Vigilant Investor

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

“I might not be able to pay our employees tomorrow.  I am sure that those money managers who withdrew all their funds are feeling really smug right now, thinking they did the right thing. But it left the rest of us holding the bag.”

– Hal Wilson, CFO for Jefferson County Florida, in reference to his $850,000 payroll obligation and his inability to withdraw the necessary money from Florida’s teetering (and consequently closed) cash investment fund.

In one way, I’m sympathetic to the institutional reluctance to face the music. I’d give a lot to mark my weight to ‘model’ rather than to ‘market.’ – Warren Buffett, Fortune, 8/16/07 (On the financial institution practice of valuing subprime assets on the basis of a computer model rather than the free market price.)

“The Fed’s going to have to ease…When you take it all the way out, you realize in the end it’s all collateralized by somebody’s house, which isn’t worth what they said it was worth when they borrowed the money for the house.”
– Peter Yastrow, market strategist with MF Global, on CNBC

We’re not trying to be smug – or to sound like we’re bragging. However, as our regular readers know – we’ve been predicting the latest events for a while. Do we deserve a pat on the back? We don’t know about that. Our humble selves would feel kind of embarrassed. Especially since we consider having predicted currently unwinding economic events sort of like saying that in December – it’s probably going to get cold and snowy north of the Mason Dixon Line.

To reprise our (dead accurate) mantra – the massive expanding of credit over the last 20 years sure has been quite stimulating to the economy. After all – when someone is willing to lend you a lot of money – you can do a lot of stimulating (see 1990’s). It’s all Jim-Dandy until your credit line runs out. Then you stop stimulating. And then things are bound to slow down (see 2000ish) – unless you can get more credit (see 2001-2007). Then you get deeper into debt. Perhaps you tap out your home equity loan. Then you tap into your credit cards at higher interest rates. And then – the gears begin to slip.

We’ve said it before and we’ll say it again – while the “financial industry” would like you to believe that this is all “Rocket Science” we have news for you – it is not! If you are willing to keep your eyes open, along with retaining your objectivity – it’s all pretty simple.

We have said all along that the reckless lending across the board was going cause serious problems. Leveraged to the gills hedge funds have recently gone bust. Today we learn that French bank BNP Paribas has stopped allowing withdrawals in three large hedge funds – and that due to Gold’s resiliency (a sign of inflation and trouble) — central banks are trying to artificially drive it’s price down. And lastly & predictably – the uber leveraged are being forced to sell their good stuff to meet their loan/margin requirements.

It’s likely to get a lot worse in housing since far more adjustable mortgages await re-sets. Auto is struggling. Borrowers and owners of debt will continue to sink. Credit will dry up. Mergers and Acquisitions will grind a halt along with the economy. And there will be an outcry for the Fed to ease.

And instead of letting a real, painful adjustment to take place – the Fed will acquiesce.

That means a increase in units of currency not matched by an increase in production of goods or hard assets. Say hello to hyperinflation.

“May you have the hindsight to know where you’ve been, The foresight to know where you are going, And the insight to know when you have gone too far”
– Irish Blessing

It is said that hindsight is the injury foresight might have prevented. When it comes to understanding what is transpiring in the U.S. economy, we worry that far too many players will learn only in hindsight they’ve made huge mistakes given so many appear to not be properly discounting much of what stands next in the line of dominoes that have started to fall in the subprime debt sector. This suggests to us a fundamental misunderstanding of the intrinsic nature of the problems we’ve covered for several years nowhere at Vigilant Investor, and since 2002 in our prior hard copy publication, The Ernharth Wealth Report.

Certainly a handful were ahead of the Curve with subprime. Deutsche Bank joined our side of the fence last year by predicting doom and gloom for the sub prime sector. Today DB is joining VI in criticizing the excesses in leverage finance in general, albeit tepidly so.

As for subprimes, the the carnage is now contained to another continent as Sydney, Australia based Basic Capital, a hedge fund manager with $1 billion in structured credits and junk rated loans warned investors it will probably restrict withdrawal requests in order to prevent a collapse from selling assets into an extremely thin market. That’s just the kind of message that should give any holder of subprime related debt instruments lots of confidence: “the market’s so thin now we can’t liquidate.” In a letter to investors, Basis Capital notes they’ve been hit by “indiscriminate” repricing of “otherwise fundamentally sound collateral.” Hmm. Not seeing the forest from the trees, anyone? Mind you, this comes in the wake of Denver based Braddock Financial closing down its $300 million Galena Street fund due to redemption requests.

The best analogy for this sort of denial comes from an editorial by John Authers, who reminds us all of Warner Brothers cartoon character, Wile E. Coyote, running off the edge of a cliff:  So long as he keeps running, he’s ok.  Its only when he looks down to acknowledge his predicament does he actually fall.  Indeed, the attempts to keep these mortgage backed securities from being priced at market are not dissimilar.  (If we don’t mark them to market, they’ll never drop!)

Meanwhile, the dollar is taking serious blows as the rest of the world further questions the U.S. economic situation. Yesterday the Euro hit as low as $1.3798 — a record low, $2.03 to the pound, and 122.48. While the general assessment is that this is related to the sub prime situation (which clearly does not help), we can’t help but tie the dollar’s woes to the global inflationary breakout we’ve seen since 2000 in hard assets that can’t so easily be printed as the dollar and other currencies. With all the world’s major currencies running their M3s in the double digit, you have to take note.

That the dollar is losing vs. the USDX despite that all, well….

With that, we’ll remind you that vigilant investors — fiduciaries or otherwise — know that every exit used means you’ve simultaneously used an entrance to another space. Doom and Gloom? Hardly! That’s where opportunities may be found.

History is merely a list of surprises. It can only prepare us to be surprised yet again.

      ~Kurt Vonnegut

More quotes to ponder for a weekend to remember those who’ve given their lives in war.

The belief in the possibility of a short decisive war appears to be one of the most ancient and dangerous of human illusions.
~Robert Lynd

Never believe any war will be smooth and easy, or that anyone who embarks on the strange voyage can measure the tides and hurricanes he will encounter.
~Sir Winston Churchill

I’m fed up to the ears with old men dreaming up wars for young men to die in.
~George McGovern

The statesman who yields to war fever…is no longer the master of policy but the slave of unforeseeable and uncontrollable events.
~Sir Winston Churchill

The urge to save humanity is almost always a false front for the urge to rule.
~H.L. Mencken

..Violence as a way of gaining power…is being camouflaged under the guise of tradition, national honor [and] national security…
~Alfred Adler

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More quotes to ponder for a weekend to remember those who’ve given their lives in war.

A lasting order cannot be established by bayonets.
~Ludwig von Mises

Setting a good example is a far better way to spread ideals than through force of arms.
~Congressman Ron Paul

War is the gambling table of governments, and citizens the dupes of the game.
~Thomas Paine

History teaches that war begins when governments believe the price of aggression is cheap.
~Ronald Reagan

Most wars are started by well-fed people with time on their hands to dream up half-baked ideologies or grandiose ambitions, and to nurse real or imagined grievances.
~Thomas Sowell

We must not confuse dissent with disloyalty. When the loyal opposition dies, I think the soul of America dies with it.
~Edward R. Murrow

The cry has been that when war is declared, all opposition should be hushed. A sentiment more unworthy of a free country could hardly be propagated.
~William Ellery Channing

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Some Quotes when thinking about the dead of war and U.S. policy.

America does not go abroad in search of monsters to destroy. She is the well-wisher to the freedom and independence of all.
~John Quincy Adams

Always there has been some terrible evil at home or some monstrous foreign power that was going to gobble us up if we did not blindly rally behind it.
~General Douglas MacArthur

The most successful war seldom pays for its losses.
~Thomas Jefferson

It is our true policy to steer clear of entangling alliances with any portion of the foreign world.
~George Washington

Commerce with all nations, alliance with none, should be our motto.
~Thomas Jefferson

There never was a good war or a bad peace.
~Benjamin Franklin

I believe in only one thing: liberty; but I do not believe in liberty enough to want to force it upon anyone.
~H. L. Mencken

Guard against the impostures of pretended patriotism.
~George Washington

If Tyranny and Oppression come to this land, it will be in the guise of fighting a foreign enemy.
~James Madison

“We are now taught to believe that legerdemain tricks upon paper can produce as solid wealth as hard labor in the earth. It is vain for common sense to urge that nothing can produce but nothing; that it is an idle dream to believe in a philosopher’s stone which is to turn everything into gold, and to redeem man from the original sentence of his Maker, ‘in the sweat of his brow shall he eat his bread.”
–Thomas Jefferson

We recently described the current phenomena of the U.S. consumer ramping up borrowing from the lender of last resort – the credit card companies. Last week, MasterCard announced profits jumping 70% for the first quarter. Now the reason seems apparent. On May 7, the Fed released their latest Consumer Credit statistics. Total Consumer Credit in March rose $13.5 Billion – a significant increase from February’s $5.6 Billion rise. Effectively, in one month, Total Consumer Credit rose from an annual rate of 2.8% to 6.7%. What’s far more alarming is the increase in Revolving Consumer Credit, which jumped from an annual pace of 2.9% in February – to 9.2% in March.

This week we also learn that economists are forecasting slower consumer spending. Based on the above statistics alone – that’s quite a logical statement – and something we’ve been warning about as inevitable, for a long time. Not surprisingly, we learn today that Toyota is forecasting it’s slowest growth in a decade largely due to weakening American demand.

The consumer is getting tapped out.

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“Never spend your money before you have earned it.”
– Thomas Jefferson

It’s been said that the stock market climbs a wall of worry. More aptly, it ought to be said that the longer the Bull – the more it is presumed that stocks, and the economy are invincible – and what would otherwise be bad news can largely be ignored. We, of course, don’t buy into this mindset – while it seems today that most investors (and the financial community as a whole) – do.

We’ve also always believed economics is far from “rocket science.” While Wall Street would have you believe it is a mystical, complex, study – we think it is in actuality, quite simple. If you understand your own personal, economy as an individual – you basically understand the concept of economics pretty well. Don’t spend more than you earn. Don’t go heavily into debt. Save money. Realize that you can’t spend yourself into prosperity, etc. And, if you hear or read things from “pundits” telling you that practicing the opposite of these basic concepts on a national or global economic scale are good things – don’t believe them!

For example, Americans have been encouraged to continue spending. They’ve been told that it’s good for the economy. We ask, how is that good for the average American, when his/her personal savings rate is negative? When the average Baby Boomer has total savings of around $50,000? Ask yourself, if you have minimal savings, are currently not saving, and are going increasingly into debt – should you cut your spending, pay down your debt, and start saving more – or should you continue down the same path your are on? Come on!

What’s really alarming is that the credit based U.S. economy cannot afford to have the average American to get his financial house in order. That’s right, this economy is running on fumes as is – and it is largely dependant on the strung out, debt laden, savings poor American consumer continuing on. If the average U.S. savings rate actually went anywhere near it’s historic level of 10% (from the current minus 1%) — the economic slowdown would be severe. Actually, even a climb to a 5% average savings rate would still have a devastating effect. This is what it’s come to. The U.S. economy has become so dependant on leverage — that a return to sanity (savings) would likely cause an extremely painful re-calibration. For an analogy, think of an addict going through withdrawal. The end result is a return to normalcy – but the journey to that place is painful.

That said, the junkie here (American consumer) is still hooked on his drug of choice – credit. The ballooning money/credit supply has allowed him to spend via zero percent financing for automobiles, cheap mortgages, and home equity extraction — all of which have artificially driven the economy over the past several years. But now he’s getting tapped out. The high is wearing off, and he needs another fix. He can’t get his home re-appraised at a higher level to extract more “equity” because prices are falling. He has no savings. So he turns to the lender some would consider one step closer to loan sharks – the credit card companies. (If you think the comparison to loan sharks harsh – what would you call lending to people and charging them interest rates from 10 to 30+ percent)? In 2006, revolving credit in the U.S. increased 6.5% (doubling the prior year’s increase). Last week, MasterCard announced that their first quarter profit jumped 70%.

Again, it’s not “rocket science” to see where this trend is heading. The endgame doesn’t look pretty.

“To suppose that the value of a common stock is determined purely by a corporation’s earnings discounted by the relevant interest rates and adjusted for the marginal tax rate is to forget that people have burned witches, gone to war on a whim, risen to the defense of Josef Stalin, and believed Orson Wells when he told them over the radio that the Martians had landed.”

– James Grant

“We have been living in a fool’s paradise. We face a financial crisis that is not understood by the public…, but there is no disposition on either side of the aisle in Congress to face up to the problems.”
      Fed Chairman William McChesney Martin, 1968

The more things change, the more they are the same.

“For the naïve mind there is something miraculous in the issuance of fiat money. A magic word spoken by the government creates out of nothing a thing which can be exchanged against any merchandise a man would like to get. How pale is the art of sorcerers, witches, and conjurors when compared with that of the government’s Treasury Department!”

–Ludwig von Mises, The Theory of Money and Credit

“The sense of security most frequently springs from habit than from conviction, and for this reason it often subsists after a change in the conditions as might have been expected to suggest alarm. The lapse of time during which a given event has not happened, is, in this logic of habit, constantly alleged as a reason why an event should never happen, even when the lapse of time is precisely the added condition which makes the event imminent. A man will tell you that he has worked in a mine for forty years unhurt by an accident as a reason why he should apprehend no danger, though the roof is beginning to sink; and it is often observable, that the older a man gets, the more difficult it is to him to retain a believing conception of his own death.”

–George Eliot, Silas Marner