Friday, October 31, 2008

Government equity stakes in banks already a disaster in the making

The government's $700 billion package to rescue the financial system included, as a Democratic Party prerequisite, the right for the Federal government to take equity stakes in banks in exchange for investments in the banks. These investments could have been super senior debt, but instead gave equity rights. Several posts here in September suggested that this was a bad idea.

Treasury's approach to the infusion of cash into banks has often been to require it, as in the case of JP Morgan Chase which did not need or want the government's money as they could raise money in the private markets if they needed it. Regional banks across the country are being arm twisted into taking the Fed money so that it looks like they are willing participants in the government's mandate to create credit liquidity.

Now the attack on the banking system is already underway, from Barney Frank and Nancy Pelosi, and AG's like Cuomo and Galvin, and countless other irate politicos and pundits, as they call for control of the banking systems dividend policies, merger and acquisition moves, compensation systems, and credit risk management decisions. As Barney Frank said today, banks who accepted these funds must conform their "bonuses, severance payments, dividends, acquisitions, etc." to what is required under the rescue plan. The "etc." is the worst part of that comment. Frank is essentially saying that for a relatively small non-voting, yes they are non-voting, equity stake the Federal government now has substantive managerial oversight of any bank in this plan whether they wanted the money or not.

Certainly banks who receive the money are to a large extent obligated to use it to shore up their balance sheets and therefore the free market will begin to allocate liquidity and funding to the those firms and the industry. From that, lending will begin to flow. That's the point. The point is not that the banks segregate the government infusion money and lend it out on some 19th banking system ledger. Certainly too, if some banks act irresponsibly it's the job of the Federal Reserve or the OCC to regulate them as always. Congressional Democrats are now actually saying that the "American people" are owners of these banks and have a right to hold them accountable for management decisions.

This is all so misguided, stupid, and political that further comment is impossible.

Thursday, October 30, 2008

Why no posts for ten days...

There are three kinds of people in this world, people who make things happens, people who watch things happen, and people like me, who wonder what's happening.

That's an old line that can still get a laugh at the right time and place even if it's a rerun. Unfortunately it now doesn't feel like a joke. Could that be why there's been a ten day lapse here.

Of course there is the fact that I was traveling for a week and after a couple of days was busy being someplace else, plus in a land with almost no wireless available, small town southern Virginia. Returning meant catching up on things here. Then the ante is raised after so many days of not saying anything and the thought creeps in that whatever is said now must be meaningful. It can't be just some random observation, some shoot from the hip guess. The pressure grows.

Or could it be that these global financial markets have gone outside of the spectrum of my understanding. My head is rattled, thinking of that Sonny Boy Williamson refrain, "whole lotta people talkin', mighty few people who know". Why would I add to that.

Then there's the election, the face-off between the searchingly earnest Obama campaign and the Pythonesque McCain/Palin attacks, Obama trying to keep the momentum going just six more days against an onslaught of absurdity that is meant to make people in general sick of politics, sick enough so that they stay home.

Can my mental gridlock be broken. Does this do it.

Monday, October 20, 2008

Sick competition overlays current market

The oligopolies of Wall Street and the "hedge fund industry" look just as such from afar, with their pricing in lockstep for most products or investment opportunities. Beneath that they are vicious competitors. On the old Wall Street there were no more hated competitors than Goldman Sachs and Morgan Stanley. Believe me, little guy caught between the two, it was real and painful, but they were corporate citizens. With hedge funds the gloves are completely off. These are folks with no connection to any community, no employee plans, no moral compass whatsover, and now in this market disruption they are preying on each other. They are networked into clans, and if they see someone outside of their clan in trouble they short, short , short those stocks owned by the hedge fund in trouble. They are vicious and there is no honor in their game. I will say no more for fear of venturing into the world of the pc crowd, which I actually subscribe to. That said, they are repulsive folks.

The lesson for now seems to be, if a great mid cap stock is going down for no reason, don't buy it yet seems to be the rule. Some hedge fund is getting run out of the stock by competitors and it will be a better buy later. Ugly stuff, but better than listenting to McCain.

Friday, October 17, 2008

Why is building fewer new houses bad?

Much was made today of the significantly lower numbers reported related to new housing starts and new house building permits. The CNBC talkers and their guests seemed to be unanimous in their opinion that this was a bad thing and pointed to a more protracted recession than they had expected.

Why is lower housing starts bad. Isn't this the way the economy is supposed to work. We have a glut of unsold new homes and unsold used homes on the market today in the U.S. Isn't it is a good thing that more new houses are not going to be added to this inventory.

The commentators discussed the impact on construction jobs and housing material companies and all other offshoots of the residential construction business and they are absolutely right, it will have an impact. But that must happen in order for the problem to eventually be corrected. Even the carmakers know that if they aren't selling the cars they build they need to cut back on production.

Lower housing starts is good news for the long term, and even for the short term from an investing perspective.

Wednesday, October 15, 2008

No results yet???

Immediately there is skepticism about the government's action to infuse banks with capital. The print and television analysts are already looking for results. As one headline says this morning, "Paulsen has no gun to put at bankers' heads". Hmm, are the bankers at JPM, for example, supposed to go up to the 50th floor and throw $25 billion off the roof down to Park Avenue tomorrow. Would that be quick enough.

The only thing that this plan can do in one day or one week is to begin building some confidence in the banking system such that short term spreads in the interbank markets begin to tighten slightly and liquidity increases on the margin.

This whole process will be really slow even if it works because:
---Securitization markets have been destroyed so the multiplier effect of banks lending and then distributing the risk to global investors, pension funds, mutual funds etc. barely exists. The impact of lending and then being able to immediately reload and keep firing is only available now in the absolute highest credit quality pools of assets with above average returns.
---Equity investors have been blown away, so access to the capital to build corporate balance sheets so that they are more reliably attractive to lenders is going to be a slow slow process. Retail equity investors are gone for a year or two almost certainly. That pulls a foundation out from under the hedge fund and institutional investors, so as they heal their wounds they will see less opportunity to get back in.
---Banks will be wary of keeping all of the risk on their balance sheets for the credit expansion that is needed. They can't possibly do that anymore, and believe it or not they have memories. Remember the 1980's, a time when the concept of bank loan distribution was in its infancy and the bond market was just coming out of its coupon clipping era. The banks ended up with massive amounts of Latin American debt, LBO loans, and commerical real estate loans on their books. When that trifecta of trouble hit because the major banks kept most of it on their balance sheets, that was the last real recession. Major banks had capital ratios of 3% and some like Citibank traded at a hat size. Banks can start lending among themselves and slowly help build the markets back up, but going back to just another bad model ain't gonna happen.
---Setting up these rescue plans with bank equity ownership and heightened regulatory oversight hopefully makes sense, but because of the political season it makes the market very uncertain. With the strong possibility of a Democratic president and Congress in January, the question for investors and managements becomes "how will this be managed?" Could it become more aggressive, and less constructive for an efficient capital market, than Paulsen or Geither said. The markets hate uncertainty and the timing of this is not helpful regardless of what one thinks about the outcome on November 4.

The media needs to agitate us it seems, but a little patience is the only way out.

Tuesday, October 14, 2008

Conventional Wisdom

The consensus view at the moment seems to be that the coordinated global support of the banking systems will at least stop the bleeding and begin to slowly encourage the reopening of the credit markets. The other part of today's conventional wisdom is that a recession of a depth that we haven't seen in 18 years is almost certain now in the U.S., and a global downturn of varying degrees is already in the cards as well. Makes sense, right.

The problem is that conventional wisdom has been so dramatically wrong at almost every turn since this all began in earnest in August 2007. So what if this infusion of capital doesn't work, that confidence has been so broken that markets stay at well below normal activity levels. It seems that anything is possible until this plays out further. On the other hand what if this panic and the resonance of the bear case has been overdone, and that the U.S. economy, the Asian economies, and the major emerging market economies are not nearly as badly off as advertised. What if this has been mainly a banking crisis and commercial and industrial companies, while in for a downturn, are in fact fairly strong and will get through this ok within the next six to nine months.

I certainly don't know.

Thursday, October 09, 2008

Dana Perino and George Bush

Dana Perino has assured us that George Bush will comment on the economy tomorrow. It's as if Sarah Palin is already in power. Limited education and limited experience but good looks add up to being a spokesperson for ultimate power. No one, even his supporters, thinks that George Bush has the slightest clue about what's going on. It is likely that no one thinks that Dana Perino knows anything about anything except how to put sentences together in public.

Being a part of history

Participating in fast paced history is generally not a good thing. That kind of history is made of wars, collapses, and horrific environmental events. Participating in slow paced history like the advance in global prosperity since WWII is accepted and appreciated, but it is not an immediate event. We are in the midst of a major historical event. If that is an exaggeration, it's not much of one given what's already happened.

The paper money paradigm is under siege. Does anyone dare say that.

The power of billionaires in the U.S., Russia, China, Australia, Hong Kong, and other nations has created a class that is now immune from whatever happens. As Ray Nagin said when Ike approached New Orleans, paraphrasing slightly, "most people are evacuating, but some folks in the Garden District, they have built up their houses since Katrina, they have their own power systems, they have stored food, they even have their own security forces, and if need be they have evacuation helicopters that will come. I don't worry about them."

Assageague Island in 1971 on the day of a total eclipse of the sun was the most powerful positive immediate participation in history that I have been lucky enough to see, or not really see except on the unbelievable horizon, sort of a neanderthal experience. Today's history is just as primal.

Monday, October 06, 2008

$60 trillion? someone help!

New know it all folks like Steve Kroft of 60 Minutes like to report that the credit default swap market is between $50 and $60 trillion, maybe much higher. We know that he has no idea what he's talking about, but what is he quoting? He said that it was from the only published reports available, an aggregate from the firms dealing in the swaps. A few thoughts:
---That's the notional value, which does not eliminate offsetting collateral
---Since this would be at at least 30 times the entire U.S. sub prime mortgage debt outstanding, is this suggesting that multiple naked bets against subprime debt were allowed to be made without collateral? That should be impossible, and is highly unlikely.
---Is a large portion of this credit default swap market written against corporate debt unrelated to the mortgage market, mostly as a hedge in stable value type money funds or short term bond funds?
---Or, do these giant numbers being quoted encompass the entire credit derivatives market?, which is far broader than the credit default swap market. The majority, likely the great majority, of credit derivatives are simply creating pools of bonds or loans, and mostly bank loans, and dividing them into strips of ratings and return so investors can reliably tune up their investment diversification. For example, take a large pool of banks loans that are not so marketable as individual credit risk, and cut this pool into AA or above, triple B and A's, double BB's and below investment grade. These tiers will obviously have different return characteristics and fund investors could calibrate their investment risk by choosing to invest in various tiers based on risk and return required by their investment criteria. This is, in the realm of derivatives, pretty plain vanilla stuff and it helps spread risk and build credit market liquidity. If these are being included in the figures being thrown around as the credit default swap market then it is a wild exaggeration.
---Is it even possible that the credit default swap market could be even a quarter of the numbers being thrown around by the talking suits on television? If it is, someone please clue me in.

Politicized house hearing today

The House Committee on Oversight and Government Reform is holding hearings today on the financial crisis in which they will unmercifully attack Lehman CEO Dick Fuld. The tone was set at the outset by Chairman Henry Waxman whose opening remarks were a litany of blame with no balance whatsoever. He had no suggestions and no recognition of the fact that the Democrats in general were the most aggressive supporters of the expansion of home lending, even mandating that the GSE's, Fannie and Freddie, seek out loans from home buyers who were unqualified for conventional loans. In Rep. Waxman's view the focus now is blame and channeling resentment into political gain and enhancing his own reputation. In a market as fragile as this one, and broken may be a better word than fragile, Rep. Waxman's approach is pretty much like throwing kerosene on a fire.

The ranking Republican member of the committee also was allowed to make opening remarks following Waxman. Rep. Tom Davis of Virginia had comments that were thoughtful, balanced, and constructive. He did not defend "either side of the aisle or either chamber" in some of the wrong headed decisions of the past decade such as the unleashing of the GSE's into new territory. He cautioned that words had power, in contributing to the radical and swift declines of companies and "in what we say today". He came across as a moderate with an understanding of markets and finance that is uncharacteristic for a member of Congress.

Now I assume as I write this that the examination of Mr. Fuld is underway. He is without question representative of the ethos of Wall Street during the last ten years that is now under attack. He stubbornly waited until too late to recognize and believe that his company could possibly go down. Without question he desperately wanted to save it, and today he will be set up by Waxman for eventual criminal prosecution.

The markets are ugly enough and this show will be just as bad.

Friday, October 03, 2008

Biden the big winner

From this perspective, Senator Biden was the big winner of last night's vice presidential debate at Washington University in St. Louis(a college that derives major financial support from yours truly, and it's money well spent). Biden handled himself well, came off as the knowledgeable and experienced foreign affairs hand that he is, and didn't do anything that could be seen as being unpleasant to the hapless Sarah Palin. Palin showed that she is not a complete blinking idiot by memorizing all of her lines well and handling the seques in the debate with ease even as she ignored some of the questions. Good for her, as we certainly don't want to continue being the laughingstock of the world.

Wells Fargo is the right buyer

Wells Fargo's bid for Wachovia is in the best interests of the U.S. financial system. Well's business is branch banking for consumers and small businesses and they are unequivocally among the best at this business among large banks. Wachovia was once part of that upper tier until Ken Thompson's disasterous acquisitions. Citibank is run by investment bankers who want the deposit base of an expanded retail bank, but they have limited talent to run the business. Their New York branch banking system is a shoddy, under invested outfit despite being, by legacy, one of the market leaders and their U.S. technology is standard at best, sub-par by some measures. Their call system for branch banking, even in mid-day, is routed to India which leads to bizarre conversations(are you a gold customer or a silver customer sir?) and of course just protocol reading by the representatives, no real human interaction.

Wells Fargo would maximize Wachovia's potential and more importantly assure that the communities it serves in its southeastern home territories would be well served, in a way that inspires confidence in our financial system. Go Wells Fargo.

Thursday, October 02, 2008

Hedge fund equity sell-off

There seems to be a significant sell-off underway in mid-cap and small-cap stocks owned and nurtured by hedge funds. These are for the most part industrial, energy, and infrastructure play stocks, most with decent balance sheets and with no finance components. Some that are followed here are down 35% or more this week. The hedge funds basis in these types of stocks was almost always well below the price of these stocks at the beginning of the week. They may be approaching break even on most by now.

This is a dramatic unwinding, suggesting that we're not done yet with this market decline. Whether this sell-off is based on a point of view on the equity markets or just on a need to liquidate for redemptions is an interesting question, but perhaps not a meaningful one.

Wednesday, October 01, 2008

Those two CNBC women

While waiting, with a break in the action, here's a major kudo for Maria Bartiromo. If anyone else saw her on Monday night, on a CNBC panel discussing the crisis given the House turndown of the financial package, you couldn't help but agree that she was brilliant. Eschewing the usual make-up and total do look, she unequivocally laid out the reasons for the public's view that the package was "bailing out Wall Street" while explaining intelligently and in a uniquely unpatronizing way why they were wrong. It was the coat check girl at her parent's Bay Ridge restaurant just giving it her emotion and best thoughts. Like I said, it was brilliant, a side of MB that we rarely see, but she's not only a pistol, not only the "money honey", she is passionately smart.

Contrast that with the new female star of CNBC, Erin Burnett. This jockette seems to think that she can get by on quips and elbows to the side of guys. She's no doubt normal smart, but she is routine, but now being groomed to gain a starring role based on her establishment approved Williams background. Listen to her, she has no depth, just the quips and the shrugs when she says something stupid, Sarah Palin-like.

Waiting for the denouement

If some financial package passes the Senate tonight and then can gain the acquiescense of the House by the end of the week there will be relief but not too much benefit at this point. The benefit will be some attempt at stability in the near term. Any move now by the U.S. is too late to reassure the European financial system which is in its own meltdown phase now and too late to prevent the erosion in confidence from spreading beyond the U.S. financial system into the industrial economy. Congress passed on their chance to show leadership, and now can just show some savvy janitorial services to keep the pipes flowing.