Vigilant Investor

The new buyers of a rundown graystone on the South Side showed up Jan. 9 to look at the house they won at a foreclosure auction. They took the plywood off the front door and went inside to make sure the utilities had been shut off. Then they called the police.

Sitting upright in the corner of a bedroom off the kitchen was a human skeleton in a red tracksuit. Next to him lay a dead dog. Neighbors told police the corpse was almost certainly Randy Johnson, a middle-age man who lived alone in the North Kenwood house.

The rest of the story is from the Chicago  Tribune…  A tale of just how deeply mortgage fraud was was ingrained in a housing bubble rife with the compounding dislocations inherent to massive money supply and credit growth.   The problem is still in the early innings and will take years to cleanse from the economy — unless the Fed and Congress try to wash it away with more money.  We expect lots of the latter.

Hey everyone! It’s me, Melissa Moody…not that other Moody’s you have been reading about. Actually that’s why I’m here I’m just so sick and tired of that other Moody! Their ratings stink, and they don’t know nearly as much as I do about debt, it’s true, I’m maxed out on 4 out of 7 credit cards I know I have a problem but I just can’t stop,ha ha. I can do a better job than Moody’s and that is what I’m gonna do! And let’s face it, their old ratings were too complicated. I mean Aa3, Baa1, Caa2, B1 who knows what that means? My ratings will be simple:

• BFFAE (Best Friends Forever and Ever)
• BFF
• FFLAF (Best Friends For Like Almost Forever)
• BFFBAS (Best Friends Forever But Also a Slut)
• FFBIHH (Best Friends Forever But I Hate Her)
• Whore

You must be blown away but I am ready to blow you even more than that — let’s get on with it already!

Please feel free to click on through to read the rest of Ms. Moody’s thorough ratings analysis of MBIA — well worth the read, as is most of the entertaining content at Long or Short Capital LLC, the funniest blog around for those following what we do.

This Credit Crisis Has a Long Way to Run
Jeremy Grantham, Chief Investment Strategist, GMO, has a few things to say about what’s transpiring in the credit markets and the very negative implications it has for the U.S economy. Among the high profile managers, he was earlier than most in calling the looming crisis. His interview is worth a read.

Turmoil as credit spreads hit record levels

The Fed disclosed a little bad news, while private equity (former) darling KKR has delayed again billions of dollars in short term paper (see below). Meanwhile commodity prices are running amuck (see below), and Hospitals, Port Authorities, and even Student Loans are not able to raise money amid a $60 billion debt auction failure last week, while what actually sold of the $330 billion total, much of it went at exorbitant rates, such as UPMC Medical system’s AAA rating fetching lenders for some of its debt sold at a mere 17% rate last week. This set in motion a plan by UPMC to buy back $91 million of debt to stem bleeding of about $500,000, which a week caused by the auction market collapse.

Woah! Look out credit derivatives markets! Hold on to your hats!

Oil Crosses $101

Granted, with oil refineries blowing up and Chavez making nutty demands, it’s easy to dismiss this news. But on the other hand, welcome to the brave new world where refineries in the United States are ancient and growing more difficult to keep up thanks to unbridled environmental and NIMBY (Not in My Backyard) Lawsuits that effectively keep new production off-line, and the U.S. dependent on foreign sources — including refineries. Get used to it!

Recession Watch: Inflation Rears Its Head You bet– It just ain’t Oil.   But what can you expect with M3 Money supply chugging at close to 15%?!?  That after all the liquidity earlier this decade.  Those new dollars all have to find a new home.   All of which is confirmed through a flurry of other news:

• Consumer Prices in U.S. Increase More Than Forecast
• Wheat Shreds Goldman, USDA Forecasts Belied by
• Soybeans Extend Rally to Record, Corn Rises on China’s Demand

KKR Seeks to Restructure Debt

Private equity, the darling of high net worth investors and the Wall Street mega-bonus / 200 foot yacht buying crowd are running into trouble. Too many models in recent years were built around unsustainable profit margins. Paying a 25% premium on a company’s price while using 4-1 leverage was la-la land thinking common to contemporary finance in recent years, slopping thinking reinforced by a long stretch of big (and I mean BIG) profits from closing deal after deal.

Subprime loans defaulting even before resets

Oy vey! Much as we’ve reported before, many borrowers couldn’t afford the below market intro rates. Even a year ago loans were slipping into late payment mode within the first 90s days.

GMAC to Shut U.S., Canada Field Offices After $2.3 Billion Loss

Housing. Auto / Credit Cards. Commercial and Retail Real Estate. Private Equity. Those are the shoes as they will drop.

Wall Street Abandons Neediest Clients, Cuts Credit

” “There’s nobody out there trying to lend money on securities,” said Luminent Chief Executive Officer Trezevant Moore. Six lenders are offering five times leverage on what the San Francisco-based company has contributed, while a year ago, 20 banks extended 33 times, he said.”

Fed Forecasts Higher Unemployment, Slower Growth

Well, there’s nothing quite like confirming the obvious… We should always remember that the Fed views itself partially as the manager of economic expectations, therefore serving as cheerleader to the economy. But when such dislocates from reality — as it clearly has with Fed governors earlier this decade cheering on Adjustable Rate Mortgages while discounting the threat of housing bubbles — it really is no better than wishing bad things away. You know… see no evil, hear no evil, speak no evil.

Here’s a little tale passed down from Guru Benjamin Graham.

“Let me tell you the story of the oil prospector who met St. Peter at the Pearly Gates. When told his occupation, St. Peter said, “Oh, I’m really sorry. You seem to meet all the tests to get into heaven. But we’ve got a terrible problem. See that pen over there? That’s where we keep the oil prospectors waiting to get into heaven. And it’s filled—we haven’t got room for even one more.” The oil prospector thought for a minute and said, “Would you mind if I just said four words to those folks?” “I can’t see any harm in that,” said St. Pete. So the old-timer cupped his hands and yelled out, “Oil discovered in hell!” Immediately, the oil prospectors wrenched the lock off the door of the pen and out they flew, flapping their wings as hard as they could for the lower regions. “You know, that’s a pretty good trick,” St. Pete said. “Move in. The place is yours. You’ve got plenty of room.” The old fellow scratched his head and said, “No. If you don’t mind, I think I’ll go along with the rest of ’em. There may be some truth to that rumor after all.”

Every age has its hot money herd whose obsession with the latest fad is their own downfall. Reading this I was reminded of the radio interview we did with the infamous Casey Serin of the now closed Iamfacingforeclosure.com website, who since went on to his 15 minutes in USA Today, on various news stories, and investment shows such as Rich Dad Poor Dad.  Casey, no matter what we told him in October 2006, that the fundamentals of credit bubble finance would bring down housing, he remained convinced that if he just did it a little different, he’d be rich

In a move reminiscent of the Federal Reserve ceasing its publication of M3 money supply figures in 2006, the U.S. Department of Commerce announced that it will discontinue its Economic Indicators services at www.economicindicators.gov effective March 1, 2008. The site has served as a key public portal to the economic indicators used by the government, the Fed, and the powers that be on Wall Street. It’s so useful that it has won a Forbes Best of the Web awards.

The Data will still be available on other websites, but it will be scattered, more raw, and tucked away.

The Department claims budgetary cuts are the reason, but more than a few analysts and research firms are questioning the timing of the closure. No doubt, politicians are always quick to deflect attention from any economic crisis, often blaming the negative coverage from the media for instigating problems — as if merely mentioning the words recession or credit crisis make them come to be. Who knows what the real reason for the cut off, but as our economic situation falls apart, the timing is suspect.

As for the Fed and M3, their claim was it was too expensive to calculate — never mind that M3 had been the mainstay money supply report during the last major recessionary inflation environment in the 1970s and early 1980s, when each week traders would huddle around awaiting the report.   What’s happened since to M3? Fortunately there are still groups out there calculating it, such as John Williams’ econometrics firm SGS.  (The were able to replicate with near exact precision the Fed’s original number, confirmed by several decades of back-testing.)

The results?  If the Fed were expecting M3 to go through the roof, but wanted to hide it to keep inflationary expectations in line, the plan couldn’t have worked better.  Below in a graph from SGS in red is the Fed’s M3  mixed with SGS’s duplication.  In early 2006 the line goes blue as SGS takes over on its own.

This is a nice video of Jim Rogers in unflattering terms describing the current official efforts to fix the price of money and other commodities. As for Bernanke? Hehehe.

“The more optimistic they were under the illusory prosperity of the boom, the greater is their despair and their feeling of frustration. The individual is always ready to ascribe his good luck to his own efficiency and to take it as a well-deserved reward for his talent, application and probity. But reverses of fortune he always charges to other people, and most of all to the absurdity of social and political institutions. He does not blame the authorities for having fostered the boom. He reviles them for the inevitable collapse.”~ Ludwig von Mises, Human Action, p. 576

That’s a big problem today. Everyone loves the big party that is ginned up by easy credit and expanding money supply. What they fail to understand is that the bust is the essential, corrective phase to the massive clustering of bad business and investment errors that were encouraged by misguided economic policy. Granted, it’s a painful process, but necessary to restore sound economic health.

But the illusion of knowledge leads most participants to fight the correction tooth and nail, and to support policies that redirect whatever productive assets remain working for the economy towards supporting the exposed, unsustainable activity of the prior bubble.

At best this is a temporary fix, and is no more sustainable or a lasting solution than is giving an addict suffering the symptoms of withdrawal another dose of the drug to which he’s addicted.    Just like the addict, our economic reality must be embraced for what it is or else that reality will be unceremoniously forced on our citizens, except with them having even less control over the situation as punishment for the extra delay.

Unfortunately we’re in the latter stages of our addiction to credit and easy money.   The economy staggered out of the dot com bubble and was going to recession to restore order, but Alan Greenspan and crew short circuited that recovery, and as dramatic an increase in credit and money as ever was injected into the economy to keep it on its feet.   A new, far larger bubble replaced the old one in technology, one that applied to all things related to credit.  As such, another dose to ward off our current withdrawal may simply send the patient reeling into the gutter of an overdose.

Does that sound too extreme? Tell me, then, what purpose dose it serve to keep asset prices with no basis in reality artificially high vs. clearing at a natural, free market price?

Why keep assets at values that are entirely dependent upon expanding credit rather than genuine economic productivity — credit that itself comes at the expense of the productive sector given it is created by inflation? Why not let normal economic order be restored?

Why enable a system that clearly cannot sustain itself without garnering purchasing power from the functioning economy to continue the ruse?

These are all questions that are answered quite simply if honest:   Because going through withdrawal is a real bitch, but the only way to pay for ones past economic sins.

But, as Mises notes, rather than embrace the bust as the restoration of economic healthy as anyone organizing an intervention with a real drug addict, contemporary finance pros and populist sentiment alike clamor for more of drug that got us into this nasty spot in the first place.  Party On!
All said, any short term benefits derived from policy that merely reallocates existing wealth through inflationary confiscation / bailouts and reallocates it in order to support all the errors exposed as unsustainable over the last 12 months, will have long term, unhealthful  consequences as yet more burden is placed on the legitimate producing economy to support ever more garish malinvestment.

Stay Vigilant, and Think it Through!

It doesn’t get any more rich than this… Cramer on there being no housing bubble!

Goes to show how off base pop culture economic analysis can be. Don’t forget how the media earns its living: Advertising. Throwing a wet blanket on the bonus party on Wall Street is not going to be promoted. They’ll cover it as it happens and in retrospect, but they’ve give guys like this 95 more times the coverage, and laugh off the critics.

Here’s part II
Continue Reading »

Nick Vardy is a well respected guru by most of Wall Street. He’s posted up a mocking critique of those of us contemplating the worst of what’s transpiring in the U.S. economy at the moment. The issue at hand is the consequence of “cry wolf syndrome”, where decades of warnings about horrid Fed policy and decadence in finance were, bluntly, way too early, causing mainstream analysts and bulls to dismiss them entirely as poppycock.

We’ll address Vardy’s comments below, piece by piece:

The Global Financial Crisis Of 2008 by Nicholas Vardy

Here we are yet again in the midst of another “global economic crisis.” From the hilltops of Davos, Switzerland, Morgan Stanley’s permabear Stephen Roach has shouted warnings of potential economic “Armageddon.” Superinvestor George Soros designated the current state of the global economy “the worst market crisis in 60 years.” Bill Clinton labeled it “the biggest financial crisis since the Great Depression” — even as global stocks responded by slumping 7.7% in January — the worst start to an investing year since Morgan Stanley began publishing data in the 1970s.

Uhh, but Stephan Roach has largely been right in his predictions since 2003, and where he erred was in underestimating the credit bubble’s blow-off. Soros has been similarly correct. Clinton? Well, opportunists always know when to hop on a bandwagon!

Bottom line, though, who do you trust? Those who failed to see any of this coming and were conceitedly dismissing warnings as crazy talk? The same ones who then failed to comprehend how severe the implosion would be, and whose advise encouraged investors to overextend and lose $ billions if not $ hundreds of billions?

But before you liquidate your financial assets, buy gold bullion, and move to a cave in Montana, you may wish to consider that current predictions of global economic collapse may be simply hyperbole. It has happened before. Clinton’s quote above actually refers to the collapse of Long Term Capital Management in 1998 — right before NASDAQ clocked an 88% gain in 1999.

Clinton’s a politician and a particularly adept one at saying whatever he needed to placate his power alliance. He’s a lousy example. However, what’s the point of bringing up the NASDAQ’s huge gains in 1999? Most who participated in that run-up gave that gain and a whole lot more back the following three years. Indeed, this was a bubble of insane proportions and who on earth can credibly use that as part of their defense for the health of today’s credit bubble economy?

Nor does this global crisis stand up to the scrutiny of historic comparison. Remember the S&L crisis in the early ’80s? It cost the U.S. economy about 3.5% of GDP — about 5x the size of subprime write-offs so far. Or how about the dark days of 1981, when the Federal Reserve drove its key interest rate to 19% in an effort to whip inflation? Bill Clinton’s “Great Depression of 1998″ doesn’t even merit mention.

Continue Reading »

That’s how one colleague in who works high up in one of Wall Street’s major muni departments described what’s been going on. Hundreds of auctions ended without a bid. The major Auction facilities (really, they’re underwriters) who are among the biggest on Wall Street are literally sitting on $ billions of muni securities that can’t find a market. 10% rates of return are insufficient to get muni auctions moving, and word is even NY City is coming up empty on their attempt to raise capital.

What this is evidence of is yet another echo wave in the credit markets, again catching the system off guard. Long term concepts have for too long relied on exremely easy short term auction money, and that’s all but dried up. Projects that could get away with short rates are now chocking on the prospects of having to finance longer term at fixed rates. Worse yet, only SSA among the insurers is considered remotely reliable. MBIA and Ambac are in a deep stew, and absent literal government assumption of their obligations, will be forced into liquidating what they can.

The mentality that we’ll always be on new era easy street when it comes to the economy is being shattered as a myth right in front of our eyes, yet so many still fail to comprehend what is transpiring. For a long while municipalities more or less hid their pension and health-care liabilities off the book, which was very convenient for big spending politicians looking to secure the important votes backing of local organized labor who benefited from such deals. In many regions, the same politicians looked at the juicy cash flow prospects coming from real estate taxes as prices lifted off into the stratosphere, and rather than fixing up the books and cutting the fat, they went the other direction to secure their immediate election prospects. Budget cuts are such ugly words when running for office, and real estate tax revenue provided the perfect cover.

Well, those gigs is also up. Home prices are plummeting and so are tax revenues, while recent accounting rule changes have force pension and other benefit liabilities back onto the books.

I get into that explanation because this all comes at a very inopportune time for municipalities. The Street is now completely disregarding whatever insurance they might have paid to insure their bonds, and out the window go any ratings implied from the now badly discredited ratings agencies. Municipalities now must put up a clean balance sheet or suffer the consequences while raising funds. No longer will we see CCC magically transformed into AAA ratings. The man behind the curtain must now stand on his own. Welcome to economic gravity 101.

You can read more about what’s transpired in the muni market today in this Bloomberg article.

In case you think we’re through the woods, this recap from Reuters at the end of last year serves as a reminder of all the dislocations. I’d add also that not only will government intervention nibble at the edges, it’ll continue throwing good money after bad when it should simply allow the markets itself to restore order, unhampered by fiddling with the real cost of money (interest rates), and by inference, money supply?.

“…but wanting to have their ears tickled, they will accumulate for themselves teachers in accordance to their own desires”.
– II Timothy 4:3

Glen Beck’s observation on all the hate mail he receives when he would talk about the bad things going on in the economy in 2007 are valid. For better or worse, folks don’t like a wet blanket at the party telling them that there’s going to be substantial consequences in the hangover (or worse) department from all the excesses. No, when it comes to bubbles, people would rather party on until they crash.

Here we are nearly 6 months after this excellent Glen Beck interview with Michael Panzer and Peter Schiff, and a majority still can’t contemplate how severe the situation is. The interview is as relevant today as it was in September of 2007. The part about U.S. economy vulnerability is crucial, especially when you consider the threats of, say, Chavez in Venezuela to cut off shipments of Oil to the U.S.

You see, it’s gradually becoming clear that the second half of the 1990s was in many respects just a lucky period for the U.S. economy — and that our luck has now run out…

…Bill Clinton got some credit for all this — but the big, undeserved beneficiary was Alan Greenspan, who looked like a genius when he was mostly just in the right place at the right time.

Now Ben Bernanke is having to try and clean up the mess Greenspan made — and do it in a much less favorable environment.

That’s Paul Krugman over at the NYT, summing up the 1990’s reasonably well.    His short post is worth a read, at least on the benefits the United States experienced due to the trade deficit building the foreign infrastructure that, in turn, brought us increasingly super-cheap goods along with the big boon in technological advancements — something we’ve previously fingered as the tail-end of a honeymoon period that has been winding down since 2000 (and discussed liberally in our 2007 annual client Wealth Report from our consulting firm).

As noted, this was the tail-end of the honeymoon, one that started after World War II with most of the industrial competition to the U.S. having been bombed out.  That environment bred

Missing, as is always with neo-Keynesian’s is any fingering of the vast credit expansion to have ginned up all the imbalance in the first place.  But that’s why Vigilant Investor is here!

“How could Ambac, through the magic of its triple-A rating, with equity capital of less than $5bn, insure the debt of the state of California, the world’s sixth-largest economy? How could an investor in California’s municipal bonds be comforted by a company that during a potential liquidity crisis might find the capital markets closed to it, versus the nation’s largest state with its obvious ongoing taxing authority?”

That’s from a Financial Times opinion piece written by Bill Gross. (Read it while you can for free at Yahoo; the links never last all that long…) Gross makes a good point about the myth that had been the monoline insurers — Ambac, MBIA, and a few others — who provided their ratings to the bonds they guaranteed.

You’d have to live under a rock these days (at least if you’ve been paying attention) to not have heard about how they’ve all been hit by guaranteeing mortgaged backed securities and CDOs squared, etc., and that they’ve simply not got the capital that’ll be required to cover the losses. Moreover, as we’ve reported for weeks, MBIA has been raising capital at junk bond rates, making their own AAA ratings from S&P and Moody’s a joke. (The same can be said for Ambac. At least ACA was dropped appropriately to the junk level it is.) MBIA this past week printed up another 82 million shares of stock for those willing to throw the company $1 billion as they scramble to keep their AAA rating. MBIA’s stock has plummeted by 80% since last October, and were down 10% alone on the news that shares would be diluted.

Continue Reading »