Shame on Congress….

Today marks another sad day in the recent financial turmoil. As our financial system teeters on implosion, the Congress of the Unites States fails to provide relief to debt burdened Americans. The bill fell short by 11 votes  and many consider the current version of this bill to be dead. Instead of a lean bill to address the immediate crisis, Congress, both republicans and democrats, loaded the bill with partisanprovisions. No doubt that by failing to resolve this matter, Congress has put the American economy, indeed the world economy in dire jeopardy.

To be clear this is a crisis that affects every single American. If you depend on credit lines to finance your business, if you are a consumer who needs credit to finance a home, if you are an employee whose employer depends on cash flow to pay your salary, or if you are a parent trying to get a loan to send your kid to college, you will be affected by this action. Do not make the mistake of believing that this rescue bill is meant to bailout only the fat cats on Wall Street…After all, those on Wall Street also live on Main Street  and be sure that not everyone on Wall Street is a “fat cat”. Many, many thousands of former employees of Bear Stearns, Lehman Brothers, Aig, Washington Mutual etc will argue to that point.

The Congress has failed not only by defeating this bill but by showing the world that partisanship is more important than rational governing in America. Bringing this vote to the floor of the house without assurance of its passing was very irresponsible…By not addressing this crisis, one that is beyond the comprehension of most Americans, the political leadership of our country has put partisanship in front of country. By not effectively corralling this complex financial quagmire, congress has, once again, caved in to their own re-election interests and not the interests of the country. 

Shame on the leadership of both parties for their irresponsible stewardship of our great country. Shame on the Republicans in the house for their blind ideology and shame on the Democratic leadership, holders of the majority in our House of Representatives for their inability to negotiate a resolution in this time of crisis and show real leadership. As the world watches, we continue to spin our wheels and slip further and further into the mud….

In Memory of Investment Banks….

Today marks a new chapter in American financial history and a first step into what I believe to be a new dawn of regulation on Wall Street. On Sunday evening, Goldman Sachs and Morgan Stanley sought shelter with the Federal Reserve to survive a financial storm that destroyed their rivals as Wall Street braced for a week of political wrangling over a proposed $700 billion bailout for troubled banks. The investment bank model that encouraged the tremendous profits of hedge fund like entities such as Goldman Sacks is officially dead. Morgan Stanley went a step further and struck a deal with Japan’s largest bank, Mitsubishi UFJ Financial Group. MUFJ agreed to buy up to a 20 percent stake, in Morgan Stanley 

The Fed’s agreement, at the request of Goldman and Morgan Stanley,  to convert the once high-flying investment banks into more conventional depositary institutions was Washington’s latest effort to restore calm to chaotic markets. It followed frantic talks between the Bush administration and Congress to prevent the crisis from pushing the economy into severe recession. By agreeing to much tighter Fed regulation as bank holding companies, Goldman Sachs Group Inc and Morgan Stanley moved to avoid the fate of rivals that either collapsed or were taken over in the worst financial crisis to sweep Wall Street since the Great Depression. 

The status change of the two surviving investment banks will undoubtedly impact their earning potential. By accepting regulation of their activities, these institutions will have permanent access to the Fed’s discount window and will allow them to raise capital much quicker in times of need. These companies will be more resistant to volatility in their stock prices and cause fire sales of assets as in the case of Lehman Brothers, Bear Stearns and Merrill Lynch, much more unlikely.

In my opinion the long term effects to today’s actions are another positive step in the fixing of the American financial system. It will help insulate main street from the greed of wall street and help foster confidence in our financial system which badly needs it at this moment. As Americans debate the merits of the candidates in the presidential election of November, I am reminded of an old saying from wall street that rings as true today as ever. “Bulls and bears prosper, pigs get slaughtered”.  No matter how much lipstick…..

Federal Government Steps Up to the Plate

The federal government in an attempt to contain the financial crisis, is about to establish a program to let banks get rid of bad mortgage based debt. This would theoretically free up capital and unfreeze the credit problem we currently face.

Leaders from the House and the Senate were briefed on Thursday evening by Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke. “The root cause of distress in capital markets is the real estate correction and what’s going on in terms of the price declines in real estate,” Paulson said at a press briefing after the meeting. “So we’re coming together to work for an expeditious solution aimed right at the heart of this problem, which is illiquid assets on financial institutions’ balance sheets.”

Even though the meat and potato of the plan still remain unclear, it is widely expected that the plan will be comprehensive and address the issue somewhat like the savings and loan bail out of the late 80’s. What is clear is that the government is set up to take tens of billions of dollars in mortgage debts.

Even though the action seems novel, there is precedent for the federal government taking on troubled assets from the private sector. In the 1930s, the Home Owners Loan Corp. was set up to issue bonds to refinance borrowers. Then during the S&L crisis Congress set up the Resolution Trust Corp. to sell assets of failed banks.

As I mentioned in my previous post, this action was warranted. It is like giving the economy a painkiller to ease the immediate discomfort of the market meltdown. The new president will have to lead the reform of our financial system which should include new regulation regarding margin levels, hedge fund disclosure, money market fund guarantees and short-selling rules. This recent action is not going to solve our problem in the long run unless we address the root problem of this crisis which revolves around lax regulation of investment banks and loose lending practices by banks and other credit institutions.

Mother Of All Bailouts!

Well good morning Mr and Mrs taxpayer! Last night as you tucked your children to sleep, the Treasury of the United States, the Federal Reserve and the leaders of Congress, all hired by you Mr and Mrs Taxpayer to manage the use of taxpayer funds, approved a “bridge loan” of 85 billion dollars to the largest insurer in the world, American Insurance Group (AIG). As guarantee for this loan, Mr and Mrs Taxpayer, you now own 79.9% of AIG!. Add that to the Bear Stearns guarantees, Fannie and Freddie and you have yourself a great portfolio!…not

Now don’t get me wrong the bankruptcy and liquidation of AIG would have been a disaster. With a balance sheet in the excess of 1 trillion dollars, the unwinding of the company would create havoc not only in the US but worldwide. Ultimately the bail out of the firm, based on what we knew yesterday, was inevitable. The issues that concern me are the following:

1- How did we get to this point?

2- Why did we get to this point and why did it take so long to for the government to act?

The first one is not that difficult to understand. U.S financials leveraged themselves to the gills and borrowed too much money to fund risky investments (ie subprime, etc). When pressed for cash to stem the effects of a plummeting stock price, there was no one there but the U.S. government albeit reluctantly. Rest assured that although some firms are less exposed than others, all have exposure to this risk.

The second point is a bit more complex and I believe more important to understand. The first issue to address is the lack of government regulation in the investment banking industry. The abilityof these institutions to leverage their balance sheets to the extent that they have is for a lack of a  better word, “reckless”. I believe the US will have no choice but to address this issue because now it owns FannieMae, Freddie Mac,80% of AIG and has billion of loan guarantees outstanding to the former investment bank purchased by JP Morgan, Bear Stearns. Not addressing this would be even more reckless than the actions of these greedy institutions and a disservice to the ones who actually fund these bailouts, the American taxpayers. Transparency of assets and transactions should be part of the what the regulators demand from these financial entities. Our financial system, not our economy, needs an overhaul.

Another issue to address is the fact that short sellers, those individuals and institutions that place bets that stocks will fall in price, be limited to shorting on upticks only. This had always been the case until about 2 years ago when the SEC changed the rules and allowed both naked short selling and short selling on down ticks. This may be complex for some to understand but suffice it to say that we need to revert to  more conservative trading rules to prevent these unprecedented run on companies which force emergency capital raising and create havoc in the markets.

 I applaud the fact that thesegovernment institutions acted but I believe U.S. taxpayers got a raw deal. If the actions, in the case of AIG for example, had come days earlier, it would have meant a savings of about 40 billion to the taxpayer. We know that we have a problem with the balance sheets of these firms and that they are over levered. Why not aggressively address these issues on an industry wide basis? All that we are doing by addressing this on an individual basis is passing the buck forward to the next victim and ultimately putting our overall economy in jeopardy. Today the market is speculating that Morgan Stanley or even Goldman Sacks may be next and the markets are reacting accordingly…The fact that we heading to an election is exacerbating the situation as republicans and democrats engage in the usual political bickering.

I liken it to the methods used by firefighters in fighting wildfires. Sometimes you have to set smaller fires in order to contain the main fire.

Oil- Is $100 The New $70?

As we enter what is sure to be an “exciting” week in financial markets worldwide, I can’t help but reflect on some of the recent commentary by the financial media pundits regarding the direction of the price of crude oil. If indeed, as the “experts” who tried to justify $150.00 oil suggest, the world is seeing an increased demand for crude led by the explosive growth of China and the developing world, why then has it plummeted so drastically over the last month? 

I believe that OPEC, an organization once ridiculed by the U.S. as being down right incompetent in the pursuit of its own interests, is finally waking up to the fact that they really do control the purse strings! I believe this recent surge in the price of oil was orchestrated brilliantly by OPEC to acclimate the U.S. and the developed world to higher oil prices. $100.00 oil, once thought to be disastrous for the world is now seen by most as “acceptable”. Indeed $100.00 is the new $70.00…

OPEC realizes that oil cannot be either too cheap or too expensive. Too cheap and they risk their financial future by depleting their valuable natural resource at bargain prices. Too expensive and they stimulate faster development of alternative sources of energy worldwide. As sovereign investment funds move around enormous amounts of money worldwide mostly outside the scrutiny of any regulators here or abroad, who is to say that OPEC is not to blame for this recent speculative spike even with oil output  remaining relatively stable.

As some analysts rejoice in this downturn in the price of oil, and attribute it to a global slowdown, I beg to differ. I believe that we being set up by the oil producing states in what I believe will be a recurring cycle of unprecedented volatility. By this I mean that  spikes will be followed by a period of consolidation and stability followed by stronger surges taking us beyond the last peak and so on. Most analysts will have you believe that it is because of “supply and demand” and that “all of a sudden the Chinese have turned on their furnaces and that there is not enough oil”. Don’t believe it…

We should not be fooled by these volatile swings in the price crude oil and stay focused on developing alternative energy sources. As the price of oil falls, the pressure on our elected officials and industry leaders to find alternatives will subside and we must not allow that to happen. The only way to stay ahead of this game is to not succumb to “acceptable” oil prices and continue to develop our alternative energy sources regardless of the price of crude. Long term, hopefully we can develop renewable alternatives that will not only unchain us from OPEC but also be kind to our environment. We should not allow 120 to become the next 100….

Who Owns Your Home?

If you have a n outstanding mortgage then, more than likely, the US government does… As the ripple of the US treasury’s take over of mortgage giants Fannie Mae and Freddie Mac subsides, one is left to wonder what this really means. The  implicit guarantee which all of a sudden becomes explicit is very important. By seizing these companies the U.S. has turned a corner into what many conservatives are saying is the beginning of socialized housing in the US. In reality these entities have become too large to fail and most policy makers are in agreement with the recent action. By backing over 5 trillion dollars of US mortgages, the debt issued by Fannie and Freddie had become less appealing to foreign governments and institutional buyers. When Pimco’s Bill Gross, the largest buyer of bonds in the world, mentioned last week on CNBC that his firm was no longer buying Fannie and Freddie debt, the Treasury dept and Hank Paulson took notice. This action is even more surprising during a republican administration and signals the severity of the credit crunch problem in the US.

The next administration is going to be left with another major issue to resolve which is what to do with these giants and how to ensure that tax payers don’t get stuck footing all of the bill for the mismanagement of these entities. The Obama camp has said it applauds the action taken by the Treasury and said that they believe that Fannie and Freddie should remain independent in the future albeit with much more government oversight. The McCain camp believes that action was also warranted and said Fannie and Freddie should eventually be much smaller institutions guaranteeing only a portion of the 5 trillion dollars in its current portfolio.

In any case, this recent action should be a very positive event for banks, especially smaller banks and mortgage brokerage firms that have had a very difficult time placing even good quality loans. Mortgage rates should decrease slightly with this action but the most important outcome is that by making the debt of these companies essentially US debt, the Treasury has effectively reassured the market that an investment in Fannie and Freddie debt is a good, solid investment. As money flows back to these instruments, funding of mortgages should stabilize which is very positive for the US recovery.

The downside of this action is what tax payers will ask, and rightfully so, who is next? Is it the airlines?, the automakers ?… I believe the fixing of Freddie and Fannie, now that it is under government stewardship, should be a top domestic priority of the new administration. These enterprises in the long run should remain private and should never again have a strangle hold on the US economy.

Unemployment Numbers Signal Tough Times Ahead

The nation’s unemployment rate skyrocketed to a five-year high of 6.1% in August. Employers cut 84,000 jobs as it becomes ever more apparent that the US economy is inflicting damage to individuals and businesses alike.

Employment number are usually very good indicators on the health of the economy and these numbers show  that the economy is headed for a nasty fall season, no pun intended. As consumers begin to feel more uneasy about their job prospects, overall consumption will more than likely tail off leading to, as most analysts suggest, a dysmal year end shopping season.

What is the investor to do? I believe that U.S. stocks already reflect the gloomy outlook as painted by today’s numbers and its likely impact on the US economy for the next 6 to 12 months. Also, as most of the world’s economies sink into recession or at least steep slowdown, the U.S. is much closer to recovery. As emerging markets and Europe alike begin to feel the brunt of the slowdown, I would not be surprised at all if the U.S. stock markets posts some impressive gains towards the latter part of the year and into 2009. That coupled with oil prices coming back to somewhat “acceptable levels” and the strengthening US dollar should make a compelling case that the U.S. economy may bounce back before the rest of the world does. 

In other words, there may be an opportunity in the months ahead to get into some U.S. names at very reasonable levels in anticipation of a rotation worldwide away from the Euro back into the US dollar.  As much as things change, some things always remain the same…