Goodnight Irene

"Sometimes I take a great notion to jump in a river and drown" sang Huddie Ledbetter in either an original or traditional ballad many years ago. Ken Kesey took note of Leadbelly's lyrics. Both nature and ourselves can be unpredicable.

By sheer coincidence I just last month had all of my trees trimmed, dead limbs out, and house overhangs removed. Of course that's no guarantee, but I can say goodnight Irene with the confidence that I did what I could.

I hope that all is well with any of you in Irene's path, and the power stays on. Hot beer and cold beans are not a desired diet.

Market in decline, positives, if any, and negatives

What was a rebounding market from March 2009 is now rivisiting the late 2008 and early 2009 crisis. It is more complicated than expected. Structural unemployment is endemic due to both technology advancement and to a lesser extent employment benefit fraud - do we need a real war like in 1941 to get people off their couches and into new locations to make money, me included maybe.

There are some positives that are obvious now that should not be overlooked:

---there are very few ways to get a return on money. Stocks, especially reliable dividend stocks, are a clear answer. Abandoning these opportunities in favor of treasuries is not a phenomenon that is long lasting. With recent market action, dividend yield on some great lasting companies are compelling.

---CNBC and other full time media market outlets go with the scare, and have had every known extreme bear highlighted in the past two weeks. Retail has been inundated with the negative. There is, hopefully from this point of view, just pure panic selling. Institutions pick and choose carefully the postions they reduce but overall they hold tight to their diversification mandates. Hedge funds are a question mark.

---Large U.S. corporates, with the exception of some exceptionally strong notable standouts, are generally in good shape with more than ample cash and strong capital positions. With the withering of the middle class and an uncertain regulatory and tax environment they are standing still. The absurd theatrics of the debt ceiling charade ruined any confidence in near term expansion.

---Every savvy investor knows that the rating agencies are second rate players in the capital markets. Unfortunately they are built into some credit agreements as functional components, at least for now and especially in Europe.


If those are the positives, they mostly affect the U.S. equity market's possibility for some revival in the next few months. The financials need to revive, and the viable consumer, now hurt by equity market contraction, needs to step back in. It's possible. Months move like years in the past.

The negatives are sort of daunting.


---U.S unemployment rates are not going away. Under-employment rates are not even counted in these numbers. While off the books work is vibrant, they do not include social security, health benefits, or any job security. The equity market does not necessarly need strong employment for growth, but with an equity market collapse and loss of consumer confidence the consumer spending that was compensating for the unemployment will decline, and that will slow growth and corporate earnings.

---Uncertainty about taxation and regulatory issues on all fronts is especially damaging to small business growth outside of the technology area. Inheritance tax uncertainty is a big issue rarely mentioned, but a really big issue for small business. Why grow to give gains to the government.

---Europe is a mess. Relatively responsible northern Europe, relative even to the U.S. by leaps and bounds, is willing to deal with chronically corrupt Greece and relatively poor Portugal, and they will somehow deal with their English speaking Irish counterparts who supported business development but mimicked the U.S. in their housing bubble, more so with foundling banks who build towers of towheads. The big question is whether German, French, and Dutch voters will form their own "tea party type groups" and reject support of the profligates in the Euro system. Italy and Spain should by any measure remain solvent but the bond vultures may try to take them down anyway, complicating everything and leading to a definite credit freeze up.

---Back in the good old U.S.A., states and municipalites are being forced to either downsize workers and avoid new hires in a way that offsets whatever headway the private sector is making. Longer term, this may be a good thing as municipal worker's collusion with corrupt politicans had led to a system where union dominated workers with limited schdules, significant overtime, and non-market rate pensions related to limited years of service could be called absurd. At the moment, however, these promises must be kept and workers are being reduced. Don't get me wrong, there are plenty of public servants who don't benefit from these mainly urban union contracts and are real mainstays, even heroes, in many communities. Many are even voluteers who with a little insurance, lunch meat, and a ping pong table may risk their health or even their lives for their communities.


As for me, I do believe we can get through all of this with a revival of business, a hiatus of business and banking bashing by the President and his administration, a development of Republican and Demcratic center groups of America and not a politics first mentality. That seems like a long shot now, but if things get worse...

Jackson Hole tomorrow. The Germans must laugh at that name. No real news expected here, because the concept of raising interest rates is off the table. That's the only real solution. Banks will not lend at any rate with such regulatory uncertainty and Congressional dysfunction. High yield debt is at a standsill. Small caps have no options except at the smallest community banks, many being closed by the FDIC.

Raising rates would rewards savers, i.e. retirees who saved their entire life, and would incent housing buyers and car buyers before there are any further increases. This is not 1937 and all historic comparisions are not the same. We don't want a war, we want a recovery.

Solid start, some promising revivals, but then the loss of key players and a slow decline by a still solid team with a hard working but inexperienced manager. With the exception of the manager, it sounds like my Long Island Mets.

The Rating Industry collapse into what should be obscurity

This happened in 2008 and 2009. A probably known writer to a recent ENS post asked "how the rating agencies could have believed that if you bundled high risk mortgage loans the bundle then would become AAA." My brief answer was that rating agencies drank the kool aid like most of the market, they were greedy and happy, and in fact rating agencies are mostly financial clerks who were not capable enough or aggressive enough to be hired at leading Wall Street firms. Decisions were made by a few at the top whose compensation benefitted.

There is more to the story that goes a few years back. It's built around a belief that diversification and a belief in satisfying investor preference in order to more efficiently distribute loan originations by the big banks was a good idea. A couple of JPMorgan folks, Demchek and Masters I think, came up with the idea. Instead of just offloading originations in bulk to correspondants in need they organized loan originations into diversified tranches, such that investment managers could both diversify their risk and choose their risk profile(even conservative loan and bond funds wanted some sliver of higher yield and higher risk components to their portfolio to diffentiate their returns).

So while at the time not subject to ratings, these loan baskets functioned well for the most part, especially for the distributors. Fund managers could load up on high rated securities and then dabble in highly diversified lower rated, or high yield, securities to augment their returns.

It was really a remarkable idea for the syndicated loan market.

The concept then migrated to the rated securities markets with some mixed results but so much of the high tech bubble was financed with private equity that there was not a significant warning sign in the early 2000's.

But then the tranche security market hit the mortgage market, and worked well in the early years. There were the 20% payers in the top tranche, then the so-called Alt-A's, then the real sub-primes, then the immigrant cash no-docs, and finally the PICS, meaning no pay but just add to principle. This was a perverse interpretation of the original concept of loan diversification.

It somehow worked for the rating agencies as housing prices soared and the agency financial clerks took notes.

Then the entire market imploded and all mortgage securities became illiquid to some degree, regardless of tranche heirarchy. Lesser tranches collapsed and went into foreclosure meaning loss of principle and interest. Servicing firms were overwhelmed and completley understaffed and under managed for the debacle.

An initial constructive idea for the loan market in the late '90's became perverted almost beyond belief, and a complete absense of a look at the macro environment created a cataclysm of losses for the financial system from which we will not recover for at least three more years.

That's my long answer, JR, to your ENS question. My answer may be flawed and simplistic to real market professionals in many ways, but there are grains of truth here that would never be found in the NYT or WPost, just in my opinion.

The really frighening thought is that we are once again focusing on the mechanics of financial solutions and not a macro picture. How can a mediterranean beach resort, olive oil producer, and country of super rich and hyper corrupt tanker owners destroy Europe. How many Americans have seen most of prosperous Europe's infrastucture which makes the U.S. look like some quait relic of the 1960's. How can an infantile politial squapple in this country derail the world?

As in 2008, the macro environment seems to be lost on the populace of the world's most prosperous country with ultimately the most potential to be a leader. We need an answer, and a new awareness. We need a global look at the world's potential and a return to the optimism as expressed in the ENS post of July 30th on the absurdity of a balanced budget amendment to the Constitution.

We may need some divine help, but self proclaimers are always charlatans.

This is not a defense of the rating agencies folly but merely a chronology of how Wall Street and the agencies perverted what was once a sound idea.

OR ...

As a follow up to the prior post, the or ... is it that we are entering a global recession. This will not be a Lehman based debacle or sub-prime mess. The word recesssion may not be adequate. Austerity everywhere will crush growth.

This should not happen. Corporations around the world are generally performing adequately if not quite well. Many balance sheets are loaded with cash. Unfortunately cash at the moment has no value except to be used to crowd the world with more organic expansion or to play pacman in a merger frenzy. This will lead to more efficiency perhaps, but also more concentration of wealth, more decimation of small business, and more pruning of workforces. Eventually these mega-corporates will have the power to make many products with the best of technology but unfortunately few buyers as the middle class disappears.

This may sound like science fiction, like some Kurt Vonnegut ironic nightmare. The resilience of ordinary human endeavor would be limited to communities of survival while titans ruled. Compliant politicians and corporate lackeys may benefit but the system as we know it can be changed, and would be even more of a shadow of democracy than it already is.

Gloomy stuff, but worth thinking about.

Volatility or ...

Is volatility an indicator of a leaderless society?

Recent radical volatility in financial markets, in political opinions, and maybe even in personal lives is not a healthy sign. How obvious is that statement.

It is a sign of no confidence. In a way it's a throwing in the towel by the general popualace. In a more sinister way it's perhaps a subconcious but still real manipulation of both finanical markets and political outcomes by an extremely privileged few for extracting ever more financial gains and political power.

This is the outcome of a vacuum of real political leadership, the kind of leadership that stands for principle and not solely self preservation and attention seeking. There's the Sarkozy Merkel tandem. Have co-CEO's ever worked. There's Obama's worthy and well worded but empty platitudes that leave nothing to grasp the imagination. There is a U.S. Congress that seems oblivious to the world scene. There's a reeling Japan. There's a United Kingdom doing its best to keep its own house in check and paying no attention to the global situation. And then there's the behemoth China, awash in funds with the U.S. still the haven and deathly afraid of political upheavel in their own country that makes economic distresss in the U.S. and elsewhere seem paltry.

Maybe some leaders in New Zealand, Switzerland, or Andorra make some sense but who knows and who cares. And only Michelle Bachman sees herself as having been anointed by God.

We can take it day by day and do our best to help ourselves and those around us. No leadership from traditional real powers seems to be forthcoming. No leader or leaders seem capable of galvanizing support for solutions. This is not only a concern. It could open the door to something more dangerous.

"It's not the heat, it's the stupidity"

The title is an ongoing quote from reporters covering the debt ceiling debate over the past few weeks in 100 degree swamp built Washington heat.

Moody's moody incompetence still reigns

It is baffling that the major rating agencies still are seen as being relevant. More than that they have once again become fundamental to the media and generic investors. These same agencies were thoroughly discredited during the '08/'09 financial crisis, yet they live on.

European countries seem to be hanging on these agencies every pronouncement. Having been stung by their incompetence in judging mortgage securities, the agencies are hyper-conservative, judging every sovereign in the shortest term possible and overlooking the residual strength of some major economies, notably Italy and Spain. They have reflexively become tools of the credit default swap market, and the bond vultures have the same backing that the sub-prime mortgage securities issuers had until 2008.

In the corporate market they have become provocative as well, in a completely destructive manner. Today Moody's put JPMorgan Chase and Bank of New York Mellon on negative watch for a ratings downgrade. These are two of the strongest capitalized as well as most profitible banking concerns in the U.S. The reason - since they received TARP money they are dependent on the U.S. government to avoid a default. That both banks were pressured to take TARP money and paid it back promptly is not stated.

Moody's, S&P, and Fitch are now in a race to see who can be the most defensive and the most sanguine in terms of short term events. Is that what rating agencies are for? Is the short term what there focus should be? That was never their mandate, but now it is their m.o.

In the 80's, 90's, and into 2003, when I was aware of these firms and had slight interactions, they were never viewed, even remotely, as having especially sharp people on the ratings side. Bizarrely, SEC rules lets rating agencies come into firms and receive confidential information that regular securities analysts have no access to, as if they are somehow the Fort Knox of corporate secrets. Companies just hand over their analysis to these folks, and the "analysts" type it up, and some senior person makes decisions. It's not much in the way of real research.

To digress further, I once worked on a banking team with a fellow business school graduate who dressed better than any of us and certainly looked the part. Unfortunately he just sat at this desk like a deer in headlights. He could not produce any work, and he could not communicate about anything other than social events. He was fired for good reason. His next stop, it was Moody's as an energy analyst. For some years he was successful there as they obviously just needed suits to fill places. I don't think that institutions change their cultures at anything other than a glacial pace unless they are shaken up by mergers or radical management change. My guess it that the Moody's that I knew is the same lightweight place with a few senior managers calling the shots to save the franchise.

One could say that these firms should have gone down with WAMU, Bear, Lehman, and Countrywide. Somehow they live on, and they are complicit now in undermining market confidence and any hints of optimism.

Economy weakens in wake of two months of political chaos

With Treasuries a safe haven again and more data that shows continued weakening of the economy, stocks continued their sell-off today with an afternoon collapse. Did the politicians think that they could terrorize the financial markets for two months and then, with a mangled compromise, step out into the cheers of an appreciative nation and adoring investors?

During the final month or more of this embarrassing display of bipartisan political petulance, businesses have been on hold. Hiring slowed generally, or stopped in small businesses, and new investment and borrowing decisions were put on hold as the coming state of the credit markets became more and more opaque. M&A activity presented a facade of real financial market activity and benefits for some stockholders, investment bankers, and private equity firms, but one must remember that M&A activity is often about cutting overlapping functions or, in other words, eliminating jobs.

Recovering from this slowdown in most productive business activity, otherwise known as growth, will not come overnight. There is now still the nagging issue of the rating agencies and how they view U.S. Treasury obligations. There is the overhang now of where $1.2 trillion in future committed spending cuts will from and how that will impact the consumer. There are foreign trade deals still held hostage and a $1 billion Boeing plant in South Carolina idled. There are state governments which fear, with good reason, reductions in Federal outlays that had been expected.

As the debt ceiling and budget balancing discussion dominated Congress, progress on other fronts stopped. At a time when the U.S. Congress could have set a positive example to other countries, especially at the moment European ones, it demonstrated almost unprecedented dysfunction.

There is now, I would guess, a 50% chance that we will be back in a recession by January. I sure hope not.