Hooray, more debt!

Maybe I can't tell good news from bad.

Honda Motor Co. reported a 41% drop in quarterly profit; quite naturally and rationally investors drove the price of their stock up 16%.

On Monday companies sold $232 billion in new debt. This is ten times the normal volume of commercial paper, (a fancy schmancy name for 'corporate debt') issued per day. $67 billion of the debt was longer term issues -- due to be paid back after mid-January.

If you were a thinking person, you might be asking yourself who in their right mind would be interested in buying long term corporate debt given the current state of the economy. You would think long and hard about the odds of getting paid back given that it is really, really hard to tell who is solvent and who isn't these days.

Well, that's what a thinking person would do. As it turns out, YOU bought about $60 billion of that $67 billion in longer-term debt! How is that for irony?

"Wait just a minute here!" you say. You're not a moron, there's no way you would do anything so obviously foolish. Sorry. You see, the Federal Reserve just got their Commercial Paper Funding Facility going, and took on a bunch of debt. Congratulations, now doing your part.

Economists and market strategists are doing all they can to make sure we know that companies going deeper in debt is a good and positive thing -- key to helping the market and economy turn around. I think my favorite quote is from Adolfo Laurenti, a senior economist at Mesirow Financial Inc.:

"That's the very first really good news in quite some time. It's probably something the government can do and the normal investor would not otherwise do."

Do ya think?! At no point could I find anybody asking why this might be the case. Why would a normal investor be uninterested in loaning money to struggling businesses that refuse to fully disclose the condition of their assets and are dependent on loans to survive? I'm sure the reason will come to me.

That wasn't the only good news though. All day long investors were looking forward to the Federal Reserves much anticipated rate cut. Expectations are for the rate to be cut to 1%. This will make credit cheaper. Which, considering we are in the midst of a rather serious credit deleveraging process, is sort of like discounting salt water sales in the Sahara.

I predict that the Fed will announce a rate cut to .75%. I think they'll do this for the psychological impact.

The problem in the market is that somehow or other we have started to go through a period where reason is breaking out in all sectors. Maybe if the Federal Reserve can jolt us enough, we'll be able to get back on the credit-expansion bubble and things will be jolly all-round again.

It wasn't all bad news though. The run-up of markets around the world presents great opportunities for short sellers (through short sales, call options, short ETFs, or bear mutual funds) to pick up even more gains.

The pickings will be even better if this rally can last through the end of the week. I don't think it can, but there's hope. If nothing else, there are literally millions of people who are determined to have a "V" shaped bottom to the market. They're wrong, and they'll pay for their ignorance... Maybe they can pay you.

http://www.bloomberg.com/apps/news?pid=20601087&refer=home&sid=aKbsT.CRaT1Q

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aYnjVgzH3ADA

The Chin -- It blocks the punches!

In an email conversation today, the question of when to start buying equities again came up. Warren Buffet's advice to be, "fearful when others are greedy and greedy when others are fearful" was cited and that's good advice. That's what Mr. Buffet had to say October 16 in an op-ed piece in the NY Times: Buy American. I Am.

I start with that because it's a good counterpoint to the rest of this. Mr. Buffet is undoubtedly smarter than me -- so pay attention to his advice. :) In the long term, stocks will rise, especially in the face of the massive inflation of the money supply over the past year.

For the next several months to year though, I think the market is in for a helluva beating.

What does it look like is coming in the next handful of months?

While the market has taken a beating lately, I don't think it is anywhere near bottoming out. As I mentioned in an earlier post, the Dow is still overvalued when compared with the monetary inflation that has happened since February 1995. "If the Dow had increased in line with nominal GDP since February 1995, it would today be trading at 7,829." In February 1995, the economy wasn't in the tank, things weren't amazing, but they weren't horrible either.

That isn't the case today. Instead, we have an economy that is unwinding 24 years of credit excess. So far, we've had only a single shoe drop and there are at least half a dozen others remaining.

• Sub-prime mortgages -- $592 billion in write downs
• Alt-A mortgages -- big resets starting in 2009 and accelerating through 2011. This market was substantially larger than the sub-prime market, the borrowers involved are getting further and and further underwater, and the borrowers are typically much more wealthy, have higher credit scores, and are the folks that churn through much more money (higher income, and more discretionary spending). Watch Mr. Mortgage comparing sub-primes to the Alt-A mortgages. There are 50% more Alt-A loans than sub-prime and twice the money involved.
  
• Credit card debt -- default rates are rising (up 45% for JP Morgan Chase, Capital One expects their default rates to hit 7% next year). Moody's expects charge-offs at American Express to increase 30% through 4th quarter 2009.
• Commercial real estate -- As consumer spending drops, and it is busy dropping, the commerical real estate sector is starting to feel the heat.
• Corporate bonds -- There's a fair bit of what I would call whining about the corporate bond sector, but as of yet, the volume of issued bonds hasn't gone off any cliffs. The price (interest rate) has jumped though making this a substantially more expensive way of raising money -- but not a bad investment if the company doesn't tank.
• Municipal bonds -- Municipalities have just started to see trouble as they deal with the impact of investment losses (equities and the death of auction rate securities) coupled with the tax-revenue impact of declining property values. Birmingham, Alabama just voted against declaring bankruptcy. The Los Angeles County Metropolitan Transit Authority may be making service cuts because of the AIG collapse. Other metro rail lines may face similar situations in the future.
• State Governments -- Serious problems exist right now for California and New York. Florida, Nevada, and New Jersey are likely to be next (can't find the link right now).
  

The key driving many of these is the increase in unemployment driving US, UK, and Euro consumer spending down, which decreases business revenue, which increases unemployment....

The US has gone well past the point where each new dollar of debt produced more than a dollar of GDP growth. We're now at the point where it takes 5 dollars in debt to produce a one of GDP growth. That rate is getting worse.

The one thing that has barely started to unwind in the current crisis is debt. We are in a solvency crisis created by 20+ years of cheap credit topped off by 4 years of insanely cheap credit.

During the past year, we haven't really seen gobs of price inflation -- at least not to keep pace with the 2 to 3 trillion dollars pumped in by the Fed and Treasury (and the corresponding actions of the European central banks). Perhaps this is because the cash pumped in has been immediately soaked up by the worthless securities so many financial institutions have on their books. Even so, this is another piper that must be paid. And the inflation piper is an indiscriminate killer of wealth.

Until we start to see a wave of bankruptcies, things aren't going to get better. Too many sectors of the nation and world are insolvent today. Until this solvency crisis is dealt with, things aren't going to improve.

So, when is a good time to get serious buying stuff? Probably once we start seeing more than just a scattered handful of bankruptcies.

This is why I think Buffet could make decent judgements about the short term state of the market.

We really haven't gotten started on the "real" economy side of the current crisis. That's coming.

Inflation -- Bring it On

Well, that should fix it.

This evening, the Treasury department announced plans to spend about $113 billion of the bailout buying stakes in private banks. The banks are: Citigroup, Wells Fargo, JPMorgan Chase, Goldman Sachs, Morgan Stanley, State Street, Merrill Lynch and Bank of New York Mellon. Apparently, none of these banks were given a choice either.

This, at least, is a better way to bailout banks than buying their junk that nobody else wants. Still, the partial nationalization of the nation's biggest banks is a helluva drastic move in the direction of socialism. By itself, this is just bad -- preventing the liquidation of poorly run businesses so those that weren't poorly run can take their place.

That's just the creeping socialism part of the plan. The part that really stinks is the FDIC's new insurance program.

The FDIC will insure new "senior preferred debt" loaned by one bank to another for a period of three years. The intent and desperate hope is that with this guarantee, banks will start lending to each other again. Bank-to-bank lending had dropped drastically in the past month or so due to solvency fears.

Up to this point, the Fed and Treasury have been treating the current mess as a liquidity problem (i.e., assuming that the problem was that businesses didn't have access to cash or credit). Their actions had been for nought though, because the reason for the liquidity pressure was solvency fears. Banks knew that their own books were full of toxic crap assets, and that any financial institution wanting a loan was likely to be in the same state. Given the massive leverage in use, the odds were too good that the counterparty could go under way too quickly as the leverage unwound (like Bear Sterns, Morgan Stanley, Merrill Lynch, Wachovia, Washington Mutual, AIG -- these aren't unfounded fears).

So now, the FDIC is the guarantor of solvency for at least some lending. The part of me that's cognizant of our nation's $10+ trillion debt, $600 billion deficit for next year (that's before the cost of the current fiasco and it's attendant tax receipt reduction -- new estimates are $2 trillion deficit), and $53 trillion in unfunded liabilities makes me wonder just how solvent the FDIC really is. They've got a bit of money on hand -- somewhere in the neighborhood of $40-50 billion.

$50 billion sounds like a lot, until we remember that we got into this mess because bad loans caused more than $635 billion in writedowns across the financial industry. With a whole passel of Alt-A mortgages resetting in late 2009 through 2012, more pain is coming. Oh, and credit card defaults are up, and Home Equity Line of Credit payments are getting late, commercial real estate is trending down, unemployment is on the rise, and consumer spending is (finally!) slacking off.

It is worth asking why our current financial crisis is a solvency crisis.

Fortunately, the answer is pretty easy to determine: way too much credit was extended and debt became too cheap. When the hangover finally hit, what have the Fed and the Treasury done -- switch from Mad Dog to Jack Daniels.

They've brought out the good stuff, and things will probably be pretty sweet for a little while. I've just got this terrible feeling we're gonna wake up in a dumpster hung over as hell and cuddling a three-day-dead dog.

Inflation can be like that.

Links:
http://www.bloomberg.com/apps/news?pid=20601087&sid=alDuNJQDu5KA&refer=home
http://www.msnbc.msn.com/id/27161138/

Our representatives should be hearing from us

Our government is set to bail out dozens of companies that acted with reckless, stupid, and wild abandon. An entire legion of drunken sailors armed with limitless credit cards could not have kept up. Taxpayers are being asked, more like told, to pony up $700 billion to pay for this bender and keep the irresponsible companies afloat. This goes beyond stupid.

I am rarely at a loss for words or a crazy metaphor. Some how, I feel like this is the metaphor that I'll be using to describe some Darwin Award attempt somewhere down the line. "Welding a seat to a JATO rocket and going for a ride with nothing but a Barbie helmet and a leather jacket? That's like the $700 billion dollar bailout of the financial sector, only without the collateral damage."

Here's the letter I'm sending to all of my elected representatives. Write to yours. Copy and past mine if you want. If you're silly enough to want them to vote for this bailout, go get your Barbie helmet.

The Honorable Tom Davis

2348 Rayburn House Office Building

Washington, DC 20515-4611

Dear Mr. Davis:

I am writing you regarding the “LEGISLATIVE PROPOSAL FOR TREASURY AUTHORITY TO PURCHASE MORTGAGE-RELATED ASSETS.” I believe this bill is both a serious moral hazard and a fundamentally unfair transfer of wealth from taxpayers to financial institutions. I urge you to vote against it.

Unlike the Savings and Loan bailout, the “assets” this plan proposes to purchase are not tangible property. Rather, taxpayer dollars would be used to purchase securitized debt instruments. The highly dubious value of these “assets” is in no small part to blame for the trouble many financial companies are in today. The taxpayers did not force these companies to buy these, and therefore have precisely zero obligation to take them off the hands of the businesses that foolishly bought them.

Even if our government were not $9.6 trillion dollars in debt, it would have no place using tax dollars to bail out irresponsible businesses. As it stands, you are being asked to spend money you do not have. Just because you have a checkbook doesn’t mean you still have money. I will be watching this vote with great interest.

Thank you for taking the time to read my letter.