Wall Street’s Katrina Moment
If we are not there yet, we soon will be…I believe that unless something is done, we are watching the slow motion collapse of our credit/debt driven economy.
Today’s Bear Stearns mess is giving me flashbacks of the camera crews filming the bodies floating in the water in New Orleans following Katrina. The flood of bad debt has been washing over Wall Street for months, last summer the credit crunch officially spread beyond sub prime when a couple Bear Stearns funds imploded and a Goldman Sachs fund needed a major cash infusion. Like New Orleans after Katrina, there is blame enough for all participants, but it is well past time for the government to step in and provide some support.
Now that the mortgage/re-fi market has come to a screeching halt, the Treasury Secretary (of an administration that believes regulation is wicked) thinks maybe we should draw up some regulations…you think? At least the “happy talk” about the strong economy seems like its being toned down. But just this week the president was talking about how the stimulus/rebate will fix any weakness/problems.
Mr. President, the problem with today’s markets will not be fixed with a $300 check, not even a $600 check in 6 weeks time. Please don't wait 3 months for this to be demonstrated as fact.
The problem is that all the existing market mechanisms for dealing with uncertainty about mortgage valuation and trading have broken down. Nobody can decide what they are worth so everybody is afraid to trade them. What was once a sub-prime debt problem has become a universal debt problem, as traders realize debt ratings are worthless and the firms that insure against defaults are on the ropes, indeed even the firms that simply trade mortgages are sinking.
What should be done? No less than the quagmire in Iraq or the Katrina (non?) clean-up there are no good options left. We must simply select the least bad option.
The government must step up and offer to purchase mortgages. It should start by offering to buy the best mortgages at a discount via Fannie Mae or Freddie Mac or an equivalent entity…indeed Fannie Mae and Freddie Mac were originally created to fix a credit/housing crisis. The discount should be steep, enough that “speculators” are not rewarded and that ordinary participants have to think hard about selling at that price. The steeper the discount the better in terms of limiting the amount of cash the feds would “tie-up” in the effort. I don’t know what the actual discount should be…maybe they should even let the market decide via reverse auction. The main idea is give all market participants a worst case value greater than zero. Depending on how that effort works the fed could then evaluate the need to buy lower rated mortgages at an even greater discount.
By establishing a floor value for the highest rated mortgages, the fed/treasury would encourage market participants to begin trading mortgages among themselves (if the felt the mortgages were worth more than the feds floor value) or allow them to exchange for ready cash mortgages they otherwise don’t want, which in turn would allow banks and market participants to get back to their real job of lending.
Call it a bailout or whatever you like, this action could easily cost a trillion dollars or more, although I would expect the feds to hold the mortgages long enough (3-5 years?) to break even or even make a modest profit from the transaction.
Eventually this will happen, because it always happens, the federal reserve and the treasury have to step in if the alternative is an economic collapse—some may laugh at this notion, but a year ago the “mortgage crisis” was a blip on the radar compared to the real problems our economy faces like energy security, runaway medicare spending (indeed health care in general), social security spending, rising inflation etc.
The question is will the “voluntary” administration wait so long that the rest of the world loses faith in the US economy, the dollar and our ability to manage either. With any other administration I believe we would be well on the way to solving this crisis, but with every passing day I’m reminded that the Bush administration is indeed unique in its incompetence and ideological opposition to government intervention (aside from war).
Trying to fix the symptoms rather than the causes?
An extra $200 billion liquidity injection by the Fed is providing the market a positive boost today, but I’m not convinced that this effort is different from previous efforts in anything other than scale.
The problem has been growing since last summer’s sub-prime implosion, as credit market after credit market becomes infected by institutions that are unwilling to trade and markets “seize-up”. With each new credit market there appears to be a new twist. At first the problem was only sub-prime debt, but then people became worried about debt tied to prime (i.e. normal) mortgages as the housing slump deepened. Part of the problem is that lending practices became downright shoddy once banks earned a fee for making every loan and another fee from selling the debt on to third parties. In the past the bank held the loan and would suffer if the loan was not repaid in full—not so in this brave new world.
Another part of the problem is that the rating agencies which provided overly optimistic credit ratings on sub-prime debt also appear to have applied the similarly optimistic ratings to regular mortgage debt, and credit card debt and just about every kind of debt they could rate. As a result nobody can trust the credit ratings. Also in this time frame the “models” banks use to value derivative debt instruments (credit swaps, slices of credit pools, default insurance etc) “blew-up” as markets experienced multiple events in a matter of days the models predicted were once in a lifetime events (a.k.a. black swans—highly unlikely occurrences). I think it was about this time the SIVs (structured investment vehicles: off the books enron-like entities banks set up to take the pieces of debt nobody else would buy) disintegrated, forcing many banks to take the loans back onto their books.
So first the growing rate of defaults causes people to question the credit ratings, then the models banks use to value debts go flat. Now banks have a whole mess of dodgy loans tossed back in their laps, and nobody has any idea what, if anything, they are worth. So then banks cut back on lending, begin raising new capital and start writing the bad debt down. This is fairly standard bank behavior which tends to drain liquidity from the market when banks slow/stop lending. Now as the banks write down the debt, the institutions that use (sell) their own strong credit rating to guarantee other debt issuers (they in effect co-sign the loans so the borrower gets a better rate) start to recieve a flood of claims which calls their own high credit rating into question.
And this is about where we are, people (banks included) are afraid to trade debt because, 1) they don’t trust the rating agencies, 2) they don’t trust their own models for debt valuation, 3) the institutions with the highest credit ratings whose job it was to stand behind other peoples debt don’t look terribly sound, 4) there is a bunch of toxic (worthless) debt swirling around. Imagine trying to drive around Baghdad with only a map of Kirkuk in the car, a faulty fuel gage, and the local giving you directions is obviously lost but the one thing you know is that there are IEDs along the road…
But I digress…through all this the Fed has been furiously cutting interest rates to try to boost the liquidity that the banks are draining away as they try to clean up their books. In other words the Fed has been treating the credit crisis as a cost of credit crisis.
Perhaps the terminology is confusing…let’s say you are going to an art auction (you know nothing about art) and a famous painting comes up for sale, but it is selling for only 50% what it should be selling for. On one side of you the person says it’s a worthless fake and on the other side is a guy willing to lend you $500,000 to buy the painting for 0.5% less interest than your bank charges. Do you bite? Most people would be more worried about paying $500,000 for a fake than the good interest rate. And this to me is exactly the problem with the Fed’s efforts; they are trying to fix the symptoms not the underlying problem.
Fortune on why no plan for health care is "best"
I know that it is foolish to look for wisdom in the pages of "Fortune" and I would never buy the magazine myself, but they decided to send me several "free" issues when Business 2.0 folded. So here it is...and I find myself reading
"Why McCain has the best Health-Care Plan" by Shawn Tully. [I linked to Fortune's website which lists the article but they provide no link to the story--sorry readers.] In any event I was astonished they would even print the article since McCain's "plan" leaves out sick people and how he intends to pay for it (according to their own reporting--see below). But apparently that is better than a health a care plan that covers the sick (& the 1 in 6 Americans without insurance) if the alternative involves some government subsidy.
Below is my emailed response to the Fortune author:
Good luck to both you and McCain selling this "plan" to Americans making less than ~$250k/yr. Companies are totally obsolved of responsibility for their workers health care, undoubtedly a plus for any C-level executive earning over $1million/yr. But how you or McCain can call this a "plan" is beyond my understanding.
It was refreshing to see an admission that "For his plan to work, McCain has to tell us how he would deal with the old and the sick" & "that means his plan will require huge subsidies he's not talking about." So if one doesn't count the unhealthy, the unemployed, people who can't afford health care or all the costs he is not talking about...this one looks like a real winner!
Meanwhile you bash the Democrates because they want regulate the insurance industry "limiting everything from profits to marketing expenses". While I disagree with this assesment...some people would consider that a prudent method of cost control for an industry where "costs are rising far faster than wages". "The Clinton and Obama plans would enormously increase total health care spending but disguise the extra costs by shifting them to taxpayers". Again one could more logically argue that controling costs will decrease total health care spending, but putting that aside the Dems are saying that Americans are already paying too much and getting too little from the health care system. At least their plan means 47 million more Americans will get something from the system.
But I suppose this flies in the face of your notion that health care is a luxury good--"Imagine a world where health care is treated as the precious resource it is"...for tens of millions of Americans, just imagining a world where health care is an available resource would be precious indeed.
Days like this I want to put my head in the sand.
"Bush to veto bill banning waterboarding"
AP HeadlineThe White House says President Bush will veto legislation on Saturday that would have barred the CIA from using waterboarding — a technique that simulates drowning — and other harsh interrogation methods on terror suspects.
And this didn't help:
"Obama aide quits over Clinton "monster" comment"
Reuters Headline A foreign policy adviser to Democratic presidential candidate Barack Obama resigned on Friday after calling campaign rival Hillary Clinton a "monster" during an interview with a British newspaper.
And earlier there was this gem:
"Bush: 'It's clear' economy has slowed"
AP HealinePresident Bush said Friday that "it's clear our economy has slowed" and tried to reassure an anxious public that the long-term outlook is good. "Losing a job is painful and I know Americans are concerned about our economy. So am I," Bush said during a hastily arranged White House appearance on the heels of a gloomy government economic report.
Now where did I leave my bucket of sand?
How can you tell when G.W. Bush is lying?
It is not the least bit funny, but there was that old joke about how can you tell when a lawyer is lying...punchline: when his lips move.
In case anyone still listens to G.W. this just proves that there MUST be two Americas...because:
"America is in the lead when it comes to energy independence; we’re in the lead when it comes to new technologies; we’re in the lead when it comes to global climate change — and we’ll stay that way."
check out the video
on Think ProgressEven G.W. had to pause before he could mouth that first lie...which is a blatant whopper. The middle part is obviously a debatable point as we are importing wind mills from Europe and solar panels from China--but this is something that everyone in the US certainly believes or wants to believe. And the last is certainly true, but not in the way the president said it, or in the way any rational person would interpret it (especially at WIREC). We ARE leading leading global climate change...the wrong way!
There must be some deep psychological trick that Rove figured out to this speech pattern. Huge lie, followed by deeply felt belief, followed by twisted statement that implies the opposite of what is said. The result is such intense cognitive dissonance that the audience is left fixated on the one part they know/believe to be true, blocking out rational processing of the other parts of the sentance.
Some beaten down tech stocks I think will bounce
Looking over the wreckage of my portfolio this weekend, a couple things stand out (other than all the red ink).
1) Solar stocks have been clobbered in the past 6 weeks; most are down 50+% from where they started the year. I think this selling is overdone. While they may not recover all this lost ground this year, I'm fairly certain that in 6-9 months time they will 30-50% higher than they are right now. The lower dollar will help US companies selling into European countries especially, Germany, Spain and Italy, which are the largest and fastest growing solar markets respectively.
Individual US companies in the solar space include SunPower (SPWR--$65.7) which is the largest manufacturer and installer of panels in the US; First Solar (FSLR--$205) which is the fastest growing panel manufacturer and possibly the low cost supplier with its thin film CdTe technology and Evergreen Solar (ESLR--$9.6) which is just turning its attention to increasing panel production in the US with its promising "string ribbon" technology for making solar cells using less silicon. I own a 200 shares of ESLR and 150 shares of SPWR.--Full disclosure.
Finally if you prefer to buy a basket of stocks, PBW-$20.7 (Powershares WilderHill Clean Energy Fund) is a way to get exposure to the clean energy sector (all of stocks I mention and a few dozen more) without relying on any single company...but be warned that the entire sector is volitile and seems to trade up and down in unison.
2) Nortel Networks (NT) has put in a thoroughly dismal performance the past 12 months (-75%) and the stock is down 25% in the past week alone. Nevertheless I think the stock has become seriously oversold...I "doubled down" on Friday buying more NT with shares trading about $8.70. The company has annual sales of $10.5billion, a $3.8 billion market cap and $3.2 billion in cash (meaning $7.40/sh in cash). While I'm not expecting a miracle, if over the next year NT can regain what it has lost in the last 3 months (in terms of share price) it will be a double. I'm looking for NT to be up 50% in 6-9 months.
FWIW, I know the markets in general look terrible right now, the credit crunch is worrying as it is hard for an "outsider" to calculate its impact. Things can always get worse especially in the next month or two as the magnitude of the economic slowdown comes into better focus. Assuming the slowdown/recession is not protracted, by late spring I expect the markets will begin to look past the slowdown and bid up share prices. So no need to "pull the trigger" immediately, but remember that the time to buy is when everyone else is selling.
Edit 3pm 3/4/08: I bought NT a few days too early--it happens. NT closed ~$7.75 per share...I'm only updating this because according to NT's recent filing they have $3.6 billion in cash, and the market cap is now under $3.4 billion.
