Thursday, December 18, 2008


One of the many old saw's about bankers is that they will loan you their umbrella but ask for it back when it rains. Common stereo types tend to be built around kernels of truth. Today, banks are lending money. The TV pundits keep saying that the credit markets are frozen but the numbers posted by the St. Louis Federal Reserve show that the growth of total loans and leases during this recession have never fallen below about 7% and as of last month were growing at about 9%!

Which do you believe, the opinion of TV pundits who might be "selling the news or talking their books" or the US government statistics offered by one of the 12 Federal Reserve Banks? It is true that banks have tightened their lending standards, that a frightened public is selling equity, buying government securities and paying down debts and that total loans are increasing. How can all of this be true?

The market, with the assistance of the FOMC, is virtually giving money away! The fed funds rate is being targeted at 0% to .25% and the FOMC has threatened to buy long treasury bonds. This extraordinary threat, along with the crash in prices of oil and other goods, has helped push mortgage rates and long treasury rates down to levels not seen since the 1940's. The 30-year bond is down to 2.6%! The 10-year bond is down to 2.09%! The 2-year note is down to .07%! The ninety day t-bill is down to .01%! And yet Gold declined in value yesterday! Gold is starting to anticipate an economic recovery that will push up real interest rates! Or perhaps the gold market is saying that at a zero percent inflation rate a .01% 90 day t-bill rate still makes holding gold expensive!

The prime rate is down to 3.75% but if a bank cannot make money by taking in money from the Fed at .25% and lending it to solid prime rate qualifying businesses with at a 350 basis point spread, then when will they ever make money?


A few of my banking friends have said that the banks will throw every possible write down and the kitchen sink into this quarters earnings reports (yes, that was said last quarter too). The reported earnings will be horrible. Some of these banking friends believe that the time to buy the bank stocks will be just after the earnings reports. However, as noted here time and again, banking stocks make a bottom long before the end of the typical recession and it looks like this has already occurred. Yesterday, I looked at the average performance of all financial stocks in the S&P 500 index and they were up 11.9% over the prior two days, yesterday they went down a little but they are up today. From the November 20 bottom through two days ago, the average financial stock was up more than 30%! The market place understands that banks have seen a dramatic decline in their cost of funds, that loan demand is strong and that banks are currently able to be very picky about who gets loans. This combination is ideal for future profits.

The coming profit write downs are related to the past decline in real estate values. However, each time mortgage rates drop a little, the net present value of the rental income stream of real estate soars. In other words, the value of real estate goes up, each time there is a decline in mortgage rates and there has been a significant decline in mortgage rates. Homes are intrinsically worth much more today than they were a month ago.

While many of the best bargains have been scooped up, there remain plenty of lesser bargains available. Not millions or billions but trillions of dollars worth of assets are rapidly moving from weak hands to strong hands. In other words, the only way for loan growth to be strong during a time when most people are focused on paying off debt and when only those with solid loan scores can qualify is for the highly qualified to be buying a lot!


Twenty-five years ago, Bill Lienbach, a broker at Merrill Lynch took his time to explain a number of things to me. I continue to be blessed by his kindness. Bill had a knack for using simple analogies to make complicated things easy to understand. In regard to currencies, he said you have to ask whose bucket is full? One country can pour so much water into another countries bucket but eventually the other country pours it back. Right now, the Europeans buckets are getting very full. The spread between the 10-year guilt and the 10-year bond has suddenly soared back to very high levels. As a result, the Euro has suddenly gained value against the dollar. Suddenly an international investor in Europe has reason to buy US real estate rather than Euroland real estate.

One of the great ironies is that politicians, the uninformed and even the well meaning who do not fully understand international economics (oops I just caught a lot of people in that net) like to go on and on about the importance of a strong dollar while the governments around the world are often engaged in a contest to try to weaken their currencies. Right now, probably every country in the world would love to export more goods. Every country has spare capacity in some area. The way to sell more goods is to weaken ones currency and the way to weaken a currency is to force down the price of long term money, which can be a difficult task to accomplish. Unfortunately for all countries, the world wide demand for their goods is not what it used to be.


People continue to look for the market bottom. They seem to forget that stocks do not bottom all at the same time. Back in on July 15, when the price of oil was $147 per barrel, the airline stocks made their bottom. My favorite company, Continental Airlines, symbol CAL traded at $6.65 on that day. Today it trades at $17.47 an increase of 262% during a recession! A few weeks ago, when talking about the turn in real estate, I mentioned REZ, a real estate investment trust. Since November 20, REZ is up 41%, the S&P 500 is up 12% and the Financial Sector is up 31%.

The ride to the bottom was no fun but investors should catch as much of the ride to the top as they possibly can. After all, the government is giving money away to the rich.