Monday, September 29, 2008

Short Story

Where does the answer lie?
Living from day to day
If it's something we can't buy
There must be another way
--The Police

Price action of Wachovia (WB) over the past few days reflects the folly of the short selling ban. After the decree on Sept 18-19, a huge squeeze chased the shorts.

Subsequently, the fundamental news at WB weakened. Absent shorts below to cover, the stock dropped over 50% in a week's time. The death stroke today took the stock to $.01 before bouncing.

Outlawing short sales strips liquidity from the system, and increases probability of an extreme move lower.

Another unintended consequence of bureaucratic intervention.

no positions

Glimmer of Good

Now that your rose is in bloom
The light hits the gloom on the grave

Gotta admit that I never expected the bank bailout bill to be voted down. In this battle between liberty and socialism, score one for the freedom fighters.

Of course, this may be a temporary respite in light of the Dow's record 778 point slide after the thumbs down vote. Pundits are most certainly screaming that the market melt is proof positive that we need to step in. Indeed, theory suggests that the odds favor the interventionists.

However temporary, I'm relishing in some sense that our founding ideals haven't totally left the building.

no positions

Sunday, September 28, 2008

Eminence Front

The drinks flow
People forget
That big wheel spins, the hair thins
People forget
--The Who

It appears a bailout deal is eminent. Note the rush to have an agreement in principle ahead of the Asian market open tonite. Those who believe bureaucrats operate independent of market influence are sadly mistaken.

Even sadder, of course, is the bureaucratic intervention itself. Some will claim that this event marks the day free markets died. But truly free markets have not been with us for quite some time. We've been distorting markets for years through various forms of regulation and meddling.
However distorted markets become, though, free market FORCES persist. Like any natural system seeking equilibrium, these forces have been building in direct opposition to the cumulative distortions.

To understand the nature of the market forces currently at work, we merely need to study the cumulative consequences of market meddling. Excesses brought about by years of inflationary distortion are what market forces want to correct. If unshackled, we know exactly what market forces would seek to do. They want to reduce asset prices, wipe out bad credit and debt, and encourage savings.

This, of course, is precisely the opposite of what bureaucrats want to see. So they craft even greater interventions in attempts to keep market forces at bay.

But market forces are patient and unrelenting. And the more interventionists meddle, the greater the potential energy built into the market's ultimate response.

It's natural law at work. The consequences of this potential energy turning kinetic seem increasingly ominous.

no positions

Friday, September 26, 2008

Spin Cycle

I can't stand this indecision
Married with a lack of vision
Everybody wants to rule the world
--Tears for Fears

As Washington Mutual (WM) bites the dust this morning, I've read or heard numerous comments from pundits that go something like this. "These bozos in Washington just don't know how serious the financial system crisis is. We need that bail out package. They're busy politicking while the system implodes. How out of touch! Their level of incompetence is unbelievable!"

Therein lies the problem, of course. Expecting bureaucrats to be on top of market issues, and to effectively be able to pull levels to 'fix' economic problems is the height of folly.

There are those who believe that it's just the CURRENT set of politicians who are the problem. If we simply changed the slate, then government would be able to correctly navigate us through these rough waters.

If we continue to focus attention on government sponsored solutions to our problems, then events are destined to play out in Ground Hog Day fashion.

And standard of living will surely decline.

no positions

Wednesday, September 24, 2008

Church Street Station

Who would be the fool to take you
Be more than just kind
Step into a life of maybe
Love is hard to find
--Culture Club

A quick shout out to the always insightful Jim Grant for his 9/23 NYT editorial "The Buck Stops Here." One passage that really made me grin:

"We Americans, constitutionally inattentive to developments in the foreign exchange markets, should be grateful for what we have. That a piece of paper of no intrinsic value should pass for good money the world over is nothing less than a secular miracle."

A secular miracle indeed. Hard to see how anything short of continued divine intervention will save the dollar from getting roasted as a consequence of the massive levels of pending government intervention.

position in USD

Tuesday, September 23, 2008

And Then There Were None

Just wait till tomorrow
I guess that's what they all say
Just before they fall apart
--New Order

On January 1, 2008, the five largest U.S. investment banks boasted a combined market cap of nearly $250 billion. Now, after the announcement that Goldman Sachs (GS) and Morgan Stanley (MS) are reorganizing to become bank holding companies, the top five players have left the field, and the remaining investment banking industry is a lot smaller.

Poof! Just like that, centuries old institutions disappear.

An example of what can occur as a consequence of extreme leverage gone awry.

no positions

Sunday, September 21, 2008

Absolute Power

I think it's time we stop
Hey, what's that sound?
Everybody look what's goin' down
--Buffalo Springfield

Hammerin' Hank is tossing together a plan this weekend that will make the 1930s Reconstruction Finance Corp and 1980s Resolution Trust Corp programs look like peanuts. The government is seeking virtually unlimited power to purchase mortgage-related and 'other' assets without explicit justification.

As usual, both sides of the aisle are in lockstep on this program's 'necessity.'

Are people of this country so comatose as to ignore the grave threat to liberty posed by this unilateral action? Surely the sheer boldness of this action will be enough to jar people awake.

Or are we destined to become human batteries for the government?

Vanishing Act

And as the flames climbed high into the night
To light the sacrificial rite,
I saw Satan laughing with delight
The day the music died
--Don MacLean

Although I fully anticipated that bureaucrats would pull out all stops to prop up badly listing markets, the historic interventions of the past week find me mired in a sadness that I can't seem to shake. From where I sit, the last semblance of freedom is being extracted from our markets.

Present and future generations will surely suffer as a result.

Two other brief comments at this point. For those unaware of our political economy's bias towards the bank, please open your eyes and observe the present situation.

Also, it's hard to believe how this activity is not bullish for gold. The sheer size and aggressiveness of these interventions further distort an already unstable system in a manner that drastically raises probability that markets will come completely unglued down the road.

position in gold

Wednesday, September 17, 2008

Tipping Point

Ahh, it'll take a little time, might take a little crime to come undone
Now we'll try to stay blind, to the hope and fear outside
--Duran Duran

A note for posterity's sake as I watch market action on the back of news of the American International Group bailout this morning. The Dow is down about 350 currently. Gold ripping nearly $70 higher on the announcement of Fed balance sheet expansion and foreigners reducing dollar-denominated investments. Banks are cracking. Money market issues. Curbs on short selling are in process. Russia down double digits.

Stock markets 'feel' like they're starting to unravel. Prolly wrong, but feels like we're edging the abyss.

position in gold

Monday, September 15, 2008

Thriving on Chaos

Tell me
Why'd you have to go and make things so complicated?
--Avril Lavigne

Today's news on Lehman's (LEH) bankruptcy and Merrill's (MER) buyout has many noting lack of direct government involvement in these arrangements. Some suggest that this signals bureaucratic realization that the general credit market situation, rather than being 'too big to fail,' is instead 'too big to bail.'

I wouldn't conclude that. After all, the Fed was in the background today with some monster repos. And it agreed to take on riskier collateral, including stocks, for borrowers at the special alphabet soup of term auction facilities. Parenthetically, this suggests that you and I are now owners of stocks 'purchased' by the government via these trades.

Moreover, I'm guessing that officials have their hands full trying to keep a bomb from exploding courtesy of American International Group (AIG).

There are so many moving parts to our fragile system right now that my sense is that government meddling is merely more difficult to detect.

But the Invisible Hand is surely active.

no positions

Saturday, September 13, 2008

Physical Graffiti

Is it every time I fall, that I think this is the one
In the darkness can you hear me call
Another day has just begun
--Led Zeppelin

We're seeing a big disconnect between the paper and physical markets for precious metals. Despite a 50% decline in paper silver since March, for example, dealer supplies of silver coins and bars are low. On ebay, I currently see rolls of silver eagles being bid at spot + $4 to $5, more than twice 'normal.' Gold coins are in similarly short supply.

What gives? I believe we're seeing forced liquidation in the precious metals (as well as all commodity) markets as speculators unwind leveraged positions. This has pushed futures prices lower. Retail buyers, sporting less leverage and more cash, are seeking to pick up physical metal at bargain prices.

Over time, physical demand should steer these prices.

My personal plan is to purchase some gold each month as long as price stays below $1000/oz. I like the value here.

I like to think of physical metals as pure tangible wealth that should not be traded. Rather, it is to be methodically accumulated at a deliberate pace, and then passed down to future family generations.

position in gold, silver

Friday, September 12, 2008

Stress Fracture

Look around everywhere you turn is heartache
It's everywhere that you go
You try everything you can to escape
The pain of life that you know

Blood continues to flow on The Street related to the financials. While overall market indexes trade relatively sanguine, individual financial issues continue to get crushed. Rumors swirling around Lehman (LEH), American International Group (AIG), and Washington Mutual (WM)--among others--suggests some type of announcement perhaps this weekend.

The volatility in these financial names is breathtaking and volume is gargantuan (the 3 names mentioned above combined for over 1 billion shares traded today!). Just as a snapshot for my future reference, some select closing bell prices today:

Fannie Mae (FNM) $0.74 (-5%)
Freddie Mac (FRE) $0.46 (-22%)
Washington Mutual (WM) $2.73 (-3%)
Merrill Lynch (MER) $17.05 (-12%)
American International Group (AIG) $12.14 (-31%)
Lehman (LEH) $3.65 (-14%)

Although it seemed straightforward to articulate the plausibility of this credit crunch situation years back, my mind balks at digesting some of the prices I see on the screen as the scenario is realized.

I have to think bureaucrats will be busy whipping up a Weekend Surprise to in yet another valiant attempt to stem the red tide. Also, I wouldn't be surprised to see a Fed easing either at their confab next week or sooner (although the bond market, much to my amazement, currently isn't pricing in a cut).

no positions

Tuesday, September 9, 2008

Break It Down Again

When it's all mixed up
Better break it down
In the world of secrets
In the world of sound
--Tears for Fears

I've heard a few folks claim that what we're experiencing isn't deflation, but a period of de-leveraging. They go hand in hand, of course. Deflation is contraction in the quantity of money and credit. And credit contracts via a process of deleveraging.

Our monetary system is tilted way towards the credit category. Credit means borrowing, and when you've borrowed, you're leveraged. You've borrowed to 'lever up' potential returns. These potential returns could be financial, or, more broadly construed, could represent targeting a lifestyle or standard of living that couldn't be achieved without borrowing.

Leverage works both ways. When market winds are at your back, returns are magnified. But when market winds face you, losses are magnified. As such, leverage increases risk.

Broad market headwinds have turned leveraged market participants into net sellers. They need to sell to de-lever, cut losses, and reduce risk. And they're selling everything. Stocks, bonds, real estate, oil, gold, commodities.

These broad price declines are a consequence of the de-leveraging, or deflation.

After the Fannie Mae (FNM)/Freddie Mac (FRE) 'bail out rally' yesterday, hard selling resumed today as chatter got loud of next shoes to drop. Lehman Brothers (LEH) may be next, as the stock tanked nearly 50% today on huge volume to close in single digit midget territory.

Observing the current price action, I can't help but think that, if we're approaching a time where a bunch of leveraged players simultaneously decide it's time to hit the eject button, then a major stock market dislocation may be eminent.

positions in oil, gold

Sunday, September 7, 2008

One Hundred Days to Nowhere

Been away so long I hardly knew the place
Gee it's good to be back home

Leave it till tomorrow to unpack my case

Honey disconnect the phone

--The Beatles

Today's news that the US government will take over Fannie Mae (FNM) and Freddie Mac (FRE) is a watershed, but not unexpected, event. Indeed, if you've been reading Minyanville, then this announcement should not surprise you much. MV has been elaborating the F-Troop situation for years.

I have no doubt that many mainstream media commentators, as well as political pundits, will portray this situation as a 'market failure' and that government intervention was necessary to preserve social welfare.

Critical thinkers likely won't drink that kool aid. Fannie and Freddie are 'government sponsored entities (GSEs)' which, by definition, are vehicles of bureaucratic intervention in market functioning. Fannie, for example, was born from FDR's New Deal programs in 1938 with the goal of boosting home ownership above what free markets would have permitted alone.

There is nothing 'market failure' related about the F-Troop case. Instead, this situation is the product of potential energy turned kinetic from pressures building over years of bureaucratic market distortion.

Claims that placing FNM and FRE in government receivership are necessary to preserve social welfare are contestable as well. Consider those likely to benefit from this bail out, including holders of GSE debt and mortgage backed securities (including bond firms like PIMCO), politicians promoting housing market preservation and housing for the poor, mortgage holders who borrowed more than they should have, lenders who lent more than they should have, among others.

Who gets hurt? Those who were prudent. People who didn't reap reckless rewards during the preceding housing boom, but who will pay for the recklessness of others as the boom inevitably busts.

As such, the rich get richer and the poor get poorer. For those concerned about increasing disparity in class wealth, look not on 'free markets' as the cause of this phenomenon. Consider instead the consequences of government intervention that distorts markets, and of our ongoing willingness to privatize gains and socialize losses.

no positions

Saturday, September 6, 2008

Loan Shark

You mention the time we were together
So long ago, well I don't remember
All I know is that it makes me feel good now
It's like I told you, only the lonely can play
--The Motels

Over the past year, the Fed has opened many special credit facilities to permit financial institutions to borrow cheaply from the central bank. The idea is that by borrowing extra cheap, institutions could then buy higher yielding securities and make money on the spread. Thus, banks could shore up their balance sheets by generating capital from the carry trade.

Problem is that, due to the sheer volume of underperforming assets on financial firms' balance sheets--assets that are highly leveraged and that continue to decline in value--there is no way this carry trade will be able to reliquify bank balance sheets in any reasonable period of time.

Insolvency looms.

Thus, we see an array of firms such as Lehman (LEH), Wells Fargo (WFC), Nat City (NCC), and Washington Mutual (WM) seeking to tap debt markets to raise capital. The effective interest rates required by creditors, however, are much higher (e.g., 9%+) than the levels where banks can make money, thus producing a negative cost of carry.

What's this tell us? Firms are desperate for capital. They're not thinking about ROI; they're thinking about survival.

Like Minyan Peter, I sense that a wave of bank failures and an overstressed FDIC are pending.

no positions

Thursday, September 4, 2008

Back to the Future

I'll tip my cap to the new constitution
Take a bow for the new revolution
Smile and grin at the change all around
Pick up my guitar and play
Just like yesterday
And I'll get on my knees and pray
We don't get fooled again
--The Who

Over the past couple of years I've probably read the Constitution a hundred times. I'm struck by its bias towards strong central government, and the 'loopholes' (see, for example, article 1, section 8) that enable government to amass additional power. The tone of this document seems inconsistent with the spirit of liberty that motivated the Revolution and this nation's founding.

It made me wonder about the historical context of the Constitution's framing and ratification. In particular, did any folks back then share my sense of concern over the contents of our country's most important structural document? Turns out the answer is 'yes.'

The 'Anti-Federalists' comprised a sizeable group of Americans who argued against the Constitution in its existing form. Ohio State professor Saul Cornell (1999) identifies nine issues that appeared time and time again in Anti-Federalist writings:

1) Consolidation. The Constitution abolishes the federal character of the union and creates a single national government acting directly on the people. Since governments capable of sustaining liberty are possible only in small state-centric republics, broad-based consolidated government undermines liberty.

2) Aristocracy. Absent appropriate checks such as annual elections, term limits, state-controlled elections, and adequate separation of powers, the Constitution promotes the development of an artistocracy that will cease to be accountable to the people. Over time, corruption is inevitable.

3) Representation. The Constitution fails to provide for adequate representation of the people in the popular branch of government; the senate is too far removed from the popular will.

4) Separation of powers. With notable examples covering treaties, appointments, and impeachments, the Constitution blends functions of the legislative and executive branches in dangerous fashions.

5) Judicial tyranny. The Constitution creates a powerful judicial branch that threatens the integrity of state courts. Moreover, jurisdiction of national courts over matters of fact and law is too broad.

6) No bill of rights. The Constitution omits a declaration of individual rights establishing essential personal liberties.

7) Taxes. The Constitution grants extensive power to tax, which may be used to oppress the people and threaten state autonomy.

8) Standing army. The Constitution neglects to prohibit a standing national army during times of peace and threatens integrity of state militia.

9) Executive. The extensive powers of the president risk creating an elective monarchy.

Many of the Anti Fed forecasts seem quite prescient.

During my study, I've found the clarity of thought surrounding issues of government during our founding period to be quite impressive--much more substantial than the drivel that commonly reflects political discourse today.


Cornell, S. 1999. The other founders. Chapel Hill, NC: University of North Carolina Press.

Monday, September 1, 2008

Slipping Away

Nobody on the road
Nobody on the beach
I feel it in the air
The summer's out of reach
--Don Henley

Two factors drive ongoing improvement in a society's standard of living. Saving facilitates accumulation of capital stock, which is essential to increasing output beyond what is possible by manual labor alone. Innovation combines resources and technologies in novel ways that increase value.

Both of these improve productivity, defined as the quantity of output derived from a unit of input. Because inputs, or resources, are scarce, society is better off when more output is realized per unit of resource. Individuals achieve higher standard of living through increased real income, expressed in terms of purchasing power.

Due to ignorance, greed, arrogance, or other reasons, people often fail to recognize the adverse effects of bureaucratic interventions on the two primary drivers of standard of living. Consider, for example, these two government programs:

a) Increase corporate taxes. Often, the stated goal is to redistribute income from businesses to individuals, particularly low income earners.

b) Supply side economics. Made 'famous' by the Reagan administration, SSE essentially amounts to cutting taxes with no commensurate decrease in government spending (in fact, spending nearly universally increases). To make up for the revenue shortfall, government must then borrow and or print money (it usually does both).

Reflect on how these programs influence societal savings (capital stock accumulation) and propensity for innovation.

Once you have reasoned it through, then test your thesis with relevant empirical evidence, such as US economic data sourced from the past 30+ yrs during which the above government programs have been particularly active.

Well reasoned, intellectually honest thought produces but one conclusion about the relationship between bureaucratic intervention and societal standard of living.