Past Tense

I'll tip my hat 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
Then I'll get on my knees and pray
We don't get fooled again
--The Who

Ponder these quotes from Thomas Jefferson:

"If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, (i.e., the "business cycle") the banks and corporations that will grow up around them will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered."

"I believe that banking institutions are more dangerous to our liberties than standing armies."

TJ definitely 'got it'...

Do you think we'd have a Federal Reserve today if TJ was still the man?

Raw Deal

Jewel box life, diamond nights, and ruby lights
High in the sky
Heaven help him
When he falls
--Sade

The more I reflected on the Fed-orchestrated buyout of Bear Stearns (BSC) by JP Morgan (JPM) last week, the angrier I got. In a market system, you can't have two parties appropriate the property of a third party without consent. John Hussman discusses it more elegantly than I:

http://www.hussmanfunds.com/wmc/wmc080324.htm

This deal is illegal. Congress needs to stop it.

Whether we step up and uphold principle here may go a long way in forecasting where we're economically, and socially, headed.

no positions

Extreme Measures

So forget all that you see
It's not reality
It's just a fantasy
--Aldo Nova

How weird is it getting out there? Take a look at some of the proposals and actions towards end-of-week:

1) Steve Forbes proposed on CNBC that the government suspend mark-to-market rules for one year so that securities holders would not have to realize near term losses. Guess I missed the textbook chapter on Pretend Accounting.

2) Government lowered the capital requirements for Fannie Mae (FNM) and Freddie Mac (FRE), freeing these government sponsored entities (GSEs) to purchase more mortgage backed securities on their balance sheets. How this does anything more than increase the leverage in an already overlevered situation is beyond me. (The obvious implication is that takes us one step closer to the nationalization of the housing market)

3) An editorial in the Wall Street Journal opines that the government buy and bulldoze foreclosed homes in order to reduce supply and increase prices.

No way, you say? Did you know that FDR oversaw the burning of crops during the Depression in a futile attempt to prop up ag prices?

no positions

Land of Confusion

Ooh superman where are you now
When everything's gone wrong somehow
The men of steel, the men of power
Are losing control by the hour
--Genesis

I've heard a number of commentators opine that yesterday's buyout of Bear Stearns (BSC) by JP Morgan (JPM) was not a bailout and didn't invite moral hazard. How can such a deal promote moral hazard, they argue, given the carnage in BSC stock and the thousands of Bear employees likely to soon hit the bricks?

Get real. Anyone with eyes can see that this deal was cobbled together to protect the broader interests of those lugging excessive risk and who stand to be crushed in a credit market seizure induced by the insolvency of a major broker dealer.

And, indeed, the risk takers were back in gear only one day after their reprieve, walking the Dow up 400+ points today.

It does appear that we've transformed into a Bailout Nation, willing to privatize gains and socialize losses. Ironically, this intervention does nothing but increase the wealth divide that so many complain about.

The meddling also increases the potential energy of market forces currently being restrained from a natural cleansing process.

At some point, however, these forces likely won't be denied.

no positions

Iron Curtain

This wouldn't be the first time
Things have gone astray
Now you've thrown it all away
--Bryan Adams

To top off a wild week, perhaps the craziest thing I saw was Friday's proposal to permit managers to revalue Level I assets perceived as 'wrongly' mispriced by the market.

A Level I asset is one that trades routinely, such that representative prices are regularly available. General Electric stock (GE), for example, whose 10 billion share float trades nearly 50 million shares daily, is a Level I asset. If you owned 100 shares of GE, the value of your position would be $3382 as of market close on Friday (100*$33.82 closing share price). Simple.

Let's say that you disagreed with the market's current price of a GE share. Instead, you think it should be worth $50/share. Essentially, this new proposal would allow you to 'legally' revalue your GE position to $5000 (100*50).

And so we have it--a government sponsored proposal for the mark-to-fantasy balance sheet.

"Pay no attential to that man behind the curtain..."

no positions

Dollar Dust

Crossing that bridge
With lessons I've learned
Playing with fire
And not getting burned
--Seal

The Fed's actions this week to accept risky mortgage paper as collateral from financial institutions in exchange for Treasuries has been crushing the dollar to new lows. Having trouble connecting the dots? The Fed puts junk on their balance sheet. If the junk goes down in value, the Fed could a) take the loss and perhaps go bankrupt b) print money to make up the difference.

The market whiffs b)...more potential dollar supply and, voila, greenbacks get sold.

Some are suggesting that a stronger economy will cause the USD to rise despite these clearly inflationary efforts. Hard for me to see.

Instead, I think the best case for a dollar rally is if folks determine that none of these interventionist policies will stave off recession. If people recognize this and become risk averse (hoard cash, pay down debt, unwind risky positions), then demand for dollars should increase.

This, of course, is the deflation scenario. Should this come to fruition, risky asset prices should fall as the dollar rips higher.

Bad Dream

Some will win, some will lose
Some were born to sing the blues
Oh, the movie never ends
It goes on and on and on and on
--Journey

Laugh of the week has to be the Ambak (ABK) situation. Initiatives discussed to keep the struggling mortgage insurer afloat have included breaking the company into 'good' and 'bad' liability entities, a straight buyout by a group of financial companies, and government sponsored relief. A day or so back, ABK announced that it will head to the capital markets to raise funds.

Currently, this company enjoys a top shelf credit rating from S&P and Moody's. The question, of course, is how does a company that needs a financial bail out merit such a high credit rating?

For the answer, study the fragile condition of the credit markets, and the domino effect that would be put in motion with an ABK credit downgrade.

no positions

Price of Ignorance

With a little perserverence you can get things done
Without the blind adherence that has conquered some
--Corey Hart

We've been conditioned to 'expect' rising prices over time. But are price increases a natural consequence of economic activity?

Suppose that, prior to lighting off economic activity, a finite supply of monetary currency is created to facilitate exchange. Further, suppose that the physical nature of the money makes it infinitely durable and that it never needs replacement. In fact, suppose that we lose our wherewithal to create additional money and we must eternally live with the initial supply. What will happen to prices 'naturally' over time?

They should fall.

As society advances and productivity improves, more output is created per unit of input. A dollar that bought one loaf of bread in the beginning should buy two or more over time.

During the late 1800's, the US saw precisely this phenomenon. During one of the most productive periods in US industrial history (which also corresponded to a period when the US Dollar was backed by gold thereby limiting its supply), broad price declines were evident. Purchasing power increased as money bought more goods and services. There was little concern about the dangers of falling prices. People were better off and standard of living increased (Rothbard, 2002).

Today, drums beat a tune against declining prices and for inflation. There is chatter that the Fed might adopt a policy of targeting a certain annual increase in prices. Critics suggest that they've been engaged in this activity for years with predictably detrimental results.

Don't be fooled. Price declines should be a welcome consequence of economic activity.

Reference

Rothbard, M.N. (2002). A history of money and banking in the United States. Auburn, AL: Ludwig von Mises Institute.

Fantasy Land

In the streets there's no wrong and no right
So forget all that you see
It's not reality
It's just a fantasy
--Aldo Nova

The debt markets largely depend on two rating agencies, Moody's and S&P, to rate the creditworthiness of borrowers. Ratings range from AAA (excellent ability to pay back lenders) to junk (very questionable capacity for payback).

Bond issuers (i.e., borrowers) want to score higher ratings, because higher ratings mean borrowers pay less to borrow funds. Moreover, many institutions (e.g., pensions funds) are by charter only permitted to invest in 'investment' grade debt; they can't buy the riskier 'speculative' grade stuff.

Recently, eyes have focused on the credit ratings of MBIA (MBI), the largest insurer of municipal bonds. Oddly, MBI has historically enjoyed the top AAA rating, despite being a highly leveraged entity. For comparison, the other half dozen companies garnering the AAA rating include some of the most hisorically solid large companies out there including General Electric (GE), Johnson & Johnson (JNJ), and Berkshire Hathaway (BRK.A).

MBI's AAA rating has been vital to its success on a number of fronts. Since they borrow so much money, their top shelf credit rating drastically reduces their cost of borrowing. Morever, those insured by MBI, primarily cities and other locales issuing 'municipal bonds', enjoy lower costs of borrowing because MBI guarantees payback of the debt that they insure. Buyers of the debt are willing to settle for a lower interest rate in exchange for the guaranteed payback.

The concern right now is that, due to the credit crunch and general economic slowdown, many municipalities are closer to defaulting on their positions than they have been in years. If they default enmasse, there is no way MBI will be able to cover all claims by muni bond holders. Some folks think that MBI is currently insolvent. In these types of situations, the bond rating agencies would typically look at the numbers and downgrade MBI's ratings. The consequences of doing so, however, would be significant. Muni bond markets might freeze up, and MBI would be rendered insolvent as municipalities defaulted.

So, lo and behold, the rating agencies came out this week and reaffirmed MBI's AAA credit rating. MBI just closed their FY2007 books with $3.1B in revenues, a -61% profit margin, and about $3 in debt for each $1 in cash. For comparison, Pfizer (PFE), a company that just LOST their AAA rating a couple months back, sported FY2007 results $48.6B in revs, 17% profit margin, and $22B in cash on the balance sheet (about $3 cash for each $1 debt).

Does something seem out of whack to you?

Why MBI ever earned the AAA rating to start with is easy to speculate about. Pessimists suggest that below-board deals were struck (and continue to be struck) to preserve MBI's rating.

The question, of course, is whether any rating shennanigans will continue to be effective, or whether the market ultimately wakes up, and finally recognizes that the emperor wears no clothes.

position in PFE

Silence of the Lambs

So hold on here we go
Hold on to nothin' we know
I feel so lonely way up here
--Motels

Toddo was speaking to Cody Willard on FBN's Happy Hour tonite, and Cody proposed that although the various government sponsored bailouts currently in motion may be 'legal,' they are unconstitutional since they essentially appropriate citizen property for the benefit of a special interest group.

What's that? You don't think you're getting poorer as a result of these bailouts? Consider the 3 ways that governments procure resources at citizenry's expense. They can walk into your house and say, 'we own it.' They can appropriate your property in a slightly less direct manner through coercive taxation.

Finally, they can print money by fiat. Government spends the new currency for whatever purpose, and bids up prices in the process. Plus the money supply has increased. Your wealth, defined in terms of what your money buys, goes down.

What evidence of wealth appropriation can we observe? Well, today crude closed above $100/barrel for the first time ever, gold is near all time highs at $948/oz, and silver closed at a multidecade high of $18.72/oz. Simply said, our dollars buy less today.

Make no mistake. You're being robbed.

The question is whether we have the wherewithal to put a stop to this. Do you know the measures necessary to prohibit government sponsored theft? (hint: we used to do all of these things)

position in gold, silver