October 2, 2023

Buy on the bad news?

It was difficult to tell today if the late Monday afternoon rally that brought the Dow back almost 400 points off the lows of the day was due to program trades or real buyers “buying on the bad news”.  If the buying was from bargain hunters brave enough to commit their capital on bad news, they certainly had a lot of reasons to buy.  In fact, if there are enough investors willing to “buy on the bad news” that read the Wall Street Journal, then we should be looking at a 5,000 point rally.  Some selected Journal excerpts follow.

Stemming the Crimson Tide

The credit freeze turns into a full-blown panic; no one wants to lend to anyone including interbank lending;  over $4 trillion in banks held by uninsured (and nervous) depositors; no easy solution to a massively over leveraged global financial system; Wachovia debacle does not inspire confidence in government’s efforts.

Iceland Risks Bankruptcy, Leader Says

Island nation cut off from global financial system as government prepares to takes over nation’s banks; tiny country’s bank assets are 10 times the economic output of the nation of 300,000; krona off 40% this year against euro and inflation is 14%.

My Comment: Iceland is bankrupt already, they simply haven’t filed the papers yet. Iceland has no capacity to bail out their banks; the real question is who will bail Iceland out?  I guess no one saw any problem with a couple of banks increasing their assets to 10 times the size of Iceland’s entire economy.

Long-Term Bond Markets Dry Up

The highest credit rated companies are shut out of the long-term credit markets; “credit is all but shutdown” said William Bellamy, direct of fixed income; CDS protection on $10 million of investment grade debt now cost $185,000 vs. a $40,000 per the credit crunch

Bofa Cuts Dividend, Posts Lower Profit

Per CEO  Ken Lewis, “It’s a damn disaster…These are the most difficult times for financial institutions that I have experienced in my 39 years in banking.”

My Comment: Dividend cut saves Bofa $5.6 billion per year which is $5.6 billion less to be spent by investors (consumers) and $5.6 billion less to be taxed by the government.

Mall Vacancies Grow as Retailers Pack Up Shop

Mall vacancies see highest rate since 2001; shopping center vacancies highest since 1994; landlords are giving breaks to tenants to try and keep them from leaving.

My Comment:  Landlords have to give big concessions to keep tenants; lower rents result in lower cash flow and more defaults on commercial loans; commercial loans next big nightmare for the banks.  Despite markdowns of up to 60%, consumer keep their wallets shut (Big Discounts Fail to Lure Shoppers) as credit card companies decrease or close down credit lines in a self defeating cycle.  The consumer was tapped out before the credit crisis, living off of credit cards and home equity lines of credit; sounds like another massive government rebate program is on the way.

If further reasons are necessary to buy this “market bottom” on the “bad news”, just pick up tomorrow’s Wall Street Journal.

The line at the Treasury grows longer

It is no secret that the budget deficits of state and local governments have been growing this year and are likely to accelerate sharply as this recession deepens.  Tax revenues for most states in the previous two months have shown no growth and this situation will only darken with each passing month as job losses accelerate.  Alaska, the only state with a healthy surplus due to higher oil prices is also likely to see their fiscal fortunes darken as the price of oil collapses due to a weak global economy.

Question: given the seeming inability at any level of government to cut spending or increase taxes (see IOU’s Pile Up – Taxpayers Refuse to Pay), what outcome can we expect?

Answer:  based on the numerous recent bailout precedents by the US Government,  the state governments, one after another will line up outside the Treasury for bailouts or government guarantees of their debt issues.  Result:more bailouts until we reach the point where serious minds will have to ask “who is going to bailout the US Treasury?

This week California was the latest supplicant to the US Treasury, asking for $7 billion to tide them over until tax receipts come in.   State officials also blamed the frozen credit markets for preventing them from tapping the credit markets.   I have news for the State of California -you can’t run up never ending debts without limit; it is not “frozen credit” markets causing the problem – it is the fact that poor credit quality borrowers cannot now expect to borrow unlimited sums at low rates.  After his election, Governor Schwarzenegger attempted to cut the State’s budget by reducing the bloated state bureaucracy; after massive political protests he gave up and here we are.

If the Treasury bails out California, there will be 49 states in line right behind them also asking for loans and guarantees.  After spending  $800 billion bailing out Wall Street and providing tax breaks to special interests, it will be politically impossible for Washington to say no to California.   Is Washington going to do what President Gerald Ford did in 1975  when New York City was on the verge of bankruptcy -“Ford to New York City – Drop Dead”?   Different time and different place -California will get their loans and guarantees and continue to spend until there is no one left  foolish enough to lend them money.

Here’s a solution for Governor Schwarzenegger – fight against the financial insanity of open ended deficits; lose  the next election if necessary for the greater good of the State.  Insist on budget cuts – increasing taxes will only make things worse; take on the unions that are bankrupting the future of unborn; get your financial house in order by reducing debt, sell State assets – there is an ocean of cash waiting for the right time and price point to invest; be candid with your citizens and tell them that we cannot borrow our way to “prosperity” anymore, there will be pain but you we will be building a future based on economic growth and real prosperity instead of the false prosperity built upon leverage and debt; tell your citizens that times have changed  and we all need to spend less, expect less and save more until we can correct the insane excesses of the past; if necessary go the route of The City of Vallejo, California which filed for Chapter 9 in order to break the fiscal stranglehold of sky high municipal salaries and benefits.

Sarah Palin touched on the need to save and only buy what we can afford to during her last debate but I am convinced that there are few politicians out there who have the courage or verbal skills to give the voters this type of message.

Unfortunately, the local, state and federal governments face tough choices on the road to financial health since they will need to reduce the multi trillion dollar benefits promised but now impossible to pay.   An age of hard times is upon us and those who chose to believe that their “entitlements” are due no matter what are in for a rude awakening since the future has already been spent.

Say no to California for  a bailout – they need to figure things out for themselves.

“Investment Time Bomb, Mega Catastrophic Risk”

I have often noted that predictions made early eventually turn out to be the most accurate, but oft most forgotten since it is yesterday’s news.  Perhaps the real nightmare now upon us is the one predicted by Warren Buffet in March 2003, as well as in earlier interviews, in which he prophetically stated that:

“The rapidly growing trade in derivatives poses a “mega-catastrophic risk” for the economy…

Large amounts of risk have become concentrated in the hands of relatively few derivatives dealers … which can trigger serious systemic problems”

Mr Buffet explained the risks of derivatives after buying a reinsurance company with a small portfolio of derivatives. These positions were gradually sold off  for a big loss “in a leisurely way in a benign market”.

In May 2007 Mr Buffet again spoke of the extreme risks to the global financial system saying:

“that excessive borrowing by traders, investors and corporations will eventually lead to significant dislocation in the financial markets.”

Mr Buffet’s dire predictions are not to be taken lightly and,  unfortunately, now appear to be occurring.   A default chain of these insanely devised and leveraged products could cause extremely significant and long lasting damage to the world economy, probably beyond the immediate ability of the world’s central banks to contain.  The collapse of Lehman, a very big player in derivatives, has some wondering if the unwinding of their contracts is the trip point for the “mega catastrophe” and the cause of the current credit crisis.  The Federal Reserve and Treasury Department apparently did not see the risk when they let Lehman go under.

Since these derivatives (specifically the CDS) are essentially a zero sum game for the parties involved (one player’s loss is equal to another player’s gain), and given the potential catastrophe we face, the government should consider a mandated freeze on the contractual obligations involved by all the counter parties in the derivatives market and then allow them to be unwound in a controlled manner.  Hopefully, at the level of power that matters, this situation is being urgently reviewed.

Fortune – The $55 Trillion Time Bomb

General Electric’s tactics incite panic

General Electric’s plan to raise $12 billion in capital via a common stock offering and a $3 billion sale of preferred stock to Warren Buffet normally would seem to be a prudent move to raise liquidity in a very uncertain economic environment.  Instead investors reacted by treating GE to a 10% loss on the day, ranking GE as the largest loser of the 30 Dow Jones stocks.

Such is the state of panic that the market is in when one of the few companies left with a triple A credit rating is viewed with suspicion.  It was very easy, however,  to conclude that something is quite wrong with the massive $700 billion GE Capital loan portfolio if GE had to pay an almost sub prime type rate of 10% on the preferred stock sale and, in addition, sell $12 billion of stock when the stock is trading at almost a 10 year low.   Making the stock sale look even more urgent is the painful fact that GE has been buying in stock for years at considerably higher prices than they are now selling it for.   Also, if GE really had no trouble raising money in the commerical paper market at 3.5%,  why would you borrow at much higher rates??  With two recent earnings warnings, one has to wonder exactly what is in the $700 billion loan portfolio, how much of it is lent long with borrowed short term funds and what type of losses will ultimately be incurred.

It is statistically stupid to conclude that Warren Buffet is not making another smart investment assuming that, as in the past, this financial panic will end and those buying now will be greatly rewarded with gains in the future.   My take is that there will be greater bargains and a better time to buy for the patient investor – maybe that day will be when we see a cover story from a national news media proclaiming the “death of equities”.

Insurance Industry Meltdown Continues

Insurance company stocks again suffered major losses today, with MET down 15%, PRU down 11% and HIG down a stunning 32%.   The Wall Street Journal reported on the various reasons for the continuing sell off including the poorly timed comment by Senator Reid that “someone in the Democratic caucus had said a major insurance company, “one with a name that everyone knows,” was on the verge of bankruptcy.”  A spokesman for his office later attempted to soften the statement but the damage was done.

The market value loss today on these three major US insurance companies totaled almost $12 billion and the total market cap loss from the 52 week highs on MET, PRU and HIG total a stunning $61 billion.   The horrific asset value losses being seen on virtually every asset class will have a devastating negative wealth affect on consumer spending which will in turn lead to major job losses as virtually every industry in the country experiences lower demand; this cycle is of course self reinforcing.

The Wall Street Journal also reported all three companies stating that their business was basically sound and that capital levels were fine.

On Thursday, MetLife said it had terminated some reinsurance contracts, so it will get back by late January $600 million in premiums it had paid. The company said the move had nothing to do with capital considerations.

All three firms distanced themselves from Sen. Reid’s remark Wednesday. Hartford also said the firm’s “liquidity remains strong.” MetLife said the company “is financially sound.” A Prudential spokesman said it has “a lot of cash at the parent-company level.”

My take on this is that things are obviously not fine but at a critical stage since insurance companies, as with banks, rely on confidence and right now there is a crisis of confidence.   After the AIG debacle, which occurred despite many assurances of financial health from the company before it imploded, investors are obviously giving little credence to assurances of any kind, especially when it is not possible to know what type of exotic financial timebombs (CDS, etc) that may be lurking in the portfolios.

In the past, this type of panic sell off would have provided an incredible buying opportunity for these three great American financial institutions, and this may indeed turn out to be the case.  My advice – wait and see who survives since trying to buy any selloffs in this bear market has more often than not produced some very fast losses.

Mortgages Still Being Approved For Unqualified Borrowers

With foreclosures at record highs and the banking system in collapse, why would the banks still in business be making loans with reckless disregard to the borrower’s ability to repay? As explained in my post “Unsound Lending Policy“, any mortgage borrower with a high debt ratio (large percentage of income devoted to debt repayment) is usually a candidate for default. The borrower may be unsophisticated or simply over optimistic but it should be the responsibility of the lender to ascertain, using sound underwriting policies, that the borrower has a reasonably probability of being able to repay his mortgage debt.

I am still seeing loans being approved by automated underwriting systems for borrowers with total debt ratios in the high 50’s and just this week another loan approved with a 62% debt ratio. The odds of these loans defaulting are astronomically high since the borrower simply does not have enough income to pay his loans and living expenses. These loans are being approved by “desktop underwriting”, a system where the loan is approved by a computer based on input values. Obviously the software underlying the desktop underwriting that determines whether a loan will be approved has not been updated from several years ago when little regard was given to income, credit or loan to value, since it was assumed that the borrower would simply refinance again or sell the home in an eternally rising property market.

The loans being approved today with super high debt ratios are technically not “subprime” loans since that industry no longer exists; these are loans that will be sold to Fannie Mae in most cases, thus assuring that Fannie Mae will continue to have future foreclosures and a need for eternal government support and bailouts.

The really dark question here is, have the automated underwriting systems simply not caught up with the times or is this an effort to keep home sales up, support otherwise starving realtors and mortgage companies and hope that future rising home prices will keep the high debt ratio mortgages from defaulting? If one chooses not to accept the dark theory, the only other answer seems to be that reckless mortgage lending is still alive and well.

Next Bailout – Insurance Industry?

Insurance company stocks continued their brutal decline today as questions continued over capital adequacy, credit downgrades, uncertainty on future portfolio write-downs, potential cash calls on CDS obligations and investor disbelief over company statements that all is well.   As noted yesterday, HIG’s stock imploded along with the rest of the industry and I stated that they should come out with very decisive action to stop the vicious downward cycle of stock declines; which is exactly what GE did today by raising cash that they said they really didn’t need.

HIG issued a relatively neutral statement saying that all was well and it’s stock continued to decline.  I don’t think investors will be putting much credence in company statements of assurance after the AIG meltdown where everything was fine until one day it wasn’t and they needed $85 billion and lights out.   With a crisis of confidence, any company that has generated questions on its financial soundness needs to respond immediately before the market makes its own harsh decision.

The insurance industry is in many ways more important to our economy than the banking system; they should take immediate action to  strengthen their balance sheets to ride out this financial crisis.

MET 48.15 10/1/2008 -7.85 -14.00
GNW 7.36 10/1/2008 -1.25 -14.50
ALL 44.00 10/1/2008 -2.12 -4.60
CB 51.55 10/1/2008 -3.35 -6.10
PRU 64.80 10/1/2008 -7.20 -10.00
HIG 38.11 10/1/2008 -2.88 -7.00

HIG Implodes

After the recent implosion of AIG due in large part to their massive credit default swap positions on sub-prime mortgages, investors did not need much encouragement to sell HIG after it disclosed having CDS exposure on AIG debt.  This, along with disclosure of holding debt securities of LEH, AIG and WM in their asset portfolio as well as a possible credit downgrade was enough to cause a brutal 20 point sell off at one point, for an intraday loss of $6 billion dollars.

HIG recovered half of this loss by day’s end but still ended down 18% and the cost of buying insurance on HIG’s debt jumped by over 40%.  We have seen this type of horror show too many times this year.   Management should immediately take steps to raise capital, reduce the dividend and make full disclosure of what CDS exposure they have, before rumors become more important than the facts.  It is interesting to note that despite the brutal sell off of many insurance companies this year and the fast collapse of AIG, the SEC did not place HIG on their restricted short sale list.

What has Bernanke learned?

The Wall Street Journal reports on the lessons that Chairman Bernanke,  a student of the last depression, learned from his textbooks and  studies in school.   According to the Chairman, “The experience of the Depression helped forge a consensus that the government bears the important responsibility of trying to stabilize the economy and the financial system, as well as of assisting people affected by economic downturns”.

This theory no doubt has been the impetus behind the efforts to provide massive amounts of liquidity and loans not only to the banking industry but also to scores of non banking related entities as well.  These operations have been criticized for their apparent ineffectiveness so far but I have no doubt that eventually,  the Federal Reserve will succeed in “stabilizing” the banks and the economy by providing oceans of credit in such great quantity  that only the most ridiculously inept companies won’t survive.  If you have an inquisitive mind, however, and analyze why we are in a financial crisis, one might conclude that it was brought forth by excessive credit creation and leverage on a scale never seen before by the same government entity now attempting to save us.  The great credit bubble did not start overnight- it began in the 1980’s and has grown exponentially ever since, propelled in large part by the Federal Reserve, which reacted to every mini crisis of the past two decades by simply providing more credit at lower rates.  Every event that might have caused a ripple in the economy was papered over with more credit instead of letting the creative destruction forces  of a capitalist system purge itself of poorly run,  financially reckless companies.  A recession, which is the mechanism by which excesses are cured and capital allocated more wisely next time, was viewed with horror and an end of the world event.

So here we are today, again, apparently left with no options to save the system, except by increasing the leverage again.   Will it work one last time or will our lust to borrow in excess once again this time be tempered by the reluctance of our foreign creditors?  My vote is that since we cannot apply fiscal discipline on ourselves, let us hope that China, Japan and the rest of the future bag-men for our treasury paper will limit our attempts at financial self destruction.