Saturday, September 27, 2008

Auto Industry: Special Loan Financing!

What do you do with an industry that has been losing billions of dollars, has an uncompetitive cost structure, is struggling to raise enough cash to fund itself, and is slow to innovate?

a) Short the stock, and wait for the bankruptcy announcement.

b) Hire an arsonist to torch the place in hopes of collecting some insurance money.

c) Lend it a huge amount of money at a ridiculously low interest rate.
If you chose A, you are of above-average intelligence and think quickly on your feet. You're well-liked, held in high esteem by your friends, and are very attractive. You're also wrong.

If you chose B, you are either a criminal, a pyromaniac, an aspiring Mafioso, or you work at the Federal Reserve. You are also wrong and should stay well away from my house and family.

If you chose C, you are correct. Unfortunately, you are either a village idiot, a U.S. Congressman, or an auto industry executive. You are not good with numbers, investments, ethics, or the truth. You think you are well-liked, but behind your back people are constantly mumbling, "Wow. I feel sorry for the village that idiot comes from."

The socialization of America continues to run amok. With the nation busy quibbling over the relatively insignificant foreign and economic policy differences between McCain and Obama and with the distraction provided by the teetering of the global financial markets, the mere $25 billion that our U.S. Congress just approved in loans to the auto industry may slip through the cracks.

Remember the widespread consternation over the $29 billion "rescue" of Bear Stearns? Just a few months ago, $20-something billion was considered a substantial amount of money and caused quite a tizzy. Ah, the good old days. Since then, we've had an $85 billion "rescue" of AIG and are now facing an impending $700 billion bailout of the financial industry. In this brave new world, $25 billion is practically quaint. It's the change between the cushions of Uncle Sam's sofa.

Nevertheless, let's put that $25 billion in perspective. Our entire annual federal education budget is $56 billion. Homeland security is getting $34.3 billion this year. $25 billion is greater than the annual federal budget for each of the following agencies: Agriculture, Commerce, Energy, Interior, Justice, Labor, Transportation, Treasury, EPA, Judicial Branch, NASA, and the National Science Foundation. I'm not saying we should spend more on these departments -- just providing some perspective.

The combined market value of Ford and General Motors is $16 billion. Raising significant equity capital would, if even possible, result in massive dilution. No private bank in the world will loan them a dime, and let's not naively blame that solely on the banking crisis. Banks weren't rushing to loan the U.S. auto industry any money before the meltdown either. The capital markets simply don't deem them worthy of investment.

Our legislators, however, always think they know better, so they've rushed in to supply the industry with $25 billion that no other sane institution/investor would provide. To add a touch more insult to the U.S. taxpayer, this loan is not accompanied by an equity stake in the participants, and these loans are coming at a below-market interest rate. According to a Detroit Free Press article:
Under the loan program, automakers and suppliers could borrow at interest rates close to what the U.S. Treasury does -- roughly 5% -- rather than the 15% they would have to pay on financial markets. On a loan of $1 billion, that's a savings of $100 million.
That, of course, is $100 million less that the U.S. taxpayer will make from this "investment," and that 5% interest rate is lower than even our best companies can get in the market. Let's remember this the next time we read how our U.S. officials are complaining about foreign tariffs, subsidies, trade barriers, and unfair trade practices. This is no different.

Why is the government intervening to prop up these companies?
As I detailed in my article "General Motors - It's Your Money Demand Better", GM has lost a cumulative $33 billion since 1993. Shouldn't it be clear by now that the U.S. has no competitive advantage in auto manufacturing? Is the auto industry really vital to the US? If our ambition is to solidify our position as a leader in the manufacture of inferior and unprofitable products, then by all means, this loan package is a master stroke.

I don't know about you, but I don't need GM, Chrysler, or Ford. There are plenty of foreign-owned car manufacturers making a better product at a better price who are eager to sell to me. Furthermore, many of these competitors have been opening up manufacturing facilities and creating jobs in the U.S. over the years. They have the cost structure and manufacturing know-how to produce profitably, and some of them have been leaders in the development of more fuel efficient vehicles. This loan supports those who have failed and is a slap in the face to every strong competitor.

Clearly, the only reason the government is making this loan is to stem the loss of thousands of jobs that would result from the failure of the industry.
It's all politics, all the time. Where do we draw the line? Nokia and Research In Motion have better cell phones than Motorola, and Motorola has had to cut jobs. Why don't we give Motorola a sweetheart deal? Our U.S. furniture manufacturing industry has suffered due to low cost Chinese competition. Let's throw billions at them. And what about our Swiss Army knife manufacturers? The Swiss are killing us! Let's give them some cash so they can compete!

Disclosure: The Rubbernecker is long the Bankruptcy Code and short arsonists.

The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.

Wednesday, September 24, 2008

Buffett Takes Goldman Stake. Bottom?

The Warren Buffett investment in Goldman Sachs is getting rave reviews from all corners. Of course, agreeing with any Buffett investment decision is usually a wise move. Those who questioned his touch as he sat out the tech bubble have probably learned their lesson.

Don't get me wrong. I'm a Buffett fan. What bothers me about this deal, however, is how it is being pushed in the press as a sign of confidence in the U.S. and our financial markets. Maybe. But I don't think Buffett did this deal to make the rest of us feel better. If that's what he hoped to accomplish, he could have bought common shares at a discount.

When you look at the details of the deal, it's pretty clear that Buffett did this deal for Buffett (as he should). He's investing $5 billion in perpetual preferred stock at a 10% yield. He'll be pulling down $500 million each year, forever, from this. He's also getting warrants to buy $5 billion worth of common stock at $115 per share over the next 5 years. This is a free call option. He gets the $500 million every year, and if Goldman stock rises, he'll get a windfall from exercising the warrants.

With the stock at about $125 when the deal was announced, Buffett already started out with about a $430 million paper profit. Considering how stocks often react to news of a Buffett investment (they go up), he was well aware (as was Goldman) that Goldman common would rise following the announcement. As of now, he's made another $150 million in paper profits.

Let's also keep in mind that Buffett did this deal after Goldman essentially became a bank and was afforded all of the borrowing rights at the Fed that banks are permitted. He also did this with full knowledge that Goldman would be separately raising another $5 billion through the sale of common shares. When you're guaranteed 10% forever from a company, your primary concern is that the company endures. These moves help ensure that Goldman doesn't go out of business and will be able to cut Buffett his check for many years to come.

In sum, this looks like another terrific deal for Buffett which is hardly surprising. He's sitting on a pile of cash, and liquidity rules these days. It's a buyer's market, and he's one of the brightest buyers around. But let's not rush to call a bottom in the market. Let's also not rush to view this as an endorsement of the economy or the financial system. Things can get a lot worse for both, and Buffett will still be sitting on a terrific investment.

Disclosure: The Rubbernecker is long savvy billionaires and short press overreactions.

The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.

Monday, September 22, 2008

"Is The Dollar Getting Moody?" or "The True Cost Of The Bailouts"

In light of the recent upheaval in the financial markets, Moody's Investors Service recently came out and affirmed the U.S.'s AAA credit ratings. According to a Wall Street Journal article, Moody's cited the country's “economic and financial resilience, flexible and competent policy-making, and a high level of balance-sheet flexibility.”

Competent policy-making! I have to leave that alone, or I'll never get this written. Moving on. Moody's also stated that the recent round of bailouts totaling $785 billion "raises the question of how much more debt and risk the U.S. government can assume before it starts imperiling its AAA rating."

This is Earth-shattering news! Yes. They affirmed the rating. But the fact that a rating service felt compelled to even comment on the "risk-free" status of the U.S. government is monumental. Questioning how much more the U.S. can borrow without impacting its credit rating is equally mastadonic.

I've warned that these bailouts are not free and that any bailout is ultimately coming from borrowing, largely from our Asian friends. At some point, our creditors will cast a more critical eye on our balance sheet. Ironically, the more money the U.S. government throws at cleaning up the balance sheet of the private financial system, the more damage it does to its own balance sheet.

Over the last 12 months, the U.S. government has paid $431 billion in interest expense on the national debt. This is the third largest expense in the federal budget. Once our creditors begin to fully appreciate the magnitude of our on-balance sheet and off-balance sheet debt, they are very likely to demand a higher interest rate on Treasuries to compensate for their increased risk. Every 1% more that our government has to pay in yield on its debt works out to another $100 billion of interest expense each year.

Let's also not forget that in such a scenario, it's likely that the value of the dollar will be weakening, destroying the purchasing power of Americans. The abundance of dollars printed up to fund our spending and bailouts is also likely to flow through to inflation, particularly commodity inflation (in my opinion).

There have been plenty of headlines highlighting the $29 billion bailout of Bear Stearns, the $200(+) billion bailout of Fannie and Freddie, the $85 billion bailout of AIG, and the now-proposed $700 billion bailout of [insert names here]. But when we're tallying the true and ultimate cost of these government bailouts, let's not forget the follow-on effects and their costs. The cost of higher interest expense, higher inflation, and a weaker dollar will likely far exceed the "hard" costs of the bailouts.

Moody's was late to the funeral on plenty of tech and telecom stocks as well as countless mortgage-related securities, but it actually appears they're being a little proactive this go around. I remain bearish on the dollar and bullish on gold/silver.

Disclosure: The Rubbernecker is busy gilding the interior of his bunker.

The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.

Sunday, September 21, 2008

Dictator Paulson's Bailout

The Treasury issued a "Fact Sheet" yesterday which shed a little more light on its proposed $700 billion bailout. Although the fact sheet was fairly brief, I'll quickly summarize it for those of you who don't have the time to read my full write-up.

I, Hank Paulson, will be granted absolute dictatorial control and power over $700 billion to buy whatever assets I damn well please under the terms of my choosing from any U.S. or foreign financial institutions that operate in the U.S. I will personally select which of my friends get to manage these assets, and you should consider yourself lucky that I intend to give you an update in a few months.

Let's look at some of the details that are coming out more closely. For starters, according to the fact sheet:

"The purchases are intended to be residential and commercial mortgage-related assets, which may include mortgage-backed securities and whole loans. The Secretary will have the discretion, in consultation with the Chairman of the Federal Reserve, to purchase other assets, as deemed necessary to effectively stabilize financial markets."
We're first told that the intent is to purchase residential and commercial mortgage-related se
curities, but then we read that the Treasury can also buy other assets. So, that really means that the Treasury can buy pretty much whatever it wants.

"To qualify for the program, assets must have been originated or issued on or before September 17, 2008."
It's been incredibly clear for at least 6 months to even the most ignorant observer that the housing bubble was imploding, deleveraging was underway, foreclosures were rising, risk aversion was increasing, and credit quality was deteriorating. Why in the world are we going to bail out those who were foolish enough to continue gambling these past 6 months?

"Participating financial institutions must have significant operations in the U.S., unless the Secretary makes a determination, in consultation with the Chairman of the Federal Reserve, that broader eligibility is necessary to effectively stabilize financial markets."

This makes it abundantly clear that U.S. taxpayer dollars will be going to help support foreign-owned financial institutions. Why are we bailing them out with our money? Why aren't their own governments bailing them out? Are U.S. financial institutions with an international presence being bailed out by the foreign countries in which they operate? This looks like yet another gift to our foreign benefactors upon whom we're dependent for funding our ever-increasing debt.

Moving along:

"The assets will be managed by private asset managers at the direction of Treasury to meet program objectives."

Private asset managers? I wonder how many companies who will be benefiting from this bailout will also be benefiting from the fees they'll earn managing these assets. The Treasury could have at least mandated that no firm that participates in the bailout will be eligible to manage the Treasury-purchased portfolio.

Other details of the plan have begun emerging as well. One of the most disturbing is that Paulson is asking that no court or government agency be able to review any of his decisions. I'm sure Paulson is a nice guy and all, but I wouldn't trust him to cat-sit for me, and I don't even have a cat. I imagine even Chavez of Venezuela and Ahmadinejad of Iran are subject to some oversight.

I still haven't heard about any protections being given to U.S. taxpayers who are the ones incurring all of the risk in this bailout. I've heard no discussion of the Treasury being given equity for access to its funding. This is even more disconcerting given the issue of bank capitalization. As I highlighted a couple days ago ("The Ugly Step-Mother of All Bailouts") the only way this bailout can really help out the banks is if the Treasury buys their distressed securities at well above market prices. Selling at a true market clearing price would likely lead to immediate insolvency for many banks. Of course, buying their toxic securities at a premium would lead to an immediate loss for the U.S. taxpayer. We should be compensated for the immediate loss we'll suffer as well as the risk of significantly larger losses down the line. When we bailed out AIG, at least we were given some consideration in the form of majority ownership and a respectable yield on the debt.

This bailout is terribly flawed. What's worse is that there is a very high likelihood that it won't ultimately save the financial system. There is no guaranty that banks will start lending again. To what degree banks will still need to be recapitalized is unclear. It doesn't improve the financial condition of the U.S. consumer/homeowner. To the degree that it slows or stalls the process of actual market price discovery and deleveraging, the downturn will be strung out over a longer time period.

The market could certainly rally into quarter-end as fund managers are desperate to salvage their performance this quarter, but once the broader implications of this bailout are appreciated, there is a good chance that the market will roll over once again. Should the market begin to doubt and question the effectiveness of this huge comprehensive bailout, we could certainly experience a new high on the VIX (fear index) and a meltdown in confidence.

We have begun to increase our short positions and anticipate building them further should the market continue to rally in the coming weeks. We also anticipate further building our gold, silver, and/or junior mining equity positions.

Buckle up.

Disclosure: The Rubbernecker is short dictators and long transparency.

The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.

Saturday, September 20, 2008

Debt Bomb

It looks like the size of the latest government bailout will total $700 billion, which works out to an additional 8.2 AIGs or roughly the GDP of the Netherlands. Of course, the U.S. doesn't have an extra $700 billion in savings sitting around to fund this program, so we'll have to borrow it. As a result, our government will yet again need to increase the statutory limit on the national debt, this time from $10.6 trillion to $11.3 trillion.

I'm surprised Congress still calls it a debt limit, since it's nothing of the sort. They've never adhered to any limit. Whenever they bump against it they simply vote to increase it further. Usually, they're far more creative with their nomenclature. You'd think by now they would have changed the name to "Government Stimulus Threshold","Graduated Investment Target", or "Super Patriotic Pro-U.S. Funding Goal."

For those of you keeping score, this latest $700 billion payoff works out to $2,333 per U.S. man, woman, and child. It also works out to $6,350 per U.S. household. The new debt limit of $11.3 trillion comes out to $102,700 per U.S. household. These figures ignore unfunded liabilities (Medicare, Medicaid, Social Security) which conservatively come out to another $50 trillion, or $450,000 per U.S. household. All in, your family's share of our country's debt comes to $552,700.

Are there any proposals to offset this $700 billion with tax increases (which I abhor) or expenditure cuts (which I love)? Of course not. To the contrary, there are discussions about another fiscal stimulus program. McCain and Obama certainly have no plans to lower the debt. We haven't heard either talk of any specific and substantive cuts in expenditure.

This is the problem with Keynesian economic theory. It looks good on paper, but it doesn't work in the real world. Everyone loves the front end of the theory -- borrow money and go on a shopping spree. It's the American way! But when times are good, no one wants to take away the punchbowl, upset the voters who are now dependent on the new government programs, and risk not getting reelected.

So, our national debt spirals ever higher, which is a bit ironic since it was ever-rising debt of increasingly poorer quality that led to the current credit collapse in the financial sector. Increasing debt necessitates the printing of ever more dollars. The more of something that exists, the less valuable it becomes. In light of this, it's difficult to be constructive on the dollar long-term. There is no way we can ever repay this mountain of debt short of inflating the currency.

We owe a debt of gratitude to the Chinese for their delicious food, movable-type, a beautiful wall, their inexpensive exports, and their continued purchase of our Treasury securities. So far it's been in their best interest to fund our debt and keep the dollar from imploding. A dollar meltdown would lead to higher interest rates which would kill our economy and severely impact our appetite for Chinese goods. In addition, a falling dollar and rising rates would decimate the value of their U.S. Treasury holdings. Over time, China will become less export driven and less dependent on the U.S. consumer, and at some point, the Chinese are going to view the risk of increased dollar purchases as greater than the reward. That is the day when U.S. interest rates will begin an ugly march higher.

Ironically, it was the Chinese who invented paper money.

Disclosure: The Rubbernecker is long gold, silver, and the Renminbi and short the greenback and government bailouts.

The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.

Friday, September 19, 2008

The Ugly Step-Mother Of All Bailouts

In less than a week, we've gone from U.S. Treasury Secretary Paulson being "adamant" that no government money be used to bail out Lehman to an $85 billion bailout of AIG to a rumored $800 billion bailout of the financial industry and a new guaranty program for U.S. money-market funds. On top of that, the SEC is banning the shorting of 799 financial stocks.

All I'm reading is praise for these moves from all corners. Has everyone gone mad? This is a sad day in this country. Taxpayer money on a huge scale will once again be used to rescue failed private businesses, the bar for "too big to fail" is being significantly lowered, and moral hazard is again being trampled on. The "communist" Chinese must be doubled over laughing at us "capitalist" Americans.

I'll save my capitalism and regulation rants for other posts. For now, let's focus on this new government plan to buy distressed securities from financial institutions. First, we need to ask why the banks aren't selling these assets to raise capital. Paulson contends that they want to sell them but can't because there aren't any buyers. That's why the government "needs" to step in as the buyer of last resort. Well, Merrill Lynch was able to offload $31 billion of these securities at what really worked out to about 5 1/2 cents on the dollar. We also know that a number of funds have raised a significant amount of money to invest in distressed debt.

So, is the issue really that the banks can't sell the securities? Perhaps it's more intellectually honest to say that the banks could sell the securities, but if they sold them at a true market price, they would end up taking huge write-offs and would be technically insolvent. If this is the case, the only way the government will be able to help these financial institutions is by buying the securities from them at significantly above market value prices. Great deal for management and the shareholders. Not such a great deal for the U.S. taxpayer.

By the way, who is going to value the securities? The Wall Street financial whiz kids don't know what they're worth. Are we seriously supposed to believe that some government bureaucrats have the answer? I imagine they'll hire some Wall Street firms to tell them how much to offer for the toxic securities owned by the Wall Street firms!

I'm sure we'll hear how the taxpayers could actually make money on this deal, and that's certainly possible if the markets settle down, housing rebounds, employment rises, foreclosures stop, wages increase, and we're able to find some greater fool of a government to sell the securities to. Unfortunately, there isn't likely to be much upside for the taxpayer. If the government offers to buy these securities at true market prices, then very few banks will likely participate, and the bailout is irrelevant. On the other hand, if the government offers to buy the securities at above market prices there will likely be many takers, with the risk being transferred to the U.S. taxpayer who will be starting out this investment already under water (think load mutual fund).

So, the markets are rallying again on news of yet another government bailout. Everyone feels good. Just remember, if you're trying to figure out who the patsy is, and you still don't know after a few minutes, then you (Mr. Taxpayer) are the patsy.

We were fortunate to have reduced a good portion of our short position earlier this week following Wednesday's decline. We're once again gradually adding to our shorts on this rally.

Disclosure: The Rubbernecker is long shorting and short longing.

The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.

Friday, September 12, 2008

Dollar/Gold Irrationality?

One day, the Dow rises nearly 300 points. The next day, it gives it all back. In the morning, Lehman opens up double digits. By the close, the stock is down 40%. United Airlines is down 99% one minute. A few hours later, it's back to even. Bernanke is forming complete sentences at the start of the day...

Fear rules the day. There is a general liquidation underway. About the only things increasing in recent weeks are the U.S. dollar, U.S. treasury securities, alcohol sales, and irritable bowel prescriptions. As for the dollar, there has been speculation that the dollar rally is the product of coordinated intervention from the U.S., Europe, and Japan given recent reports of just such a plan being drafted back in March. Given the fundamentals in the U.S., I wouldn't rule this out.

Aside from possible government intervention, the best thing the dollar has going for it right now is that it's not the Euro or any of the commodity-based or emerging market currencies. People have to keep their money in some currency, and as money is extracted from markets around the world, investors are choosing to move it to the "safe" U.S. dollar. Although this dollar rally has been powerful, its sustainability needs to be seriously questioned given the following:

  • The U.S. government is now on the hook for future Fannie/Freddie losses. Total losses will depend on the severity of the housing/credit debacle, but it isn't a stretch to imagine losses in the $1 trillion range.
  • The U.S. budget deficit in August alone was $112 billion.
  • The U.S budget deficit is forecast to be $407 billion in 2008 and a record $438 billion in 2009.
  • The $438 billion for 2009 does not include any funds used to "conserve" Freddie or Fannie or any new fiscal stimulus package, and it doesn't account for the full cost of the Iraq War (let alone any new incursion into Iran, the Caucusus region, or Pakistan/Afghanistan).
  • About the only thing supporting GDP growth in the past 2 quarters has been net exports, thanks to the falling value of the dollar. The recent strength in the dollar is likely to blunt this tailwind.
  • The risk of competitive currency devaluations is very real as every country battles for a piece of the shrinking pie of investment and consumption spending.
  • The Fed continues to swap high-quality Treasury securities for garbage securities.
  • U.S. unfunded liabilities range from $50 trillion to $95 trillion (depending on the assumptions used).

Of course, we don't have the money to pay for any of these items since our national debt exceeds $9.6 trillion, and we're already running an annual budget deficit. So, our over-leveraged government will have to rely even more on the kindness of strangers to fund our spending.

A borrower living beyond her means. Using her "home" as an ATM. Deteriorating credit score. Stagnating real income. Dependent on low-cost borrowings. Sound familiar? It's comically implausible that our financial obligations will be repaid with dollars worth anything close to their current value. (The dollar has lost 95% of its purchasing power since the Federal Reserve system was created in 1913. Given our current debt situation, this trend is certain to continue over time.) The difference between the U.S. Government and a subprime borrower is that the government controls the printing presses. There is little doubt that the presses will be working over-time in the years to come.

As history has shown, all fiat currencies are ultimately doomed. The temptation to devalue the currency is just too great over time. The dollar may continue its near-term rally as investors search for "safety" and/or if government intervention is indeed underway. Ultimately, however, the fundamentals will matter again.

Our Chinese Renminbi and Japanese Yen exposure have held up fairly well this year, but the "currency" position that we find the most intriguing currently is one that has stood the test of time and held its value for hundreds of years. This solid currency has been caught up in the recent wave of asset deflation and is now off its recent peak by about 25%.

I'm talking about gold (and silver). As I always caution, trying to pick bottoms is futile, as is trying to time short-term moves. In the current environment, the curtailing of risk, fund redemptions, and losses on a variety of securities is forcing the sale of virtually all liquid assets, including precious metals. However, given the poor and deteriorating financial condition of the U.S., the need for our government to continue depreciating the dollar over time, the historical track record of all fiat currencies, the recent pullback in the price of gold and silver, and the supply constraints facing mining companies today, this may well prove to be another excellent long-term opportunity to add to gold and silver. We are increasing exposure in most portfolios at these levels.

Disclosure: The Rubbernecker is long alchemy and sluice boxes and short printing presses.

The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.

Wednesday, September 10, 2008

"Rangel"ing With The Tax Code

As you may have seen, Congressman Charles Rangel of New York is in a spot of trouble after it was disclosed that he failed to pay federal taxes on $75,000 in rental income from a beachfront house he owns in the Dominican Republic. He claims that he had trouble getting information from the resort's managers. “Every time I thought I was getting somewhere, they’d start speaking Spanish,” he told reporters. I'm sure Ma and Pa Mainstreet are sympathetic to his plight since every time they think they're getting somewhere with their taxes, their accountant starts speaking Greek.

I can imagine how frustrating the language barrier must have been for Rangel. Spanish for goodness sakes! Who speaks Spanish anymore?! I went searching for some information to bolster his case. Here's what the poor guy was up against. As of 2004, the Hispanic population of the U.S. was estimated to be only 41.3 million people. Only one of every two people added to the U.S. population between July 2003 and July 2004, was Hispanic. The U.S. has only the fifth largest Spanish speaking population in the world.

And poor Mr. Rangel is stuck in New York City. According to the Zoni Language Center's website:

New York is the world's seventh most populous Spanish-speaking center, with more Spanish speakers than Quito, Ecuador, Asuncion, Paraguay or La Paz, Bolivia and almost as many as Havana, Cuba. At least a third of subway advertisements are in Spanish, and signs in hospitals and other public institutions are usually in both Spanish and English.
If only it hadn't been so difficult for Mr. Rangel to find someone who could translate for him.

What makes this equally absurd is that Congressman Rangel is the chairman of the House Ways and Means Committee. If you're not familiar with this committee, it's one of the most powerful Congressional committees as it is responsible for writing the federal tax code. So, the head of the committee charged with writing tax legislation can't even figure out his own 1040. That's a bit disconcerting, eh?

I may be a little skeptical, but I bet that if his villa incurred any recent hurricane damage, he'll manage to hurdle any language barrier and claim every last one of his deductions and credits.

Monday, September 8, 2008

GSE = Government "Saving" Everyone

With Fannie and Freddie common and preferred all down 80-90%, it might seem a little persnickety that I'm irritated that they have any value whatsoever. That the U.S. taxpayer can be on the hook for future losses yet shareholders not be completely wiped out is absurd and disgraceful.

A lot has been written on this bailout, so I'll just focus on a few areas. Let's start with who's to blame. If you listen to management or government officials, no one is really to blame as they attribute the downfall to the housing bust. Funny how that works. If house prices had only kept going up at an unprecedented rate, everything would have been fine. We'd all be millionaires sipping umbrella drinks and stroking our cockapoos in our newly installed home theaters with our mortgage brokers as we prepared to take another slug of cash out of our residential ATMs to fund the botox injections we'll need to stop all that smiling over our good fortune.

The truth is that there is plenty of blame to pass around. The very structure of the Fannie and Freddie has been flawed from the beginning, and we can thank Congress (and FDR) for that. Coupling profit-making with a government mandate to make home ownership more widespread was never very neat and tidy. This was made very clear recently when Congress pressured Fannie and Freddie to expand their activity to the less credit-worthy at a time when housing was weakening. That was exactly the wrong thing to do. It's like hitting the gas rather than braking when the car in front of you slows.

We can also place some blame at the feet of their regulator (OFHEO). Back in March, OFHEO lowered the amount of capital that Fannie and Freddie were required to hold. As I wrote in my very first post on this blog, "...lowering capital requirements during a time of distress seems quite the opposite of what common sense would dictate. Credit losses are rising and asset values are falling, so let's reduce our safety cushion! Sounds like dot-com math to me." The regulators should have required Fannie and Freddie to raise capital, curtail new lending, and increase prices.

Of course, management and the board are to blame as well. They had a front row seat to what was unfolding in the housing and mortgage market, and they should have known better than anyone that it was time to pull back, take less risk, and bolster capital. They also should have known better than anyone just how weak their capital position was. Perhaps the CEOs were too busy counting the millions they received in compensation to bother with such trivia.

So, let's not blame the housing bust. Busts follow bubbles, and isn't it the job of management and regulators to account for and adjust to the dislocations that occur at such times?

What does this bailout mean? First of all, U.S. taxpayers will now be stepping in and shouldering the risk of this housing collapse. This obligation could run north of $1 trillion. Although the U.S. taxpayer is now on the hook for future losses, foreign governments around the world have just been bailed out and will be made whole on the debt that they own. Perhaps this is why the dollar continues its rally on this news. We're telling our foreign benefactors that we're willing to sacrifice ourselves to make them whole. Good deal for them. Bad deal for us.

The implications of this bailout for correcting the scourge of moral hazard (the propensity to take increased risk when you believe the government will bail you out if you fail) are grim. The Treasury and Fed continue to pay lip service to moral hazard as they commit to serial bailouts. What a message it would have sent if Fannie and Freddie had been allowed to fail, and shareholders and debtholders had to go through Chapter 11! It would have been earth-shattering. It would have clearly sent the message that the government does not exist to bail out industry and that there is a cost to taking higher risks. Stop laughing. A guy can dream.

What does this mean for the market? Judging by the initial response, market participants seem to think that this is unquestionably positive. As is typical, I disagree. The market hates uncertainty, and the bailout definitely helps to resolve some uncertainty near term. Thus the rally. So far during this bear market, the bulls have tried to rally the market on every government intervention. I would be shocked if any form of government intervention actually marks the low of this bear.

Does this bailout change the overhang of housing inventory? No. Does it encourage banks to lend more? No. Will it prevent future foreclosures? No. Does it bolster the consumer's balance sheet? No. Does it address the commercial real estate imbalance? No. Does it create new jobs? No. Does it bolster the capital of other financials? No.

Importantly, this bailout does nothing to change the fundamentals impacting the country. The bulls can have their 300 point day, but eventually they'll have to face the fact that this wasn't done from a position of strength. Rather, it illustrates the weaknesses and challenges our economy faces. Until this is adequately reflected in valuation, it would be foolish to chase these knee-jerk rallies.

Disclosure: The Rubbernecker is short moral hazard and the socialization of losses.

Friday, September 5, 2008

August Employment: The Good, The Bad, The Ugly

Another 84,000 jobs gone and another large jump in the unemployment rate -- this time from 5.7% to 6.1%. The auto industry was a big player last month, which is no surprise given the dismal car sales figures we've seen in recent months. Motor vehicles and parts manufacturers shed 39,000 jobs and dealers let go another 14,100. Rumor has is that to spur sales, GM, Chrysler, and Ford will soon be offering a free house with each car purchase. Also on the losing end of the employment report were employment services firms, which reported a decline of 53,400 jobs last month.

Those adding jobs in August include the government (go figure) at 17,000 jobs, educational services (16,300), hospitals (14,800), and social assistance (uh-oh) which added 11,200 jobs. Also of note, construction had its best showing in a while with a loss of only 8,000 jobs due to some resilience in the nonresidential arena which is unlikely to last.

These figures are bad enough on an absolute basis, and they were worse than the expected decline of 75,000 jobs. Worse still, June's figures were revised from a loss of 51,000 jobs to a loss of 100,000. Let's also not ignore the increase in the marginally attached. Per the Bureau of Labor Statistics release:

About 1.6 million persons (not seasonally adjusted) were marginally attached to the labor force in August, an increase of 275,000 over the past 12 months. These individuals wanted and were available for work and had looked for a job sometime in the prior 12 months. They were not counted as unemployed because they had not searched for work in the 4 weeks preceding the survey.
When we combine the unemployed with the marginally attached we come up with a rate of 10.7%, which is the highest in 14 years.

And, finally, let's turn to my personal favorite -- the Birth/Death model. (For a review of the Birth/Death model, see my article "Death, Taxes, and a Ridiculous Employment Report.") This go around, our government statisticians have come up with an increase of 125,000 jobs for August due to net firm births. This number makes no sense unless these are all recently laid-off folks starting up their own Ebay stores to sell off their ceramic unicorn collections to pay for gas for their SUVs. The fact that the birth/death model estimates that 9,000 financial jobs and 16,000 construction jobs were added last month should be proof enough of its absurdity.

Let's conservatively assume that there was no real job change per the birth/death model. That would mean that there were 209,000 nonfarm job losses in August instead of the reported 84,000.

Unfortunately, over the next few months, the employment figures are likely to suffer further as the last of the federal tax rebate checks are largely spent. In addition, the recent rebound in the value of the dollar coupled with increased economic weakness overseas will likely put the brakes on the recent export revival.

The good news is that if these trends continue long enough, US employment is certain to rebound as China and India will eventually start outsourcing their call centers and sock manufacturing business to us.

Disclosure: The Rubbernecker is short cutesy ceramic unicorns and sock manufacturing.