the ratings agencies did. Similarly, as evidenced by the steadily increasing yield on the 10 year Treasury note, The Market is clearly beginning to question the vaunted AAA rating of the United States of America. The signalling process is in its very early stages however, and a change of course by Washington could still prevent the embarassment of a downgrade. Unfortunately, the sort of ideology/principles that would be necessary to effectuate this change of course are notably absent in both of the major political parties that operate in Washington.  
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Monday, May 18, 2009

America and Recurring Panics

"History never repeats itself; at best it sometimes rhymes."
-Mark Twain

The history of the Federal Reserve is one defined by various Panics throughout US history, and the subsequent granting or elimination of Fed powers as a result of the supposed "lessons" learned from the Panic. Obviously, none of these Panics possessed the exact same set of circumstances, however, owing to the simplistic brilliance of Mark Twain, it is clear that there is some rhyming happening.

In October of 1907, the Knickerbocker Trust Company failed. The Company, run by one of J.P Morgan's good buddies, was allegedly involved in a multi-institution scheme designed to manipulate the price of copper(gone bad). Regardless though, the failure of Knickerbocker stoked a considerable amount of Panic, leading to additional bank runs/failures and a 48% decline in the Dow Jones Industrial Average. As a certain version of history tells it, the Panic subsided due to the heroic actions of James Pierpont Morgan, who stepped in to provide confidence and financial backing for the system as a whole. Of course, we must include the fact that Mr. Morgan benefited from the whole episode, as many failed insitutions were enveloped by his empire in the midst of the mayhem. More importantly however, the Panic of 1907 created the political impetus for the creation of the Federal Reserve. While conspiracy theorists cite more sinister motives for the Fed's creation, we would posit that men like JP Morgan simply wanted some other entity to shoulder the burden of the financial system during the next inevitable Panic. This is not to say however, that vested interests did not play a role in this story.

The "Crisis" that errupted in October of 2008 certainly has some parallel to the events of 101 years prior, the bulk of which we theorize is yet to come via reforms at the Federal Reserve. If you are in fact a conspiracy theorist, it should be quite easy to discern who or what helped spur the Panic of 2008: Simply make a list of who stands to benefit the most from potential reform of the financial system.
Sphere: Related Content

Friday, May 15, 2009

The Current Consensus: Close But No Cigar?

Over the course of less than two months, we have seen the phrase "green shoots" enter the public vernacular, and proceed rapidly towards cliche status. Now, the problem with using green shoots as a metaphor for the current economy is that it is a wholly inaccurate description. The implication of this overused phrase, insofar as the broader economy is concerned, is that growth, albeit meager, is occurring. In the current environment, there is not only a lack of evidence that the economy is growing, but there is also the existence of evidence that the economy is in fact shrinking.

The US economy lost over 500,000 jobs in the month of April. Given that the Department of Labor, by way of the Birth/Death model, has cited mythical business creation statistics that account for job gains, thus offsetting the headline number, and the fact that the same agency will undoubetedly revise April's job loss total down further, we would argue that there was nothing "green shootish" about April. We understand that the labor market is considered a lagging indicator of the direction of the economy, however, we know of about half a million people in particular who would likely classify the lagging aspect of the labor market as either irrelevant or innacurate.

The truth is, that this recession has been a largely unpredictable one. For our part, we proscribe to Mohamed El-Erian's assertion that the world economies will experience a "new normal", characterized by heightened volatility and systemic risk. That being said, we do not expect this "recovery" to proceed in any sort of typical fashion. It appears that, for now, the risks of a banking sector collapse have been averted. However, new problems could easily arise. Consider what it would mean for the banking system if the average default rate on bank's holdings of credit card backed assets reached 50%. Before you dismiss this possibility as crazy and assign a 0% probability, consider your reaction if a friend had, in early 2007, predicted the collapse of both Bear Stearns and Lehman Brothers.
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Friday, May 8, 2009

New Car Sales: The Obvious Impediment

Now that the Federal Government has wrested control of a substantial portion of the US auto industry, we feel entitled to offer advice to Uncle Sam concerning his management of this newest addition to the Portfolio. After all, we do have the honor of filling out a check, on an annual basis, made payable to the "United States Treasury". Additionally, this site is frequented by various Government Agencies, Commissions and mysterious crawling bots that originate from Washington DC. That being said, we have taken the liberty of creating the very simple chart positioned above. Our theory: A sustained increase in US light vehicle sales is rather unlikely if the cost of financing for this product continues to rise.

As is evident from the chart, interest rates for new auto loans have steadily risen since November of 2008-a point in time that coincides with a severe decline in the availability of financing for vehicles. Through the TALF, the Fed is aggressively attempting to restore the availability of auto finance credit. However, that is only half the battle. If the above trend continues, the Fed's actions will be muted. That is our humble opinion.
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Thursday, May 7, 2009

The Logic of Optimism

The fanfare and anticipation surrounding the release of the vaunted stress-test results have overshadowed certain adverse developments within the US Treasury market. Once again, a Treasury auction has been met with anemic demand. In this instance, the bastardized portion of the curve was the 30 year bond. We have warned of these developments in the past, portraying the situation as analogous to a sputtering car engine in need of repair. Additionally, the yield on the 10 year note continued to rise, reaching 3.2950%. Apparently, the Fed will defend neither 3%, nor 3.25%. Mortgage rates have followed suit, and as indicated by BankRate, the average rate of a 30 year fixed mortgage is now above 5%.

The typical market/economic optimist, engrossed in the stock-pumping rhetoric of the various market television shows, would argue that as the Fed/Treasury have instilled confidence in the Market, and as investors have become less risk averse, they have collectively shifted capital from the safe haven of Treasuries back into the equity markets. Therefore, according to the purveyors of happy-talk, this Treasury market behavior is only what is to be expected. Unfortunately, this sort of reasoning presents us with a logical quandary.

Assumption: The Government/Fed actions to date have been vital in restoring the economy's health. 

If the stock market is to continue its rally, Then the flow of money from the Treasury to the equity markets should continue. If money continues to leave the Treasury market, Then the yield on the 10 year and other Treasury issues will rise AND the interest rates of mortgages and other consumer finance instruments will rise. If the cost to finance mortgage/consumer/auto loans continues to rise, Then the Fed's allocation of $1.3Trillion to these markets will have been rendered useless. If the Fed is rendered useless, Then the economy will resume its fall.

Therefore, If the stock market continues to rally, Then the economy will resume its fall.
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Wednesday, May 6, 2009

Puerto Rico's Bailout

On October 14th, 2008, the Treasury Department posted an announcement, the full text of which can be found at . Below is the first paragraph of said announcement:

Treasury Announces TARP Capital Purchase Program Description

Washington- Treasury today announced a voluntary Capital Purchase Program to encourage U.S. financial institutions to build capital to increase the flow of financing to U.S. businesses and consumers and to support the U.S. economy.

Throughout this announcement, in three separate instances, "U.S" is used as an adjective to emphasize the fact that these activities are being conducted for the benefit of the United States. However, the Treasury, on its own website( ), posts information that would seem to contradict the stated purpose of the Capital Purchase Program as advertised to the public. According to the impressive interactive map, Treasury has funded $1,335,000,000 worth of transactions in Puerto Rico. A closer look at the reports reveal that the lions share of this amount, $935,000,000, went to Banco Popular (Popular, Inc.) , a San Juan based conglomerate with assets in excess of $45Billion. The most compelling piece of information that we can identify concerning Popular is that, in early 2008, it sold its US consumer finance division to AIG. This transaction was apparently quite beneficial, if not necessary for Popular- both Moody's and Fitch had placed the Company on "negative" outlook and were reviewing it for a possible credit downgrade. After the sale however, Moody's immediately assigned a "stable" rating to Popular.

To put Banco Popular's amount of US Government support in perspective, consider that it received more Federal support than the did the financial institutions of 34 individual US states. 

We did not choose to bring this information to light out of xenophobia(or any other phobia), but rather to point out that the public's attention has been skillfully manipulated throughout this entire economic episode. Case in point: there has been considerable rage leveled at Banks who received TARP money, and then planned to hire recent MBA's who happened to be from another country. However, there has been zero mention in the traditional media of the billion or so that has flowed directly to Puerto Rico.

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Monday, May 4, 2009

The 5th Amendment: Optional?

It would reduce the whole instrument to a single phrase, that of instituting a Congress with power to do whatever would be for the good of the United States; and, as they would be the sole judges of the good or evil, it would be also a power to do whatever evil they please.
-Thomas Jefferson

We believe that the statement above, penned more than 200 years ago by Thomas Jefferson, could serve as an all encompassing "Statement of Purpose" for everything contained within the Constitution. Clearly, the founding fathers understood that legislators and executive branch figures, prone to the numerous character deficiencies inherent to the human race, required a comprehensive set of parameters governing what they may or may not do. That set of parameters was created, and became known as the Constitution. Subsequent to the adoption of the Consitution, a series of Amendements known collectively as the "Bill of Rights" were incorporated. We would like to discuss the 5th such amendment today, as we feel that is has been sufficiently trampeled upon by both the Bush and Obama Administrations, as well as Congress.

To kick things off, we have provided the full text of the fifth amendment below, and have taken the liberty of bolding the portion in question:
"No person shall be held to answer for a capital, or otherwise infamous crime, unless on presentment or indictment of a Grand Jury, except in cases arising in the land or naval forces, or in the Militia, when in actual service in time of War or public danger; nor shall any person be subject for the same offense to be twice put in jeopardy of life or limb; nor shall be compelled in any criminal case to be a witness against himself, nor be deprived of life, liberty, or property, without due process of law; nor shall private property be taken for public use, without just compensation"

In legal circles, the bolded portion of the text is referred to as the "Takings Clause" of the fifth amendment. This Clause is most regularly cited in cases involving eminent domain, a power exercised most often by local governments. Most of us probably know of someone who has recevied a small check from the Government in exchange for title to a small strip of his or her front lawn that is necessary to widen a road-this example being the most common manifestation of eminent domain power. Unfortunately, governments do often times attempt to "push the envelope" and test the true power of eminent domain. Instances such as this, and the subsequent court outcome, form the basis for the modern day legal precedent surrounding eminent domain.

In Hawaii Housing Authority v. Midkiff (467 U.S. 229), a Hawaiian State Law was passed for the purpose of ending the land oligopoloy that existed on that island for so many years(a small number of people owned virtually all of the land in Hawaii). The law sought to achieve this goal by establishing a process whereby the renter majority of the island could petition for the forcible purchase of his/her particular lot from the actual land owner. The owner would be compensated at "fair market value" for his land, the exact amount of which was a Government determination that was often dislocated from the land owner's perception of reality. This law caused the aggrieved land owners to sue, arguing that this action amounted to a Government taking of private property for private use-not the public use demanded by the Consitution. The Supreme Court disagreed, and in doing so distinguished the public use requirement with the language that "Government does not itself have to use property to legitimate the taking; it is only the taking's purpose, and not its mechanics, that must pass scrutiny under[p231] the Public Use Clause."

Having established that the Government may in fact take the property of one private party and transfer it to another private party, provided of course the purpose will serve a public good/use, we will move on to Berman v Parker (348 U.S. 26). This case was a challenge to the constitutionality of the District of Columbia Redevelopment Act of 1945. The purpose of this act was to eliminate "blighted"(a euphemism for poverty stricken, run-down parts of a town that the rich folk are embarassed to let visitors see) portions of the city by forcing current land owners to sell their property to developers, for the express purpose of tearing everything down and building more "desirable" neighborhood fixtures. This Act was challenged on the grounds that there was no legitimate public benefit derived from this property transfer, and thus was not a public use. The Court disagreed in the majority opinion, proclaiming that the Act served a public purpose to:
"prevent slum and substandard housing conditions -- even though such property may later be sold or leased to other private interests subject to conditions designed to accomplish these purposes."

This language has allowed cities and towns across the country to move into impoverished areas, displace the current residents, compensate land owners "fair market value", and turn the land over to developers. This sort of behavior was permitted to an even greater extent by the landmark 2005 case Kelo v City of New London (545 U.S. 469). Essentially, New London's city planners formed a group huddle, and emerged with a grand new vision for the City that would be implemented via a development commission. This commission set about acquiring tracts of adjoining land, at first from every willing seller, so that the land could be given to the pharmaceutical conglomerate Pfizer to build a new "campus". Eventually, some of the owners of the targeted parcels banded together and refused to sell. The commission quickly classified their property as "blighted" and initiated condemnation proceedings. The livid owners sued the City, and the case made it to the Supreme Court. The Court upheld the City's assertions, saying that:
"The city’s determination that the area at issue was sufficiently distressed to justify a program of economic rejuvenation is entitled to deference. The city has carefully formulated a development plan that it believes will provide appreciable benefits to the community, including, but not limited to, new jobs and increased tax revenue."

Kelo v New London was a 5-4 split decision by the Court, and remains extremely controversial because it essentially authorizes a Government taking through the claim that the transfer of property ownershipwill increase tax revenue to a municipality. We can safely say that the current interpretation of the takings clause has been pushed to the liberal boundary, if not beyond, based upon the current ideological make-up of the Court. That being said, we believe that several of the Government's financial rescue measures are clear violations of the 5th Amendment's Takings Clause.

Specifically, we refer to the losses forced upon Chrysler's creditors and the pending legislation that will allow for mortgage modification. Regardless of where one stands concerning the dispersion of blame for the financial crisis, it is undeniable that the Government is taking money from one private party, for the benefit of another. Its actions are not justified by any study proving that, to be specific, there will be a concrete taxpayer benefit from a Chrysler restructuring as opposed to a liquidation. There is also no evidence that mortgage modifications will lead to fewer foreclosures, in fact, there are studies that indicate the opposite effect. The Government's actions, in these two respects, are transfers of wealth from one private party to another, where the taxpayer is the damaged party. Could the Government prove in court that saving Chrysler serves any truly public benefit? Certainly, the UAW stands to benefit, but they are only one segment of the population, not representative of the public as a whole. Does the taxpayer benefit by the taking of value from holders of mortgage backed securities and the transfer of that value to homeowners? We would say no on the basis that a large portion of the "public" are actually indirect investors in these securities through pension and mutual funds. Additionally, the integrity of the MBS market is vital to the functioning of housing finance in general, which, as evidenced by various Congressional actions over the past twenty years, is apparently a source of pure public "good" Our conclusion is that neither of these actions can be justified as being a legitimate beneficial public use, at least not outside of the political arena, where fact and reason often take a back seat to the art of vote buying.
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Friday, May 1, 2009

Of Nero and Fiddles

One of our favorite historical tales features the Roman Emperor Nero, who ruled during the years 54-68 CE. It was during his reign that the Capital was ravaged by what later became known as the "Great Fire of Rome". As implied by its name, this fire was particularly destructive, decimating a substantial portion of the City. According to the lore, during the fire, Nero was spotted on top of a hill overlooking Rome, playing a fiddle while the City burned to the ground. Nearly two thousand years later, remnants of this sort of behavior still exist.

The "fiddlers" of today are the chief economic policymakers of the United States. Instead of playing a musical instrument, these individuals are aggressively pushing a storyline that contains, as its foremost element, a concept described simply as "green shoots". The media has been complicit in the advancement of this fable: one morning while perusing a rather well known newspaper, we noticed that across two consecutive pages, there were six separate articles. Every article invoked the term "green shoots" in either its Headline or Sub-Headline. 

The "fire" at present is the financial system, which continues to deteriorate. The most recent flare up is the somewhat under-reported trouble at Syncora, a provider of debt guarantees, or bond insurer if you prefer, with Total Assets in excess of $5Billion. New York State insurance regulators have literally compelled Syncora to cease all payment of claims until the Company can reduce its liabilities to a more manageable level. Presumably, New York will attempt a Chryler style Creditor Coup in order to avoid bankruptcy proceedings.

Our primary issue with this latest strategy is simply that the Government's hired economic hands know better. While they may misspeak in public occasionally or fail to fulfill their tax liabilities, these men are not obtuse beings when it comes to reading the economic tea leaves. We would classify the current developments as merely part of a larger strategy-one that has been conceived for the purpose of allaying public discontent for a minimum of two years. The reasoning is simple: as long as the public perceives a recovery to be close at hand, overall levels of unrest will remain minimal. The prosecution rests.
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