Political Pandering

Well, it seems that Barney Frank has no more brains than Barney the Dinosaur. According to Housingwire, they demanded TARP funds back from Northern Trust. Apparently, Northern Trust sponsored a lavish golf event. Unlike money-losing banks like Citigroup, Northern Trust was profitable in 2008. My guess is that they were force-fed the $1.5 billion in TARP that they received.

There are so many good companies real cheap out there: DIS, FWLR, SDRL, TOL, but with political hacks like these running the show, it makes me even more bearish.

Bernanke's latest speech was a disaster. The plan is to take "Ownership Stakes Only as Losses Rise."

Translation: the banks are dead zombies and we don't know how big the losses are. If we knew, we wouldn't want to admit it. Therefore, we will keep them on life support. Whenever they keel over and flatline again, we will give them another transfusion.

Keeping comatose banks alive at great cost is a disaster. The time has come to admit the losses, wipe out the shareholders, give failed management the boot, turn the debt into new equity, and inject enough capital to make the banks healthy again.

There are some problems, as there always are. First, many institutional debtholders aren't allowed to hold equity, and would have to sell. I say, better get something to sell than try to recover through bankruptcy, or suffer the fickleness of the government. The second problem, as personified in Bernanke, is that there is no political will to admit the size of the problem and fix it. No nationalization, my ass! The banks have been 70-90% nationalized anyway. Or maybe Bernanke doesn't understand the problem....

"We're not making it up, Bernanke told the House Financial Services panel. We're working along a program that has been applied in various contexts. We're not completely in the dark." - Marketwatch

Treasur - ies

Yesterday's auction of $40 billion in one year notes was a great success. People keep saying that there isn't enough demand for Treasuries. They say there's too much supply. However, if we look at the auction numbers, there's no problem at all. Bid to cover was 2.6 times, greater than the average of 2.3X over the last ten auctions. Foreign demand was strong as well, taking 28% of the issue.

If the auctions the rest of this week are successful, it will show that the Treasury can raise $100 bil at the drop of a hat. That means that they can finance a $1.5 trillion deficit easily. That's only $30 bil per week. (Only!)

Black Hole

AIG is a black hole for taxpayer money. Bloomberg has an update.

American International Group Inc. may scrap a plan to repay a $60 billion U.S. government loan by selling businesses, after failing to find enough promising bidders

Translation: AIG is going to stick taxpayers with a $60,000,000,000 loss. And what is a "promising" bidder. They're looking for suckers, not bidders. No one will touch AIG toxic assets with a ten-foot pole.

AIG is proposing additional ways to reduce the company’s debt to the U.S., including handing over stakes in some operations directly to the government

Translation: if we sell the assets, we will have price discovery of the losses. If we just hand it over, we can all hide the losses from the people.

AIG is also in talks about converting the government’s preferred shares, valued at about $40 billion, to common stock, which would reduce pressure on the company’s cash flow, a person with knowledge of that plan said yesterday. The preferred shares pay a 10 percent dividend, while the common pay none

Translation: not only is AIG insolvent, they are practically out of cash as well. They can't afford to pay the dividend on the preferred stock.

Downgrades by Moody’s Investors Service and Standard & Poor’s may force AIG to post more than $7 billion in collateral to counterparties, the insurer said in a November filing. AIG’s units could also lose access to the federal commercial paper program if they are downgraded

Translation: AIG is a black hole. With a trillion dollar plus balance sheet, the oncoming additional losses could easily triple or quadruple to $400-600 billion from the current $150.

However, there is no political will to acknowledge losses, and either nationalize these companies once and for all, or let them fail a la WaMu.

In my opinion, WaMu is a success, while Lehman is not. Bankruptcy is too disruptive to the system. However, as long as there is no political will to face the reality of current and growing losses, we will have more and more AIG's in the future.

Trade

Bought 5% position in NG.

I think this pullback is an opportunity.

Baby Steps.

I'm trying to take baby steps here. Right now, I'm seeing the gold miners get clobbered, while gold has retreated to $985. NG is down 15% and reports earnings later today. They're down 40% from their recent highs. I'm really tempted to put 5% in at $2.50.

Another development is the recent strength of the dollar against the Yen. This could become a new trend as the market realizes that Japan's economy is completely dependent on our consumer. With consumer confidence hitting a new low of 25, (yes, 25) this could have a long way to run. I could short the Yen here. The dollar strength is very good for my Treasuries, though, and I already have a 100% position here. The volatility in Treasuries is making me nervous, as well as the hidden supply that keeps coming from selloffs in foreign reserves such as Russia and S. Korea. On the other hand, all the money the Fed loans to banks goes right into Treasuries and back to the Fed.

According to this blog, Chinese commercial real estate is now imploding. In Shanghai, they built the entire island of Manhattan's worth of 20%+ empty skyscrapers. This is a fourteen year supply (at peak demand rate of 2007). And we know what real estate collapses do to bank balance sheets.

Analyzing debt loaded companyies, Or should I buy KBH?

KBH has a market cap of $684 million at the current $8.79. Last quarter, they managed to come up with $300 million in cash flow. This looks cheap compared to market cap. However, if we look at the balance sheet, we see some huge problems.
Although cash flow was large, liabilities were only reduced by $30 million. However, assets fell by $340 million. In other words, asset selloffs of $340 million produced cash flow of $300 and reduced debt by $30. If assets are falling faster than liabilities, then equity must shrink. The long term trend shows this more clearly: over the last four quarters, assets fell by $1.1 billion, and liabilities only fell by $0.3 billion.

However, I will close this position today. First, it's a huge down day, and the foreclosure prevention plans and stimulus packages have been a big bust for homebuilder hope. It's time to buy the dip. I will sell the next rally. Second, at under 3.5% of my portfolio, it's time to close the position or short more.

Trade: buy to cover KBH @ $9.30 *the market recovered almost 200 points, but I decided to take some of my chips off the table anyway. I'm not happy about losing $80 writing this blog, but I don't want to be penny-wise, pound-foolish greedy either.

+38% on this

In other news, gold hits $1,000. David Rosenberg from ML reports that "Global
buying of gold bars and coins in 4Q reached 148.5 tons – an 811% surge from a
year ago." Since the end of last month, when the Chinese finance minister reiterated his intention to keep buying U.S. Treasuries because gold was the only other (dismissed as ridiculous) option I've been of the belief that consumer buying of gold as a safe haven against currency devaluation is greater outside of the U.S. than in it. In fact, I believe that this is precisely what is causing the curious phenomenon of gold rising along with the dollar.

I think it's time for another trade as Germany finally addresses the economic troubles of its neighbors. "German Finance Minister Peer Steinbrueck became the first senior policy maker to broach the topic this week, saying some of the 16 euro nations are “getting into difficulties” and may need help (Bloomberg)."

Time to sell EUO.

Trade: sell EUO @ $24.37. *I wanted $25 for this, but ultrashorts are craxy. One thing I noticed was that this is listed as "hard to borrow" on Schwab, which means I should go back in soon and hope for a short squeeze, if it doesn't happen now that I've sold it.

+ 12% here.

Forgetfulness

The CBOT estimates the output gap, which is the gap between savings plus debt repayment and borrowing, to be $2.5 trillion. The stimulus is $800 billion. Which means it's too small. Also, one of the things we learned from Japan is that the multiplier effect is very small. As soon as the stimulus is removed, the economy plunges back into recession.

Forgetfullness?

What does that mean? Well, one of the things I've noticed is that I haven't heard about the Iraq War for maybe three months now. Three months ago, there was this daily mantra of "The Iraq War has cost us $2,000,000,000,000 (trillion)." What was this $2 trillion, but a fiscal stimulus of the economy? Granted, some of that stimulated the Iraqi economy, but most of it went through U.S. contractors, such as Halliburton or Blackwater, or any of the defense companies. But now we have a new plan.

So, how does the stimulus play out? First of all, it may very well bump up GDP (or at least put a floor under it) in the second half of this year, and possibly through next year. Even President Bush's measly $600 tax rebate checks bumped the economy up from a negative Q1 in 2008. However, the economy will wilt as soon as the stimulus is withdrawn. The question, then, is what will the unintended consequences or side effects be? One that popular opinion increasingly predicts is that the Treasury won't be able to borrow the money for the stimulus without pushing up Treasury yields. Since the U.S. is a trade deficit nation, this may be the case. It may well be impossible to finance both the trade deficit and the government budget deficit. Policy makers will most certainly choose protectionist measures to close the trade deficit if this becomes a problem. This makes me even more bearish on the rest of the world.

And now for the worst of it: S&P 500 earnings are coming in at NEGATIVE 9.00, according to David Rosenberg at ML. Earnings for the year will be about $28. And the S&P 500 is at 793.... hmmm...

Well, what to do with this info. First, I'd like to take some profits off the table, as it may be hard for the news to get worse in the short term. Second, this news is extremely deflationary, notwithstanding the stimulus. So, this points towards Treasury bonds, especially since at 3.5%, they're up almost 1% off the lows. Strength in the dollar will more than compensate for low yields and attract overseas investors. Some of the stimulus will go to savings and be recycled into Treasuries. The trade deficit is still at $40 billion/year. And finally, if the S&P 500 decided to go to a reasonable 12X operating earnings, we get 660, which will chase more retail investors into bonds. In Japan, individual investors learned the lessons of the Heisei bubble and now put their money in the bank, even though it earns nothing.

Trades:

Well, this bit of news seals the deal: Oil for December 2009 delivery: -$3.46 to $49.06. Deflation here we come. I'm going to buy a 70% position in 30-year Treasuries for maximum leverage of 100% of equity (with my current 30% position).

Oh, and there's more: state governments will eat $141 billion of the Stimulus. However, that doesn't cover the $350,000,000,000 (billion) budget deficit through 2011. The stimulus keeps shrinking and shrinking, in my opinion. States will cut spending and raise taxes - the anti-stimulus effect at work.

I was looking at taking a profit in OZN today, but it's still too cheap. The ore costs $600 to get out of the ground, but it's only $86/oz. in the ground. Cheap! ABX is at $266 in the ground + $415 mining costs = $681. IAG is at $320+$550, but they have vast resources at $700 in mining costs that are not included in reserves. These cost $130/oz in the ground, and you get them for free at the $320+550 calculation.

One trade today: bought 70% position in 3.5% 30-year U.S. Treasury due Feb. 15, 2039.

Trade

Bought a 10% position in ABX today.

Here are my reasons:

1. I like gold. Why Barrick?
2. Mines in US and Canada - don't have to worry about dictators nationalizing mines
3. Strongest return on equity I could find in peer group - 12%
4. Management started the company from scratch and built it into the world leader.

Priceless

Sell Everything!

Geithner has just unveiled his stimulus plan. It is a $1.5 trillion stimulus. Oh, really? The first part of stimulus is for the Fed to resurrect some as yet unnamed (by the AP) but unused plan. Excuse me, but if it was unused up to now, how good could it be? How stupid does Geithner think we are? And this is supposed to be a "new" plan? Unbelievable! I'm starting to think I could do better. In fact anyone with some common sense could do better. Well, I guess if the Fed's resurrecting some dustbin solution, then Bernanke's in on this as well. The AP story on Yahoo! has already changed, so I won't give a link here. However, the earlier version - never mind. It's been taken down, so it's probably not true anyway. Here's what I'm getting from the Federal Reserve Press Office. The plan is to resurrect the TALF, and lend to holders of AAA securities backed by "newly and recently originated auto loans, credit card loans, student loans, and SBA-guaranteed small business loans." This will be funded by the Treasury with part of the TARP 2 funds. I'm jumping to conclusions from the Fox article, but it appears to me that this fund will increase TALF from $20 to a measly $100 billion. However, it's expected to have a multiplier effect on the economy of $1 trillion. Hogwash! The problem is lack of demand for loans! Consumer credit is contracting. The savings rate is increasing. Companies are laying off employees. If they're laying off people, I guarantee you, they're not borrowing money to expand.

This part of the plan is a total ZERO.

The second part of his plan is to use the remaining TARP funds to convince investors to buy bad assets from banks.

“We are exploring a range of different structures for this program, and will seek input from market participants and the public as we design it,” Geithner said in prepared remarks for a speech today in Washington.
“We believe this program should ultimately provide up to $1 trillion in
financing capacity, but we plan to start it on a scale of $500 billion, and
expand it based on what works.” (Bloomberg)

This is not a plan because in a case like this, the plan IS the details. So, we have two possibilities here: either Geithner is a fool, or Obama is lying about "transparency." Where's the transparency when the detail aren't revealed?

FOXnews calls this "TARP 2":

Within TARP 2, as it is called, the Treasury plans to purchase between $250 billion and $500 billion in toxic bank assets under a "legacy asset program," which Treasury officials told House members could grow to $1 trillion, a House source said. The program would be launched in partnership with the Fed and the Federal Deposit Insurance Corp., the source said, "to leverage the capacity of the public sector."

This part may be slightly better than the first part of the plan. However, the only way for the Treasury to encourage private investors would be for them to guarantee large profits for the investors. Maybe that's the point.

Did I say sell everything? The market seems to agree. It's down 300 points, since I started this post. This plan has been so hyped and so meaningless I will not be surprised to see it fall much further.

********************

And this news is just too bad to pass up: Wholesale inventories plunge by most in 16 years. Inventories plunged 1.6% in December. Here's the meat of the article:

Despite the sharp cut in inventories, sales are falling even faster, which means it is taking longer for distributors to sell their goods.

The inventories-to-sales ratio rose to 1.27 in December, up from 1.24 in the previous month. The ratio measures how many months it would take to
clear inventories at the current sales pace. The ratio is at its highest level
since March 2002.

Yup, we are clearly in a deflationary spiral, and we have an incompetent government that doesn't even understand what's going on.

time to buy Dryships?

David White give a great reason: he believes that DRYS will spin off their RIG holdings before diluting the company's equity base by selling up to $500 million in new equity.

There are two other strong reasons: first of all, companies that survive near-death experiences tend to come out stronger than ever. Second, the Baltic Dry Index is finally bouncing back to profitable levels.

Sudden Debt has a great blog post today. He explains why many AAA 'super senior' MBS bonds may even have a negative real value. His suggestion is that the government guarantee a price of $0. But I don't think that Geithner has this in mind. So, what are the implications of the Treasury giving free put options to investors who buy depressed loans from banks? This will obviously increase the value of bank shares, MBS, CDO's, and anything else that is subsidized. But what will decrease in value? How do you hedge against these assets? These are the questions I need to answer. A possible implication would involve a redistribution of institutional money from "good" MBS with no guarantee to "bad" MBS with a guarantee. This might push up mortgage rates. The best way to hedge would be to lower the price below the government guarantee. This may or may not involve collusion between buyers and sellers at the expense of the Treasury.

And Merrill's Rosenberg says it's time to buy 30-yr. Treasuries again, based on collapse in demand for credit.

Credit contraction has continued into 2009

Meanwhile, we can see below that the contraction in credit (is it supply,
or supply AND demand?) has continued into 2009 – bank credit declined $55 billion in the week ending January 28th on top of a $40 billion slide the week before. So far this year, bank credit outstanding has plunged at an 18% annual rate and by a record 11% on a 13-week basis. Not exactly an
environment conducive to a sustained increase in bond yields.

Let's see, $50 bil./wk comes to a $2.5 trillion annual rate. Is the stimulus enough? Is it too much? Will it sink Treasuries and possibly the dollar as well?

Hard to tell. I'd like to pick up some DRYS here at about $6.50. If the market recovers, they'll probably beat it by a mile. I'm going to think about this some more.

Confused

The market's up 223 points while I'm writing this, completely ignoring a payroll report showing -600k jobs and unemployment up to 7.6%. Everyone wants to be in the market over the weekend, as the Senate says they'll pass something tonight, and Geithner is supposed to announce the "big bang" bailout on Monday.

Now I've laughed through much bigger losses before. What's different today is that I can see what's happening now, namely, good news and expectations of good news. The Baltic Dry Index is up again. US Steel +11%, CLF +14%, the moves are enormous. What is different is that I don't have a clear picture of the future to compete with my sense of the current market.

Part of me wants to be contrarian and short the market more just because expectations for Monday are probably too high. The other part of me says that when you can't see, you should slow down, which would entail taking a loss on SDS, for example.

I need to get a read on the long term, and if I don't I will need to make decisions very quickly, and try to adjust my strategy to a much shorter term.

The biggest questions I have are: Is the bailout enough, and what will the side effects be?

How things REALLY work in China!

It appears that upsurge in bank lending China reported in Janruary is a sham. Here are two phenomenal examples from Michael Pettis on SeekingAlpha.

There are persistent rumors that part of the increase in bank lending consisted of putting back on balance sheet loans that were taken off balance sheets in 2007 and 2008 when the PBoC was trying to constrain bank lending. It isn’t really new credit.

Brilliant! Bring bad loans back on the books, and Voila! more lending! It's a good thing I don't live in China. The temptation to cheat would be very high. This next one's even better:

there is clearly an increase in lending games aimed at making policymakers happy by showing fat loan books. One of my students just visited me today with an example that involved his father. I don’t want to get into too much detail, for obvious reasons, but the net effect of the transaction involving his father was that an entity was created to borrow money from a bank, the proceeds of which were deposited in a CD, which was then assigned in
ownership to the real borrowing entity, which then used the CD as collateral for the “real” loan. Aside from the complications used probably to get around credit restrictions, one single loan was recorded as two loans plus a CD deposit.

Awesome! Money gets put in a CD and is called a doubling of credit. Sounds like someone in China deserves a promotion for this brilliant thinking.

Trade!

Closed short position in COF @ $14.47, for +67% profit.

COF was only 1% of my portfolio. At this point, it was time to close it or short more.
Although I believe they'll take at least $3 billion in losses this year, they've fallen to a 52 week low, as well as 25% since announcing a loss last quarter.

I admit to confustion

Right now, I am confused about the market's direction. Today, at least, the bad news was focused mainly on unemployment which is primarily a backward looking indicator, despite the fact that layoff announcements happen prior to the fact.

The ISM service sector data showed continuing decline, but with a better than expected reading, showing a slowdown in the steepness of the decline.

Here are a few of the interesting stories out there. First of all, more vehicles were sold in China than the US in December. This begs the question, "is China's economy as bad as I think it is?" Has the US market been beaten down much more than is warranted? Lending by Chinese banks reportedly surged in January. The loans were for railroads and other projects. Perhaps the stimulus is more than window dressing after all.

Also, the Baltic Dry Index has made a convincing bottom, doubling off its lows of 650 to over 1300 today. It is time to buy a virtually debt free company like Diana Shipping (DSX)? Unfortunately, they suspended their dividend to take advantage of "opportunities" that may arise. The also bought back 10% of their stock below current levels.

Rail shipping in the US is down, but the the different sectors vary widely. Autos: -65%, coal -2%. Has the recession reached it's limits in utilities? Is it time to buy Peabody Energy (BTU)? Or maybe CONSOL Energy (CNX) which has less debt leverage.

Has oil bottomed? Is it time to buy Exxon (XOM) with their 0.08% debt to equity level and $40 billion cash warchest?

I really don't know right now. So, I think it's time to cut back on some of my shorts. I'm looking at closing the Euro ultrashort and also KB Homes. Both have been pretty volatile lately. I also need to do some risk assesment/allocation management, as I just transferred my student loans into the account, increasing it by about 40%. So that takes a bite out of a lot of my risk right there, at least percentage-wise. COF is now only 1% of my portfolio. It's time to close it, as it's just too small to make a difference profit-wise. I'm probably just holding on to it going lower more as an ego thing to post a more impressive looking number on the profits board.

I think I'll wait with EUO for the ECB to make their next decision on interest rates. If they cut more than expected, the Euro will have a nice little dip to trade on. Looking at KBH again, they're up 15% over book value. They don't get much benefit from the stimulus bill. I also have this notion that the stimulus bill is pretty much priced in about now. I saw a nice chart yesterday that showed the stimulus adding 4% annualized growth to GDP in Q's 3&4 of this year.

Crap. Now I'm convincing myself to wait a little longer. Well, this story about Mexico's central bank intervening to stop the Peso from dropping through record lows shows that there are still a lot of hidden time bombs to go off yet. I'll just keep waiting for the next big one.

Trade

I just bought a 40% position in 30-yr US Treasuries @ a yield to maturity of 3.59%.

Why? Because the inflation theme is out of control. The inflationistas are going nuts, what with $2 trillion big bang bad bank bailout plans, $800 billion stimulus plans, and $500 quarterly federal deficits. Alright, looks pretty scary.

But what about the other side of the coin? Deflation is running at an 8.4% annual rate. Add in 3.6% and, Voila! 12%. As Cramer says, "Boo-Yah!" What about credit? Bank lending is down at a 5.6% annual rate. And it's not just banks, demand from lenders is declining as well.

Failure

So far, in my opinion, the Obama administration is a failure on the economy. Here are my reasons.

1. The stimulus plan went from creating 2 million jobs to 4 million while being the same plan. This tells me neither Obama nor any of his advisors knows what they're doing, or has any clue how many jobs they will save.

2. Geithner's first move - even before being approved by the Senate - as Treasury secretary was to accuse China of currency "manipulation." This makes me think a global trade war is more likely than not. No one in their right mind can expect China to strengthen their currency when they are in a recession.

3. Obama wanted to make a "bad bank." That idea lasted about a week, before being rejected. Leaking untested ideas willy-nilly like this smacks of gross incompetence and desperation. As soon as the $2 trillion price tag came out, they dropped it like a hot potato.

4. Now we have the "big bang financial cleanup." When the economy is imploding and people are panicking, you probably don't want to use the word "bang." I wonder how long this one lasts.

5. This one's a beauty: "Frank Says Obama to Force Banks in TARP to Lend More." How are banks going to lend more, when only insolvent companies and underwater consumers want to borrow? Consumer debt shrank for the first time since the Revolutionary War in the last two quarters. The savings rate has skyrocketed. NOBODY WANTS TO BORROW (except those who need to refinance existing debt.) One of three things will happen if Obama tries to force banks to lend money. Either the banks will refuse to take money from the government, or they will lend and lose the money, or they won't find any credit-worthy borrowers. This plan shows no knowledge or understanding of human behavior, economics, or what the problem is at all.