Saturday, December 20, 2008

UAW troubles a harbinger of things to come

While we watch the slow death of the big three from the weight of massive liabilities due to excessively generous pension and health care benefits, it should be noted that the automakers are just an illustration of what will be happening at an even larger scale across the company with another large segment of the workforce:   government employees. 

State employees have pension and health care benefits comparable to what the UAW has extorted from the Big 3.  However, the key difference is that state employees have near iron clad job security.  The Detroit News had a great report on how the Michigan Teachers' Pension plan will bankrupt many districts from their overly generous benefits (see here, here, here).  This is not just a Michigan problem.   Almost every state has this issue, and it will get worse over time.  Most governments will not tackle this because of the power of the state employees unions (see the budget crisis in California and how there are no layoffs, just tax increases).

The difference between the Big 3 and the state governments is that we have no choice in funding the state employees.   We do not have the option to not pay taxes.   The solution has a ton of up front costs and would ensure a huge political and legal fight.   The fair way to deal with this is to convert all defined benefit plans into defined contribution plans (e.g. 401(k)).  It would apply to all workers under a certain age or seniority.   Current retirees or those close to retirement would be exempted.   The same actuaries that run the pension plan would figure out for each plan contributor what their current pension would be if they retired on the conversion date, and the state would pay a lump sum into their 401(k) equal to the amount necessary to buy an annuity at conversion date rates to fund that.   From that point on, the risks are transferred to the employees from the taxpayers.   This would need to be coupled with a plan that makes retirees responsible for their own health care expenses at retirement (like pretty well everyone else who is not a union/government employee).   

This would be the mother of knock down/drag out fights, with legal challenges galore - but it has to be done.  During these tough times, perhaps some forward looking state politicians will start demanding change before the structural costs cripple the economy.

UAW bailout - debating point du jour

I have been listening to a lot of talk radio about the auto bailout the past few weeks, and it is always interesting when I hear some of the arguments made by UAW members as to why their perks should be subsidized by the American taxpayer.   One that I have heard a few times is that it is OK for the Feds to bail out the big three because Southern States have been giving tax money to the foreign automakers to build in their states.
Is it true that foreign car makers get unfair tax incentives from Southern state governments?   This is kind of half true.   Now, for the record, I am not in principle a big fan of "targeted tax relief" in the form of incentives, as it reeks of state governments picking winners and losers.  Plus, I think sound tax policy focuses on making taxes as low as possible for all business, not just big ones looking to invest in your state.     That being said, it is true that Tennessee, Alabama, Georgia, Mississippi, and South Carolina have been very aggressive in putting together attractive tax packages to lure factories in their states.  
But what is also true is that the Big three have been playing this game for years in the Mid-West and Canada.  When Chrysler mulled expanding Jeep production, the State of Ohio and the City of Toledo made sure that there were ample incentives to expand on their existing site there.   When the automakers consider scaling back production in Ontario.   The Canadian government and the province of Ontario are there with massive packages of tax credits and loan guarantees.  The state of Michigan and the City of Detroit gave some generous tax breaks when GM bought and moved its headquarters into the Renaissance center. So, when your UAW flack talks about the "unfair" tax subsidies that foreign automakers got to locate in the South, tell them they were just following the lead of the big three.

Saturday, November 22, 2008

Into the Crystal Ball

After being to a few investment symposiums (one of the benefits of having the CFA charter) and doing my own overview of the markets, here are a few things I think are probable:

  1. Long term interest rates will go up significantly while short term rates will stay low (i.e. a very steep yield curve).   One of the reasons is because of all the debt the U.S. government will have to issue over the next few years.   Currently, the 30 year bond is yielding 3.66%.   Warren Buffett got 10% yield on his preferred interest on his investment in Goldman Sachs.   The Chinese, with their massive dollar reserves, will be financing this, like it or not.   They will not accept a 3.66% return on their money if Buffet is getting close to 10%.   The yield on a 30 year bond will be hitting 8% over the next year or so in order to pay for the TARP program and whatever else Congress dumps on us.
  2. If we are looking at a 8% 30 year bond rate, the stock market will drop to a level relative to this.   If we assume a 3% dividend yield (a bit on the hight side) to make the math earlier and a 30% risk premium, the S&P combined earnings and dividend yield (i.e.  dividend yield plus the inverse of P/E) should be roughly 13%.   That implies an earnings yield of 10% or a P/E of roughly 10.  S&P 500 earnings will likely drop by about 30%, so that gives an implied index level of 450 as the bottom - so a worse case scenario of a 40% + drop.   Mind you, that is a worse case scenario, but I can see it dropping down below 600.
  3. Commodity prices will continue on a short term downtrend, and will start back on an upward swing  once the markets start to recover from their bottom.
  4. There will be another major bank failure in the next year.

Saturday, November 08, 2008

Tax Planning tips for the new administration

I have talked to CPAs who are advising this already.  The consensus that taxes are going to go up a lot starting in 2009.  The tax planning for anticipated rate hikes is the 180 degree opposite of traditional tax planning, which are:

  1. Make any anticipated capital asset sales now while the 15% capital gains tax rate is still around.
  2. If you have a C corp, and are anticipating distributing Earnings & Profits - make the dividend now while 15% dividend tax rate will be around.
  3. Accelerate all revenue streams (i.e. complete contracts, etc) to have as much in 2008.
  4. Exercise any employee stock options now  - it might be better with 15% tax rate in a crappy market than 25% in a good market.  Then again, we don't know where the dividend rates are going, they might go back to the top marginal rate.
  5. Accelerate your gifts for 2008 and consider electing to pay gift tax.   Minimize the estate and gift out as much in anticipations to changes to gift and estate taxes.
This is some of the things that people are doing right now.   Miami Dolphins owner Wayne Huizenga has already said that he will now attempt to sell his remaining 50% interest in the team in 2008 rather than in risk substantially higher promised future capital gains tax hikes by the democrats.   Huizenga said " He wants to double the capital gains tax, or almost double it.   I'd rather give it to charity than to him."

Remember, this is generally one of the reasons why increase in marginal tax rates don't work - people with the means to plan accordingly, do so.    Hint to the Democrats - if you really want to raise revenue, expand the base and lower the rate.  But then again, Obama has said that he will forego revenue in the name of "fairness".

Well, the bright side is that CPA's like myself will continue to be employed and see additional work as people try to figure out the inevitable tax changes that are being anticipated.

Monday, November 03, 2008

Barrack Obama = Pierre Elliott Trudeau

It has been almost 25 years since Trudeau left 24 Sussex drive, and we are still dealing with the wreckage of his policies (Constitution, NEP, welfare state).   Their lives are parallel in many ways.  Check out the wiki post on PET.  Ignore the Liberal hagiography of his political accomplishments - ask any Albertan about the NEP.   

America, you've been forewarned.   

Sunday, October 26, 2008

A modest tax proposal

We have heard enough about what the candidate's tax plans are.  We know the current system is complex, and distorts economic decisions, and on some levels - unfair.  

Ideally, I think the 16th Amendment should be repealed.  Washington should not have been given the ability to tax income because it gives too much money, and thus too much power to meddle in our lives.    Ideally, a 10% VAT, excise taxes, and modest duties should cover the duties that are the prescribed powers of the federal government per the constitution.   But let's just admit that is not happening any time soon.  Sorry fair taxers, we're stuck with the income tax for a while.

So what principles do we want for an income tax system.  I would propose the following:
  1. That it raise sufficient revenue to cover necessary government expenditures (sorry - this would probably mean a realistic downsizing of the Washington - i.e. no more department of education.
  2. Not distort economic decisions - it should try all types of income the same - a person making $100K/year only as salaries should pay the same amount of tax as someone who makes $100,000/year on dividends.
  3. Everyone should pay a de minimis tax.   I do not believe that people should not have to pay tax if their income falls below a certain level - citizens should all bear a minimum burden for the government they want so that they do not become detached from the costs of running it.   
  4. Not be burdensome on those of modest means.
  5. Simple to administer (this is tricky, you will still need a ton of volumes to define things, even a simple income tax needs to determine a lot of things).
So this is kind of what I came up with.
  1. Income tax with one bracket of 20%.
  2. All income taxed at same rate - interest, dividends, capital gains, wages...
  3. Capital gains is determined with a CPI adjustment in order not to be taxed on inflationary changes in prices.  
  4. Capital losses are 100% deductible immediately.
  5. Only itemized deduction is charitable contributions - but with no income limitation.  No more deduction for state and local taxes (subsidizing those living in high tax states) and mortgage interest (no more distorting the housing market and putting renters at disadvantage).
  6. Standard deduction of $10,000/filer and $5,000 per dependent.  Married filing joint with two children have $30,000 deduction.
  7. Minimum tax is $250 - regardless of income.
  8. Contributions to tax deferred retirement accounts deductible - no limitations.  However, early withdrawals subject to 15% penalty.

Sunday, October 19, 2008

James Grant on the credit bubble - WSJ

James Grant is one of my favorite market commentators. Read his article in the Wall Street Journal on the confidence game that is the US dollar and credit markets. The key passage in my opinion:
But it wasn't the vigilance of monetary policy that facilitated the construction of the tree house of leverage that is falling down on our heads today. On the contrary: Artificially low interest rates, imposed by the Federal Reserve itself, were one cause of the trouble. America's privileged place in the monetary world was -- oddly enough -- another. No gold standard checked the emission of new dollar bills during the quarter-century on which the central bankers so pride themselves. And partly because there was no external check on monetary expansion, debt grew much faster than the income with which to service it. Since 1983, debt has expanded by 8.9% a year, GDP by 5.9%. The disparity in growth rates may not look like much, but it generated a powerful result over time. Over the 25 years, total debt -- private and public, financial and non-financial -- has risen by $45.1 trillion, GDP by only $10.9 trillion. You can almost infer the size of the gulf by the lopsided prosperity of the purveyors of debt. In 1983, banks, brokerage houses and other financial businesses contributed 15.8% to domestic corporate profits. It's double that today.

Monday, October 13, 2008

The dirty secret of Obama's job creation tax credit

So Obama is now proposing a temporary tax credit of up to $3,000 for firms that hire new workers.   I'll tell you why it is a scam, and is typical of the sound goods on the stump/sucks in reality:
  1. The full credit doesn't kick in till $75K.   Most new jobs are well below that.
  2. If they business is a S-corp/partnership - Obama's proposed income tax increase and FICA limit increases will not be offset by this credit.
  3. If you are a Schedule C/S-Corp/Partnership - the credit in all likelihood will not be creditable against AMT.   Most tax credits are not good for AMT for individuals.  So, you might get the credit for regular income tax, but then it'll be taxed right back under AMT.
Basically - the credit is useless for small business.   When taxpayers normally talk about tax credits - they never work because the bulk of them are not creditable against AMT.

Friday, October 10, 2008

There are opportunities in the markets

What I love about panics like this, is that there are some great companies now on sale.  I see many well run companies now at valuations where I can envision buying them.   I have become, though experience a Graham/Dodd value investor.   For those of you who aren't familiar - this is classic value investing - placing emphasis on a strong balance sheet and buying stock priced with a "margin of safety".

We have been due for a sustained bear market for a while.  We haven't had a real one since the 70's.   The media and most people do not remember what a sustained bear market is like, as most of us were too young or not born yet to fully grasp it.   It is a bit of a shock, as too many people have been conditioned to think of perpetual growth in the markets with minor dips here and there. 

Everybody needs to chill out, and just understand that it is not the end of the world.   The markets will eventually sort itself out as they find natural support levels and stabilize.   The best things people can do is save, pay off your debts, and start looking for investment opportunities in the markets.

To paraphrase the great emerging markets manager Mark Mobius - "the best time to buy is at the point of maximum pessimism".   Keep that in mind when watching the market.   Those who keep their heads on a swivel and have cash available will reap the rewards.

Thursday, October 09, 2008

This is what I think Obama's Tax Policy will end up being

I've been a CPA for almost 6 years know, and in the financial services industry on and off for the last 15. Based on those experiences, I can say I have a good understanding of both items. Well this article about Congressional changes on pension plans show that there is no limits to the obtuseness of both Democratic Congressmen and academics. A brief passage:
“With respect to the 401(k), it appears to be a plan that is not really well-devised for the changes in the market,” Rep. George Miller, D-Calif., said.

“We’ve invested $80 billion into subsidizing this activity,” he said, referring to tax breaks allowed for 401(k) contributions and savings.

With savings rates going down, “what do we have to start to think about in Congress of whether or not we want to continue and invest that $80 billion for a policy that is not generating what we … say it should?” Mr. Miller said.

Congress should let workers trade their 401(k) assets for guaranteed retirement accounts made up of government bonds, suggested Teresa Ghilarducci, an economics professor at The New School for Social Research in New York.

When workers collected Social Security, the guaranteed retirement account would pay an inflation-adjusted annuity under her plan.

“The way the government now encourages 401(k) plans is to spend $80 billion in tax breaks,” which goes to the highest-income earners, Ms. Ghilarducci said.

That simply results in transferring money from taxed savings accounts to untaxed accounts, she said.
Where do I start on this? Needless to say, this really got me riled up. How this is so wrong:
  1. The idea of retirement accounts and the corresponding tax deductions was to encourage people to save. Savings means capital for economic growth. The U.S. has one of the worst savings rate in the industrialized world. This would encourage consumption and deter investment. We complain now how all these Sovereign Wealth Funds are buying up all the companies and real estate in the U.S. They will own a lot more once Americans are deterred from saving.
  2. The other part of 401(k) plans is that the taxpayer gets a deduction now, all growth in the account is tax free, but the catch is that all withdrawals from the account are taxable as income. Phasing out or eliminating the deduction for 401(k) plans would result in double taxation for many taxpayers.
  3. Does Representative Miller mean that only 401(k) plan deductions be taxable? What about contributions by employees to big fat unionized defined benefit plans? If we are talking about taxing contributions to retirement accounts as a subsidy, shouldn't we throw in defined benefit plans, SEPs, IRAs, SIMPLE, Keogh plans as well?
  4. The individual 401(k) limit is $15,500 if under the age of 49 and $20,500 if over 50 for 2008. An individual in the top bracket would get a reduction of income tax to the amount of $5,425 - but they would have to make at least $357,700 filing joint for the maximum bang. If someone is in that bracket, they are paying roughly north of $100,000 in federal income tax. I don't think this is such a huge "loophole for the rich"
  5. Teresa Ghilarducci is a retard. Period. "Congress should let workers trade their 401(k) assets for guaranteed retirement accounts made up of government bonds" Hmmm.. hasn't Ghilarducci heard of social security? In case she hasn't it is essentially a guaranteed retirement account made up of government bonds (in theory, but I bet congress would raid your retirement account like it does social security). It is going insolvent in the next couple of years.
  6. Government bonds have underperformed the stock markets historically. This plan would impoverish savers by limiting their returns to fixed income securities, even if you include this recent meltdown. Even though investors "lost" $2 trillion in the past month due to the stock market turmoil - most investors are in for the long term. They are paper losses until one sells. To reiterate - over the long run, stocks outperform bonds.
This is just wrong wrong wrong on so many levels.... cradle to grave! We're on the road to serfdom and the pedal is to the metal. Someone has to straddle this road and scream "stop"!

Sunday, October 05, 2008

The End of the Beginning

With the passage of the rescue package by Congress, we have started the next phase of this contagion.   

I cannot say that this package will have any effect outside of psychological.  It might help settle the overnight LIBOR rate drop from its record highs as some confidence comes into the system.   The problem is, like a lot of things that get passed as legislation these days, is that rushed bills like this are like a condom - they let you feel good when in reality you're getting screwed.   Perhaps that is a harsh judgement, but the problem we have here is primarily about capital, not illiquid assets.

Let me put it to you this way, any institution who sells their toxic assets at a fair value to the Treasury for government bonds is only exchanging an illiquid asset for a liquid asset.  While this may help the liquidity of the institution in question, it does not address the problem that it is woefully undercapitalized.  Insufficient capital leads to bank runs, and the inability of banks to make new loans and extend credit.   In other words, we still will have a significant contraction of lending as banks still de-lever their balance sheets.

And we have not addressed how the "shadow banking system" of hedge funds and SIVs are going to get clobbered on this.  They, as it stands to the best of my knowledge, are not eligible for the rescue plan.  They will have to liquidate their positions as they lose capital to redemptions.  Hundreds, if not thousands, of hedge fund will be going bust as they face increasing redemptions, the inability to refinance on the commercial paper market, and with large illiquid toxic assets on their balance sheets.  This gradual unwinding of trillions of dollars of assets and liabilities will depress the stock markets for at least another year.

So, looking into the crystal ball, I see the following trends for the next year or two:
  1. Several large banks will still fail and will be taken over by the FDIC.  Dozens, if not hundreds, of regional and local banks will be too.
  2. The S&P 500 will drop below 900 points by the end of 2009.  We should expect a 25% decline in the markets as companies continue to de-lever.
  3. Credit card and auto loan defaults will hit record highs over the next year.
  4. Home prices, as measured in the S&P Case-Shiller index, will bottom out for most markets by Q1 2010.
  5. Depressed demand will bring oil down to under $70/barrel.
  6. Gold will be off its record high, but not much due to the debasing of the U.S. dollar that this rescue plan creates.
  7. One of the big 3 automakers will not exist as a stand alone entity (either bought out or Chapter 11) by the end of 2010.

Saturday, September 20, 2008

Updates on Financial Meltdown


There is a lot of blame to go around for what is happening.   I found out from my reading that the SEC exempted 5 broker dealers (Merrill, Goldman, Morgan Stanley, Bear Stearns, and Lehman) from SEC leverage limits in 2004.  
To recap, let us look at the government's role in all that (notwithstanding the fact that borrowers and lenders are just as much to blame).   It is just another example of unrelated changes in government policy can cascade into financial disasters:
  1. The Federal Reserve in the mid 1990's until recently - abandons all pretense price stability, continues to recklessly expand the money supply.   The result was a weak U.S. dollar and artificially low interest rates.  This encouraged financial institutions and hedge funds to significantly leverage their balance sheets to goose up returns.   If we assume short term debt is at 3%, we lever 24-1 into a trade that makes 5%, our return on invested capital is 53% for the year.   Trades with small returns highly levered in a low interest rate environment create massive returns on capital.  However, small losses wipe out capital - which eventually happened.
  2. Mark-to-market accounting - accelerated this, distorting equity in these firms in upswings (thus allowing firms to take on more risk) and pushing the insolvency in downswings.  That, coupled with the fact that a lot of these assets have no real liquid market for determining fair market value.
  3. Capital requirements by the Fed under BASEL II used backward looking risk models that provided a feedback loop.   Using data from the last 20 years, essentially an extended bull market distorts the effects of low-probability, model changing events.   These risk models helped exacerbate the Mexican Peso crisis .   A risk model that is looks at the "fat tail" events and is more principal based would probably be wiser.
  4. Congress' enforcement of the Community Reinvestment Act under the Clinton administration (I wrote about this earlier, but the best source on this is from the City Journal, which is more thorough) essentially compelled lenders to provide loans to uncreditworthy people.   
  5. The tax system - with the mortgage interest deduction and property tax deduction is a government subsidy to home ownership that doesn't help.
  6. Freddie Mac and Fannie May were political entities that were told by their congressional masters to push more home ownership for people who shouldn't.
That's the short list .. 

Monday, September 01, 2008

Strange, isn't it

  • That we find out within 48 hours of Bristol Palin's out-of-wedlock pregnancy, but it takes months for the MSM to cover John Edward's lovechild?
  • We hear the MSM coverage of Palin's alleged involvement in the firing of her state trooper brother-in-law and promises by the MSM to properly "vet" her, and yet, how much investigation has the MSM done regarding Obama's relationships with Tony Rezko, Jerimiah Wright, and Bill Ayers?
  • Hearing the MSM talking heads stating Palin is "unqualified" to be VP based on her term as Mayor and two years as governor, yet we haven't seen similar comments about Obama's experience as a state senator or less than one term in the U.S. senate.
If this isn't the media in the tank for Obama, I don't know what is...

Obama's Tax Plan - why it won't work

You cannot cut taxes on the "middle class" much more than already.

What I mean by this, is that the bottom 50% of households don't pay any income taxes or very little.  I calculated in a prior post that a family of four making $50,000 filing joint with two children pay roughly $1,500 in federal taxes using only the standard deduction.  This would be less if they itemize.  Now mind you, $50,000 is above the median income, but is a good proxy for "middle class" for most of the country.  So the median family has an effective income tax rate of 3.5%  How can you cut it more, Barrack?  The top decile already pay the majority of income taxes.

So based on this, there is a limited amount of ways to cut taxes on the "middle class" based on this.  Second, there are not enough "rich people" to soak with massive tax increases.   Most of these people will just work less, thus depressing tax revenues.   So the only way to the Democrat's tax plan to work is to define "rich" as low as possible - probably to the point where you're rich if you're employed.

Sunday, August 31, 2008

Transformative Candidates

A few days of digesting Obama's acceptance speech in Denver has brought some perspective "transformative" candidates.   Everyone talks about how X or Y is "transformative" as a candidate.   That is utter B.S.  A candidate is never transformative, only when elected do they have the ability to become that by action, not deed.

Barack Obama is NOT a transformative politician.   He is quite conventional in many ways, but he is exceptional in his ability to give prepared speeches.  His acceptance speech was quite conventional, the laundry list of liberal programs, criticisms of the current administration and candidate, and platitudes of hope and unity going forward.  

Transformative politicians change the political roadmap for generations.  They are few and far between.  Examining U.S. presidents, the truly great ones changed the political landscape for generations.  Think Lincoln, FDR, and Reagan.  Obama's record and rhetoric shows he only wants to transform America into a socialist state.

Monday, August 25, 2008

Classic Bob Hope

I almost forgot this priceless Bob Hope clip.

H/T Dirty Harry's Place.

Thursday, August 21, 2008

Barack Obama = Ron Burgundy??

I'm telling you right now - Barack Obama is Ron Burgundy. He will read anything on a teleprompter like a god among men, but is useless without one. Ron Burgundy will read anything put in front of him. I'm wondering when "the one" will have his moment like poor Ron above.

Friday, August 08, 2008

Accounting gimmmickry...

For those of you who like to invest in individual stocks in the market: read the financial statements. I am a traditional Graham-Dodd value type (most of the time) who likes to dig through the financial statements and find equities that trade below "intrinsic value" so that I have a margin of safety in a down market.
In light of the downturn in financial stocks as of late, and the corresponding collapse in the housing bubble, there are buying opportunities out there to purchase solid companies at discount prices. But, not all companies are created equal.
One of my biggest negatives on a company are accounting issues. During the tech bubble, a lot of companies (i.e. Nortel) were playing fast and loose with revenue recognition rules to front load as much of it as possible. Others were playing with the valuation of officer stock options. Others just took accounting policies that were too aggressive or down right misleading.
Case in point: Wells Fargo (WFC/NYSE) came out with stronger than expected second quarter earnings (i.e. a profit) on July 16th and the stock price jumped from $20.51 at the close of the prior day to $27.23. However, upon further examination of their earnings, things were not a rosy. A little change of their accounting policy for home equity loans explains it. In prior quarters, Wells Fargo would write off any home equity loan that was in arrears for greater than 120 days. However, at the start of the second quarter, they changed this to 180 days. My changing the criteria of when a loan was to be written off, they essentially added roughly $265 million to their earnings - turning a loss to a gain in the case of Wells Fargo's second quarter.
The worse part of this is that considering how many home equity loans they had in the housing bubble epicenters of California and Nevada, where the drop of home values they loans are essentially now unsecured, that the better accounting policy would be to more aggressively write off these positions? Wouldn't you, as a shareholder or depositor, show you a "worst case" balance sheet where there is less likelihood of downward surprises rather than overly optimistic guesses that have read downside?
As I said earlier, I don't like companies that play games with their accounting, as it reflects poorly on management in terms of performing their fiduciary duty to shareholders.

Saturday, July 12, 2008

Next time Chuck, better to shut your pie hole!

The seizure of IndyMac Bancorp by Federal regulators yesterday afternoon was a result of a bank run by depositors. How did this run start. Well, Senator Chuck Schumer (D-NY) commented publicly that the bank was insolvent and the regulators should take it over. When you're a prominent Senator on the finance committee, every word you say has ramificaitons. Now, your stupid comments caused a bank run.

Perhaps next time he opens his mouth, he should have to put $200,000 in each bank he mentions by name. That should help.

Freddie, Fannie, IndyMac, and one big banking mess.

What a mess of a week. First Fannie Mae and Freddie Mac become technically insolvent, and the financial institution IndyMac fails and is taken over by the Fed. The problem with the GSMs is that they have over $5.1 trillion of guarantees on mortgages and under $50 billion in equity on a market cap basis. That is a leverage factor of over 100-1, greater than most hedge funds, and much greater than Bear Stearns, Lehman brothers at the beginning of their respective troubles. Add to this equation, fraudulent accounting, political cronyism, and a congress that has ordered it to start guaranteeing loans up to $700,000 (from $400,000) and passed lesiglation having it guarantee another $300 billion of the banks most toxic debt.

This is not good, and fixing it will not be cheap. If congress decides to explicitly guarantee their debts, we are looking at another $5.1 trillion of government debt. This will severely hamper the ability of the government to borrow (not necessarily a bad thing), probably result in higher taxes to service this debt (very bad), drastic reductions in government spending (good) and entitlement reform (good), but also in a real decline in American's standard of living as the dollar would tank (very bad).
The less expensive option would be for congress to shore up the GSMs balance sheet with about $100 billion of preferred equity, and slowly start winding up the two companies over time. This would take several years, but would keep all the guarantees off of the federal government's balance sheet. After the windup, the companies would be dissolved and this monstrosity of a program could be abolished.

These programs show what happens when the government creates moral hazard by distorting the credit markets with guarantees. The reality is that a lot of people who own houses should not be owning houses, and government policies (Freddie, Fannie, the mortgage interest deduction, and deductions for property taxes) distort the true cost of housing.

Sunday, June 29, 2008

Confirmation of my thoughts on bumper stickers

I have always thought that a factory option on a new Prius, Scion, or Honda Escape was a choice of the "Obama 2008" or "Coexist" bumper sticker. This article explains a bit more of the phenomenom.

A tip of the hat to Captain Capitalism for this.

Friday, June 20, 2008

Top Ten Communist Jokes

These are classics!

1) Three workers find themselves locked up, and they ask each other what they’re in for. The first man says: “I was always ten minutes late to work, so I was accused of sabotage.” The second man says: “I was always ten minutes early to work, so I was accused of espionage.” The third man says: “I always got to work on time, so I was accused of having a Western watch.”

And here are the nine runners-up:

2) An old man is dying in his hovel on the steppes.
There is a menacing banging on the door.
‘Whose there?’ the old man asks.
‘Death ‘comes the reply.
‘Thank God for that,’ he says, ‘I thought it was the KGB.’ A KGB officer is walking in the park and he sees and old Jewish man reading a book.
The KGB says "What are you reading old man?" The old man says "I am trying to teach myself Hebrew."
KGB says "Why are you trying to learn Hebrew? It takes years to get a visa for Israel. You would die before the paperwork got done."
"I am learning Hebrew so that when I die and go to Heaven I will be able to speak to Abraham and Moses. Hebrew is the language they speak in Heaven." the old man replies.
"But what if when you die you go to Hell?" asks KGB.
And the old man replies, "Russian, I already know." Larry Rasczak
Dan Sweeney

3)Pravda announced that it welcomed letters to the editor. All correspondents were required to include their full name, address and next of kin.

4) Q. "Why do the KGB operate in groups of three?" A. "One can read, one can write and one to keep an eye on the two intellectuals."
Lee Jakeman

5) Leonid Brezhnev pays a state visit to France and he's given a VIP guided tour of Paris. He's conducted round the splendours of the Élysée Palace, but remains as stony-faced as ever. He's shown the masterpieces of the Louvre, but the curators fail to get any reaction out of him. He's taken to the Arc de Triomphe, but displays not the slightest interest. Eventually, the official motorcade drives him to the foot of the Eiffel Tower, where Brezhnev finally stares up in amazement and astonishment. He turns to his French hosts and asks in bewilderment: "But, Paris is a city of 9 million people... surely you need more than one watchtower?"
(first heard by me in the Brezhnev era)
Geraint Jennings

6) Stalin decides to go out one day and see what it's really like for the workers, so he puts on a disguise and sneaks out of the Kremlin.
After a while he wanders into a cinema. When the film has finished, the Soviet Anthem plays and a huge picture of Stalin appears on the screen. Everyone stands up and begins singing, except Stalin, who smugly remains seated.
A minute later a man behind him leans forwards and whispers in his ear: "Listen Comrade, we all feel exactly the same way you do, but trust me, it's a lot safer if you just stand up."
Robert B

7) A man saves up his ruples and is finally able to buy a car in Soviet Russia. After he pays his money the he is told he will have his car in three years.
"Three years!" he asks "What month?"
"August? What day in August?" He asks
"The Second of August" is the reply
"Morning or Afternoon?"
"Afternoon. Why do you need to know?"
"The plumber is coming in the morning."

8) Why do ex-Stasi officers make the best Berlin taxi drivers?
Because you only need to tell them your name and they'll already know where you live!

9) Moscow in the 1970s. Deepest winter. A rumour spreads through the city that meat will be available for sale the next day at Butcher's Shop no. 1.

Tens of thousands turn up on the eve of the event: wrapped up against the cold, carrying stools, vodka, and chessboards, they form an orderly queue.

At 3 am the butcher comes out and says, "Comrades, I've just had a call from the Party Central Committee: it turns out there won't be enough meat for everyone, so the Jews in the queue should go home."

The Jews obediently leave the queue. The rest continue to wait.

At 7 am, the butcher comes out again: "Comrades, I've just had another call from Central Committee. It turns out there will be no meat at all, so you should all go home."

The crowd disperses, grumbling all the while: "Those bloody Jews get all the luck!"

Saturday, June 07, 2008

First tech stocks, then real estate, now oil

I can now say, based on the chart (left) that Oil is now in a "bubble" - where fundamentals or rational analysis have nothing to do with valuation.
The market is ignoring new significant finds in China and Brazil, declining demand due to economic softening., among other factors. Yes, the US dollar is tanking, but that does represent the run up in price (see right) over the past two years. Fundamentally, with the dollar where it is, my stab is that "fair value" is closer to $70 than $130.

Comapre with the run up of the NASDAQ 100 from 1995 through 2001 (below):

Notice the similarities - starting in 1998, the NASDAQ 100 stopped trading on fundamentals, with speculators (i.e. day traders) making wild profits, IPOs being easy money, and talk of a "new paradigm" of valuation, where analysts justify even wilder P/Es even through cash flows and sales don't support them.
My experience on this was first hand. I was working as a broker for a firm up in Canada, and I have several stories about the irrationality of investor behavior. I had one client - married couple, whom I invested their RRSP (for those of you in the US, think IRA) in a balanced portfolio of stocks - both domestic and international, some growth and some value, bonds, and cash. They had a 12% total return in 1998 and they fired me because their friends where invested in tech and were averaging 35%/year and were furious that I wasn't making them 20%+. I had another client who kept buying Nortel stock, even though I did a comprehensive analysis showing it was way overvalued - when it finally tanked in 2001, the client lost $4 million from the time I pleaded with him to sell.

Now, since I'm on a chart fetish, lets look at US real estate prices using the Case-Shiller Index. This chart from the New York Times shows you the run up through mid 2007. As we know, the index has dropped precipitously since then:
We are all aware of this chart - once again, the same facts. An asset (Oil, Tech stocks) starts showing appreciation, then speculators jump in. Initially there are easy profits and they are disproportionate relative to historic returns. As speculators continue to enter the market, pricing no longer is based on fundamentals (in the case of housing, it has no bearing on median income) driving beyond reason until there are no more marginal buyers and the prices collapse.
There is a historical pattern. It repeats itself because human nature is constant. When there is easy profits, speculators jump in, drive up the price well beyond fundamentals, until a point where there there are no marginal buyers and the price collapses from lack of demand. The question at hand, though, is when will the tipping point occur, and what will the top be. We'll only know in retrospect.

Monday, June 02, 2008

Finally.. more Shatner!!!

I think this one takes the cake. If I didn't know better, I would say he was Jim Lahey drunk.

Even more craptacular - Shat-tastic!!

This, I think is worse!

Craptacular Nimoy

This is absolutely priceless. Nimoy at his worst!

Saturday, May 31, 2008

Three Cheers for Vaclav Klaus

Of course, it would take a resident of a former communist country to point out the obvious similarities between the modern environmental movement and Marxist-Leninism. But this essay is a must read!

It is a stark reminder that the green movement is a watermellon: green on the outside and red on the inside.

EU Referrendum in Ireland

Voters in Ireland have an opportunity to vote on ratifying the Treaty of Lisbon on June 12. This would integrate Ireland under Brussel's control. As it has been in other countries, all the political parties are in favor of this, but it still looks possible that it could go down in flames.

The Irish would do well to cherish their hard won independence and vote "no". A yes vote would in all likelihood result in the Celtic tiger being bogged down in high taxes, excessive regulation, and a flood of immigrant - stagnating wages and the economy. On top of that, an unresponsive Brussels would dictate by fiat the end the Irish identity.

Look across the Irish Sea at Britain: do you want that kind of decay at home?

Sunday, May 18, 2008

Stupid ideas week

It appears that this past week has been ripe with stupid decisions. For example:
  1. The EPA has ruled the Polar Bear is a threatened species. This is a back door implementation of Kyoto in the U.S., as almost any project can now be challenged by tree huggers by stating that any greenhouse gas emmisions anywhere in the U.S. threaten the polar bear. Never mind the dubious science, just think of the costs that consumers will pay as any electric plant, refinery, factory, oil platorm, aggregate plant will now have millions in compliance costs from lawsuits. Hugh Hewitt has more on this.
  2. A Canadian court has delayed the Kearl oil sands development by Imperial Oil, citing environmental concerns. This will ensure that energy independence will be a pipe dream without a significant decline in standards of living. The hypocricy of the left on this matter, who decry high energy prices while doing everything in their power to prevent practical solutions.
  3. The U.S. House of Representatives passed a pork laden farm bill, providing billions of dollars of subsidies to millionaire farmers during times of record crop prices. This is a bill that should be vetoed, as it takes tax monies from American families to subsidize millionaires while doing nothing to address rising food costs.
If I didn't know better, it is the 1970's redux. Seems like it only takes elected officials 25 years to ignore the errors of the past. I'm waiting for WIN (Whip Inflation Now) buttons, price controls, gas lines, pet rocks, and disco to come back.

Tuesday, May 06, 2008

Hitchens on the Obama two-fer

Christopher Hitchens asks a pertinent question: with Barrack and Michelle Obama, are we getting another two-for-the-price-of-one deal like the Clintons? He digs into the Obama's background and comes up with some disturbing answers.

Saturday, April 19, 2008

Joy Division - looking back

I've been on a Joy Division kick the past few months, revisiting a band I used to listen to a lot when I was younger. I find that even at this stage of my life, being a lot older, wiser, etc.. I still find the band as compelling as I did then. The haunting themes of Ian Curtis' lyrics still resonate with the passage of time, and show glimpse into the tortured soul that was Curtis.

My personal favorite song is "New Dawn Fades" from the album "Unkown Pleasures". Better yet, pick up the 4 CD set called "Heart and Soul". Here is a bootleg video of the song:

Saturday, April 05, 2008

The mortgage mess

Listening to congress, the Federal Reserve, and the Democrats discuss "the credit/mortgage crisis" is pretty depressing at times. There is plenty of blame to go around:

  1. The Federal Reserve has to take its share by creating a credit bubble with articifically low interest rates from 2003-2006. Their easy credit policies started the bubble then migrated towards the housing market. They created excess amounts of money which went into housing speculation. Worse of all, the Fed appeared to abandon all pretenses of protecting the integrity of the dollar from depreciation and inflation and looked to manage economic growth - a fool's errand. Part of this was using "core inflation" as a key target. Ignoring spiraling energy and commodity costs belies the real inflationary pressures that most families have to deal with in their budgets. As a result, American's have suffered a real drop in their standard of living due to this deliberate devaluation of the dollar, which must be remedied - dynamic economies do not survive on a weak dollar that masks structural weaknesses. It can also be argued that expanding the discount window to non-brokers in the circumstances it did to Bear Stearns/J.P. Morgan is unconstitutional. Although probably necessary - such actions should require an act of congress. Judge Andrew Nepalontano on Fox Business News strongly believes that such actions violate the general welfare clause of the constitution - which prohibits direct handouts to individuals and businesses.
  2. Congress - despite all the preening about caring about the "poor homeowners" Congress did it's part in cultivating this problem. Congress had many policies to foster home ownership - often to people who should not be buyers due to bad credit. The Community Investment Act essentially forced banks to lower their credit standards to questionable borrowers to help low income communities. The mortgage interest deduction and property tax deduction gives a tax subsidy to homeowners over renters, further distorting the costs of home ownership over renting. Some of the few saner voices in Congress have noticed this. I can't believe I'm saying this, but Barney Frank (D- Mass), Chairman of the House Banking Committee has said as much, stating that government policies create too many home owners and not enough renters. Current proposals to "fix the problem" only create moral hazard for marginal borrowers who should not have been owners or speculators who could never afford the houses to begin with. Finally, the issues with the "shadow banking system" of broker-dealers were never addressed with the end of the Glass-Steagall act in 1999. Though Congress at the time did not know at the time the ability of these firms to be critical cogs in the banking system, it is another example of the unintended consequences of legislation.
  3. Loan securitization - securitization of pools of mortgages started in the late 70's/early 80's, but really took off in the past ten years. The prime driver of this was record low long-term interest rates on Treasuries. With so many institutional investors hungry for yield, as many were required to have minimum fixed income positions, the investment banks stood ready to securitize loans to these investors. The rating agencies slapped a AAA rating on some of the tranches, pocketed the fees, and repeated. This created a viscious circle - lower interest rates created greater demand for additional yield, which created lowered lending standards to create product and nice investment and ratings fees. Securitization also created more revenue for financial institutions than holding them to maturity. If more of these loans were held on the balance sheet, they would be more thorough in terms of due diligence.
  4. Risk models - all financial institutions use modeling to determine the amount of risk their investments have to a significant decline. These models are quite complex and use a lot of historical data and assumptions. These models, while helpful, have two fatal flaws. The first flaw is that many of these models assume that returns are normally distributed - it under-estimates losses at the extreme ends of of the curve where most statistical relationships fall apart. The second problem is that it fails to account for changes in behavior. In this case, it assumed that homeowners with zero equity in the house would behave the same as homeowners with a significant amount of of equity in the house in the form of a large down payment. People purchasing houses "no money down" have no financial incentive to stay in the homes once they are in a negative equity position - thus the "jingle mail" phenomenon. It appears that these risk models never figured that part
  5. Developers. I worked with a lot of construction clients over the years, and many of these people are really smart and successful. What I don't understand is how they could keep building when there is all this supply lying around, thinking that it will sell quickly. The first rule of any business is to minimize inventory - and when stuff sits unsold, then it is time to stop building and take a vacation. Nope, can't do that. Then on top of it, selling properties to people probably have a good idea that they can't afford the house; no worry to them - FHA normally bailed many of these people.
  6. Borrowers. If you are looking to buy a home, there are a few cardinal rules: (i) have a good size down payment (i.e. at least 5-10%); (ii) mortgage, taxes, and insurance should take up less than 1/3 of your gross monthly pay with a standard 30-year fixed; (iii) the maximum home price you can afford is roughly 3 1/2 times your annual pay. So, with this in mind, are we surprised that there are foreclosures involving borrowers who bought with no money down for homes that are 8-10 times their income? I have an additional rule - couples, do not buy a home assuming both of you will be working. If you buy based on one income, there is always a good cushion and it opens up more work/life options.

Saturday, March 29, 2008

Interesting reading

I found this Wall Street Journal article about Hyman Minsky. He was a "post-Keynesian" economist whose writings focused on the inherent instability of financial markets. I found his writings were a good summation of the behaviors that cause financial bubbles. Taken together with one of my favorite books, Mackay' s "Extraordinary Popular Delusions and the Madness of Crowds" - it gives a good explanation of how bubbles happen and burst.

What it should remind people, especially politicians, that human behavior has been a constant throughout existence. Bubbles have happened before, and will happen again.

The week in review

Random observations...
  • I was in California for parts of last week, just North of Los Angeles. Beautiful area. I can see how living with perfect weather can make the brains go mushy with silly ideas. I found an eerie new age totalitarianism at my accommodations. The ambient music (though not as good as Brian Eno, and with hints of Zamfir) at beyond ambient volumes, the excessive notices such as "this building may contain materials, known to the State of California, to cause cancer..." These notices are the face of the maternal fascism. It explains why businesses are leaving the state in droves for more hospitable locations.

  • Notice the differences between Kwame Fitzpatrick and Eliot Spitzer. Spitzer resigned once all the legal troubles came out. Kwame is still fighting. Eliot couldn't tough it out because he alienated too many people in his own party - the Democratic party in Albany was not going to go to the mat for him. Kwame still has a base, one that does not show up in the polls, and was the basis of the late Detroit mayor Coleman Young's electoral success. Kwame figures he can hang tough and get support by casting himself as a victim of a media inspired "lynching" - playing that card as much as possible. It got him re-elected in a tough campaign against Freeman Hendrix where polls showed Fitzpatrick trailing significantly. Another black mark for the city of Detroit.

  • Obama's stupid tax plan. Where do I start? First - exempting seniors who make under $55,000 from income tax (they'll be responsible for bankrupting Medicare and Social Security and we want to reward them by not having them pay taxes?)!? Second, he wants to raise the capital gains tax to 25% from it's current 15% - that'll kill investment in a downturn. Finally, he wants to raise taxes on the rich, whom he defines as the top 20% of all taxpayers. Grab your wallets, because that top quintile begins at $75,000. I know a lot of people who make $75,000 per year and I would not call them "rich" by any stretch of the imagination. If you live in a high tax/high cost of living area like LA, DC, or New York, seventy five grand barely keeps you afloat. And I haven't even got around about his plans on expanding FICA taxes. If I was to summarize Obama's tax plan in one word, it would be "Canadian".

Saturday, March 15, 2008

We're now in a solvency problem

Now that we have hear news that Bear Stearns needed to be rescued by JP Morgan and the Federal Reserve to cover its borrowings, the real depth of the credit crunch is becoming apparent. We have moved from a liquidity to a solvency issue, where many non-bank lenders are now having extreme difficulty meeting their obligations. The LBO firm Carlyle group defaulted on an investment fund heavily invested in sub prime mortgage.

More and more firms will become insolvent as the assets backing their debts fall in value, forcing loans to be called and additional defaults. Bear Stearns will in all likelihood be acquired by another firm, as will many other companies who leveraged themselves to the hilt on easy credit.

The move by the Fed is a realization that monetary policy will do little to help the situation, and that partial nationalization of bad debts is the only way to avert a full solvency crisis. Better late than never.

All of these problems materialized because of a Federal Reserve, encouraged by a U.S. government that wanted perpetual economic growth, that kept creating money and generating excess credit and a devalued currency. The problem is that the Fed must allow the market to find a bottom and facilitate an orderly liquidation - delaying the inevitable by attempting to protect people from price drops will only exacerbate the situation.


It also appears that Lehman Brothers is having some troubles as well after the Bear Stearns debacle. This will bear watching.

Tuesday, March 11, 2008

First Kwame, now Elliott

First it's Detroit mayor Kwame Fitzpatrick's text messages about his illicit affair with his chief of staff and potential perjury charges. Now it's New York governor Elliott Spitzer's involvement in a prostitution ring.

As we have seen with Kwame, we will see with Elliott - neither will leave voluntarily. They will cling to whatever vestiges of power they can. They have do regard for the shame and hurt they bring their families and their respective offices. To them, it's all about "me".

BTW - this also applies to Larry Craig too!

Monday, March 10, 2008

Daylight Savings Times Sucks

I'm half awake, but I know John Miller of National Review is onto something on this scam.

Sunday, March 09, 2008

What I know, what I'm somewhat confident, and what I think may happen

Looking around at the economic and financial situation, I am drawn into making further analysis and comment based on the all the reading I have done on the topic as of late. So kind of wrapping up all this into a general piece of scribe, I decided that it would be more coherent if I broke things up into categories.

What I know (a.k.a. things I am pretty certain about):
  • We are just into the beginning of the credit crunch and the looming credit crisis. The sub prime mortgage market may only be the tip of the iceberg. There are major issues around the corner involving the solvency of monoline bond insurers, a potential cascade of muni-bond defaults, counterparty risk with credit default swaps, and other bad loans on the balance sheets of banks that have not been marked to market.
    • The bond insurers and rating agencies made fundamental errors in judging the risk of these mortgages. Credit standards in the past few years have been so lax that there was in the sub prime arena, no real effort to have collateral or prove ability to pay. When these crappy mortgages (which coincidently, had high degrees of fraud embedded in them, whether it be on the applicant or the mortgage brokers who initiated them) were securitized, the bond insurers took the money to guarantee them and the rating agencies gave those tranches a AAA rating.
    • The rating agencies and insurers made, in my opinion a fundamental error in behavior: they believed that homeowners would do what they traditionally do and pay the mortgage before anything else. However, the psychology of the home buyers in this bubble behaved differently (albeit rationally) than homeowners in the past. Traditionally, homeowners had put in a significant amount of money down in a purchase of a home (15-20%); with that amount of equity in a home, there was downside cushion for the lender, and the incentive for the borrower to continue to make payments, less they lose what equity they have in their home. Plus, there was a moral incentive to pay the mortgage, as there has been traditionally a shame factor in losing one's home in foreclosure. However, that sense of shame in society is well gone, and beyond the scope of this piece. The key point is, though, that a borrower has little economic incentive to continue to throw money into a mortgage when there is negative equity in the house. Add the fact that for most states, mortgages are non-recourse loans, which means in the event of default, the lender cannot sue the borrower for any deficiency. Thus the increase of jingle mail homes, where borrowers are just mailing in the keys to the house and walking away. Outside of their credit rating taking a bath, there is no real cost for borrowers to do this.
    • The bubble of easy credit fueled housing is starting to cascade through the entire financial system. The municipal bond market is now looking at a spate of defaults. First, the bond insurers are teetering on the brink of collapse from the CDOs they guaranteed, and now the muni bonds they have insured have problems. Many local governments, whose coffers were flush with cash from inflated property taxes and developer fees, now are in a cash bind with regards to all the bonds they issued during the fat times. Some localities will cut spending on services and other items and ensure that they make their loan payments on time. However, some localities will rather default on their debts than make the cuts in services necessary. Bloomberg reported that Vallejo, California is looking at defaulting on its debts. This is just the tip of the iceberg, as more and more localities will be hit with declining property tax bases.
    • Defaults in auto loans and credit cards are increasing sharply as well, but nobody really knows how much bad credit card debt there is out there.
    • This is not just an American problem. Britain, Australia, Western and Eastern Europe have similar issues with their housing markets and the debt that is financing it. The credit crunch is much more global than it has been in prior time.
  • So, who can we blame? Predatory lenders? Greedy real estate speculators? Well, yes, and yes. But if one person, overall, had to have this simmering crisis pinned on their chest, it is none other than Alan Greenspan. The Fed has implemented a massive monetary expansion since the mid 1990s. It has manifested itself in many ways during this time. It first fueled a capex (capital expenditure) bubble in the mid-1990's, which then gravitated to financial assets (i.e. technology stocks) later on. This excess money in the capex bubble led to deflationary pressures as companies kept high production volumes to cover the fixed charges. The excess money in the economy kept interest rates artificially low, with inflation a non-factor with China and other developing economies tempering those pressures. Then September 11th punctured the tech bubble, and it looked like that saner monetary policies would prevail: that there would be sufficient liquidity to provide an orderly liquidation of bad stock positions, increase in margin requirements, and then a reduction in the money supply to allow the economy to de-leverage from its current high-debt position. Alas, Greenspan and the Federal Reserve pumped more money into the system, and the reflation has resulted in a debased U.S. dollar, inflation, and a housing bubble from easy credit.
  • Now Bernake and company are trying one more kick at the can with pumping even more liquidity into the economy. The Federal Reserve has abandoned any pretense of fighting inflation or following a "strong dollar" policy, but is in full Keynesian mode of using monetary policy to fight of a recession. Meanwhile, holders of American dollars are seeing their holdings frittered away from inflation and devaluation - a much more sinister remedy than allowing an orderly (albeit painful) liquidation of excess supply and nonperforming loans off the balance sheet.
  • On the fiscal front, the outlook is even bleaker. Congress and the White House have shown no inclination at fiscal restraint. The Democrats want to implement major tax increases that would only exacerbate a tittering economy. Of course, that didn't stop Jennifer Granholm and the Michigan Democrats implementing the largest tax increase in state history in the midst of one of the worst economic crises as well. So, 2010 (expiration of tax cuts from 2001 and 2003 tax reform bills - i.e. 15% dividend and capital gains rates) is looming as a tipping point.
  • Any attempt by the Federal government to "fix" the sub prime problem is moot, and will be limited. Allowing bankruptcy judges to amend mortgage agreements would be a disaster on the long run, forcing borrowers to incur additional costs for a bankruptcy premium. Any "bailout" of lenders would have to be minor and targeted, as there is a growing backlash by responsible borrows who will resist having their tax dollars subsidize those who where irresponsible in their financial decisions.
What I think will happen:
  • This is going to get a lot fuglier before it gets better. If we look at ARMs and sub primes independent of the greater credit markets, a lot of this will not get worked out until 2009-2010, as resets work through the system. This, coupled with excess inventories of housing, will keep additional downward pressure on housing markets and bring them back to historic averages. If we look at the Case-Shiller Index of home prices, many markets still have 20-50% downside before they meet historic averages.
  • Lower interest rates won't help. Even if a lower rate refinancing would save you money, good luck getting an appraisal that will hold a mortgage if you bought near the top with little money down. The tightening in credit standards mean that most people will not be able to take advantage of low rates.
  • Credit Card and Auto loans will have increasing defaults. This ties in with the Greenspan excess money creating easy credit. One could say that a large part of the economic expansion in the past ten years has been debt financed consumer spending. The abrupt change in consumer sentiment, coupled with the evidence of a housing correction and slower economic growth, is leading people to de-leverage. People are either paying off their debts if they have the financial wherewithal to do so, or just defaulting on it and walking away, bankruptcy be dammed. The U.S. economy, if viewed as a balance sheet had inflated asset values, large amounts of debt, and little equity; this worked as long as interest rates stayed low and asset prices continued to climb. Now the asset prices are no longer supporting the debt loads, so leverage is now exacerbating that fall in prices.
  • Long-term interest rates are starting a long-term uptrend. Long-term interest rates are cyclical in nature, but the cycles are generational. We are ending a cycle whereby long-term rates were on a downtrend since 1981. This uptrend could last twenty to forty years, which is the historic norm.
  • Inflation will be with us for a while. It seems that people forget everything that happened more than a year ago, and now it is a repeat of "That 70's show". Even though Keynesian economics has been discredited by Milton Friedman and the monetarists, the powers that be are all sharing the believe that government manipulation of fiscal and monetary policy can "prime the pump" and avert a recession. I'm still waiting for the "Whip Inflation Now" buttons to come out and then price controls.
  • The question is what kind of investment strategy mitigates this risk. Well commodities and non-U.S. dollar assets seems to be a start. Real return bonds is the safest bet on the fixed income side. As for stocks, "buy very very cheap" is the first answer. The second answer is to look at stocks with a very strong balance sheet: low debt, lots of cash, and no accounting gimmicks.

Saturday, March 08, 2008

George McGovern said what??

I had to check the author again of this Wall Street Journal article by George McGovern titled, "Freedom Means Responsibility". These nuggets of wisdom actually came from the man often labeled as the most left wing president candidate in modern time. His insight was that,
Why do we think we are helping adult consumers by taking away their options? We don't take away cars because we don't like some people speeding. We allow state lotteries despite knowing some people are betting their grocery money. Everyone is exposed to economic risks of some kind. But we don't operate mindlessly in trying to smooth out every theoretical wrinkle in life.

The nature of freedom of choice is that some people will misuse their responsibility and hurt themselves in the process. We should do our best to educate them, but without diminishing choice for everyone else.
Seems that being out of government is the best way for politicians to realize the unintended consequences of government action, as so eloquently written by Frederic Bastiat in The Law.

Saturday, March 01, 2008

Obama's Mendacity on NAFTA

It is fun to watch Barack Obama's contortions over NAFTA.  In the Ohio debate, he talks about how is is going to scuttle the deal unless "environmental and labor standards" are changed (newspeak for forcing Mexico to lose it's competitive advantage by imposing Scandinavian union and environmental laws).  He repeats during the Cleveland State debate how he is going to "unilaterally" pull out of NAFTA unless these changes are made.
Of course, it is then reported on CTV (Canadian Television Network) that a "senior Barack Obama campaign staffer" went to the Canadian consulate in Chicago to assure them that Barack's rhetoric is merely political and he has no intention of repudiating the treaty should he become president.
Let's look at all the inconsistencies on Barack's NAFTA bromides so far:
  1. He is looking like a typical left-wing demagogue with language on this.  Not very presidential.  The back channel reassurances to the Canadian government illustrate that Obama is just a hypocritical as any other Democrat on trade.
  2. The Democratic party has gone bezerk the last 7 1/2 years decrying the "Bush unilateralism" on the ABM treaty, Iraq, Afghanistan, etc.   At least we can say that  such unilateralism was in the sphere of what some would call America's security interests.  Instead, the Democratic presidential contenders would unilaterally  scuttle trade agreements it has with its neighbors.  So it appears that the Democrats want to be nice to Iran, Cuba, Venezuela, and North Korea; but will jerk around Canada and Mexico.
  3. Obama's contradictory stands on Mexico.   Obama has said the best way to stop illegal immigration from Mexico into the United States is to develop the Mexican economy so that the economic incentives to illegally cross the border are gone.  This is a very sensible point.  However, when you then turn around and threaten to kill the trade deal that has created hundreds of thousands of good paying jobs in Mexico.  Just imagine the torrent of illegals migrating Northbound if that happened.
  4. The United States, both economically and politically, has a weak hand to force any changes.  With oil north of $100 a barrel, the dollar tanking with no end in sight, and the economy weakening, what are we going to get if Obama did open up negotiations with Canada and Mexico.   Mexico could turn around and say that they will sell their oil elsewhere.  They could also really turn a blind eye to drug and human smuggling across the border.   The Canadian government could pull the preferential treatment of oil exports to the U.S.  (Canada is the largest supplier of oil to the U.S., Mexico is second - so you can see the weak hand the U.S. would have).  Canada would also want to reverse the softwood lumber tariffs, put restrictions on water and oil exports to the U.S., etc.   Canadian Prime Minister Stephen Harper has already made that point.  

Sunday, February 24, 2008

Looking Forward

I have been spending a lot of time reading economic commentary for 2008 and 2009.   I think the most sobering analysis has been coming from Nouriel Roubini of RGE Monitor.  While a lot of economic analysis seems to form the consensus that things will slow down in 2008 and pick up in 2009, Roubini talks about the possibility of financial meltdown and the inability of the Fed to stop it.  I think that Roubini and Jim Grant were amongst the minority of market watchers that were pessimistic about the financial system a few years back.
My observations on the matter are not as pessimistic.   There are major stability issues of the financial markets right now.   While everyone is focused on the subprime mortgages, I think what is not seen right now are the substantial increase in delinquencies and defaults of auto loans and credit card debt.  All of this is the sign of reckless debt financed consumption by the American consumer.   Even without the defaults, the typical consumer is over-leveraged, and more and more are in negative equity situations, thanks to falling home prices.   I believe the next two years will be a period of paying off debt.   The stimulus package passed by Congress  will not stimulate anything;  for the bulk of people, it will be used to pay off debts from consumer spending that stimulated the economy a few years ago.  This definitely implies that with the consumer fixated on paying off debt versus other spending, that the economy will soften.  
What will amplify this slowdown is the precipitous fall of the value of the U.S. Dollar, which is also driving inflation.  The Federal Reserve has little choice right now but to provide liquidity to the banking system at the cost of inflation and further declines of the dollar.   Consumers will now face a lower standard of living after years of living beyond their means.  The federal government has not helped the problem with their profligate spending and deficits.  If the Democrats take over the White House in 2008, and embark on a program of tax increases, this will only exacerbate the situation.

Saturday, February 23, 2008

Saturday, February 09, 2008

Back door Sharia in Ontario

The Toronto Sun reports that Ontario muslims in polygamy are getting multiple welfare benefits, much like in the U.K.  Why is the  West slowly surrendering it's values in the name of multiculturalism, so a civilization intent on destroying the foundations of the West - freedom and pluralism.

Mark Steyn at CPAC

A great stump speech by Mark Steyn at the Conservative Political Action Conference, yesterday in D.C.

Michael Barone on the Detroit Riots

Michael writes about his first hand experience in Mayor Jerome Cavanaugh's office during the 1967 riots in The American magazine.   Barone's impart is that the primary role of local government first and foremost is to preserve order.

Friday, February 08, 2008

Immature Civilization

Check out this article in The City Journal by Kay Hymowitz, called "Child-Man in the Promised Land. It focused on the delayed adulthood of people today. A teaser for it:

Not so long ago, the average mid-twentysomething had achieved most of adulthood’s milestones—high school degree, financial independence, marriage, and children. These days, he lingers—happily—in a new hybrid state of semi-hormonal adolescence and responsible self-reliance. Decades in unfolding, this limbo may not seem like news to many, but in fact it is to the early twenty-first century what adolescence was to the early twentieth: a momentous sociological development of profound economic and cultural import. Some call this new period “emerging adulthood,” others “extended adolescence”; David Brooks recently took a stab with the “Odyssey Years,” a “decade of wandering.”

But while we grapple with the name, it’s time to state what is now obvious to legions of frustrated young women: the limbo doesn’t bring out the best in young men. With women, you could argue that adulthood is in fact emergent. Single women in their twenties and early thirties are joining an international New Girl Order, hyperachieving in both school and an increasingly female-friendly workplace, while packing leisure hours with shopping, traveling, and dining with friends [see “The New Girl Order,” Autumn 2007]. Single Young Males, or SYMs, by contrast, often seem to hang out in a playground of drinking, hooking up, playing Halo 3, and, in many cases, underachieving. With them, adulthood looks as though it’s receding.

It is a rather profound effect. Read Hymowitz's related article The New Girl Order. Diana West makes mention of it in her book "the Death of the Grown-Up". Mark Steyn makes comment about this in many of his writings. One of his prescriptions is to return to the idea of a thorough K-12 education, not the fixation on University; his point is with the decline in standards and achievement has made K-16 (public school and university) is now marginally poorer than K-12 of forty years ago.

Wednesday, February 06, 2008

More Primary-polooza

It now appears that, at least on the GOP side, that things are beginning to settle and that John McCain is the presumptive nominee.   What I think is the main story is two fold.    The first is that until last night, no candidate was really overwhelming the primary electorate.  Second, is the disconnect between Romney in the polls and Romney in the ballot box.   It appears that poor Mitt has a hard 35% ceiling, and for one reason or another, is not connecting with voters.

Thursday, January 17, 2008

The GOP Primaries so far - musings

I have been watching the GOP primaries with a lot of attention, the political junkie that I am.   With Nevada and South Carolina this Saturday, we are drawing to the end of the "retail " segment where candidates can spend a lot of face time with potential voters.

Call this an endorsement or not, here are my observations on the candidates so far:
  • Rudi Guilliani.    He has been out of the limelight, choosing to make a stand in Florida and Super Tuesday, letting the other candidates use up cash fighting each other.   This could be a brilliant move or will backfire, depending on how he does in Florida and on Feburary 5th.   It is plausible that he comes out of the February 5th primaries with the delegate lead, but that remains to be seen.   In terms of the debates and substance, he has done OK overall.  He emphasizes his executive accomplishments, explains his liberal social views in a way that is non-threatening, while acknowledging that people with views outside of his have valid concerns.  He has tried to address them without flip-flopping or out and out pandering.    As to my opinion, while I have some concerns on this matter, specifically 2nd ammendment issues, I think Rudy overall has made himself an acceptable candidate.  I think that he may become the compromise nominee.
  • Mike Huckabee.    Yes, he is charming, engaging, and funny at times.  He just rubs me the wrong way though.  I do not trust him on policy issues - as I think he is a Christian nanny stater.  His views on immigration, education, taxes, smoking, foreign policy and federalism are anathema to traditional conservatives.   His fair tax proposal is pie in the sky and will not work with a federal government the size it is.  Now, if you want to bring the scope of the federal government back to where it was in 1913, it would work, and I would wholeheartedly support that.  But with the welfare state as it is - the fair tax will not work.  He is unaceptable as the nominee and a Huckabee candidacy would be Jimmy Carter redux.
  • Mitt Romney.    Mitt has the policies right, but his presentation is in some ways is offsetting.   You would think that he would have won Iowa and New Hampshire, but somehow he has not closed the deal with primary voters - which would indicate some skepticism.   I think some of this can be addressed with better communications.   He has the resources to lead the delegate count after February 5th, but he has his work cut out for him.   Right now, he is the de facto establishment candidate within the party.  He would be an acceptable candidate, and would be a good president, but needs to do more to address concerns amongst the electorate.
  • Ron Paul.  He is interesting to say the least.  He has had the opportunity to be the figurehead of the libertarian wing of the GOP, but has thrown that out the window with his "blame America first" musings.   His defense of federalism and limited government is solid, but his explanations of his isolationist tendencies come off as bitter.  He could have made a more positive argument on why isolationism works.  That, and his support from neo-nazis and other questionable relationships leaves him as a fringe candidate.   He had an opportunity to start a real movement within the party, but has proven he is not the leader for libertarianism  within the party.   The GOP could use that as a counterweight to the  big government Republicans in the party.  Obviously, he is unacceptable as a candidate.
  • John McCain.   He is infuriating to the party base.  While nobody questions his patriotism and credentials on national security, his personality and record on domestic issues have put off large segments of the GOP electorate.   His embrace of anmesty, campaign finance reform, global warming hysteria, and agnosticism on taxes.  What makes it worse is they way he demonizes those who disagree with him on policy -  this is particularly annoying.     His ill temperment and his embrace of many liberal policies will make it difficult to gain delegates in closed primary states.
  • Fred  Thompson.  I think Fred is the total package in terms of policy and presentation.   He articulates conservative principles forcefully and in a folksy, easy to understand manner.  His problem is that he started too late and his campagin has fumbled to maximize their opportunities. 

  UPDATE:    Well Fred has dropped out - so much for my endorsement!  Now the question is who the bedrock conservatives go to - Mitt, Rudy, or McCain?

Saturday, January 12, 2008

McCain's "blunt talk" has a blaring caveat

I was reading in the Detroit News a story written by Ron French, who IMHO, the best investigative writer the paper has - always a good read).   His story talks about McCains "straight talk" on how the manufacturing sector has a bleak future, and how many economists agree with that assessment.  The article reminded me that McCain, if elected, would be just as detremental to Michigan's economic future.  McCain's embrace of increased CAFE standards, as well as his drinking of the global warming kool aid, would just exacerbate  the problem.  He would be no better than the Democrats, claiming to be for the "working man" but pursuing policies that will just shutter more businesses in the United States and ship them off to where it is more feasible.

Wednesday, January 09, 2008

Republican primaries so far.

My impressions so far:

  • This is still anyone's battle.  The delegates are somewhat evenly spread so far.  Romney has dissappointed with second place finished, but he placed to different candidates and has the money and organization to hold out for super Tuesday in February.  He needs to win a few by then or there is major trouble.
  • Guiliani's decision to use Florida as his firewall and not contest in the early states seems strange right now.  With the momentum that Huckabee and McCain have now, Rudi has his work cut out.   He needs to get a good number of wins on super Tuesday or else he is in trouble.
  • I'm really disgusted with the MSM laying the kid glove treatment to Huckabee and McCain.   Closer examination of their records would show that they have done many things that conservatives find objectionable.   It seems that they want to have the most liberal Republicans win so that the conservatives stay home in November and give the Democrats a win.   We have not hear anything in the MSM about Huckabee's record on tax hikes, tuition breaks for illegals, and pardons of violent offenders.  Neither have we on McCain's record on amnesty, the Gang of 14, opposition to tax increases, embrace of environmental radicalism, and McCain-Fingold.  
  • We'll know more on Super Tuesday, but I'm rooting for a Romney win in Michigan and let the chips fall where they may.  I don't think McCain and Huckabee will do well in many of these states because they are closed primaries (no Independents allowed to vote) and this is where we'll see grassroot Republicans show their disdain for these CINO's (Conservative In Name Only).
In a perfect world, Fred Thompson has impressed me the most with his thoughtful policies and gravitas.   Alas, his poor campaign managment skills will probably ruin any chance at the nomination.   So, unless Fred proves me wrong in February, it looks like the most viable choices in my view are Romney and then Guiliani.  Huckabee and McCain are unacceptable as their records show a consistent streak wholly inconsistent with conservative prinicples.  Romney and Guiliani's records are not perfect, but in light of the political landscape of their respective prior positions - their accomplishments look very good.  Both men have said the right things about the principles they would govern under, and have explained their executive records adequately.  

So here's hoping that the MSM cheerleading squad gets proven wrong again.