ANOTHER GOOD DAY FOR FINANCIALS

Yes. It is true. When the markets fell like a rock yesterday, the average financial stock went down less than the average energy or basic material stock. Today, when the market is up strong, the financial sector is the leader. The turn is here.


A reader wants to know if a sector fund such as the XLF is the way to "play". Before several buy out consolidations go through, the weight of the top four stocks held are JPM 10.6%, BAC 9.7%, WFC 7.7% and C 6.8%. If you don't mind paying a annual fee for holding these stocks, then the XLF is a decent way to buy into the "big boys". When ever you buy whole sectors, you buy the "see" and the "saw" within the sector. There are other more "pure" funds that track banks, regional banks, capital markets, insurance and more.


As always, 90% of performance is being in the right sector. However, the smaller companies have a much higher beta and they will be the big winners in the months ahead. An equal weighted index will do much better than a cap weighted index such as the XLF during a strong run.


The fees on exchange traded funds range from about a quarter percent to as much as 2% per year. The XLF carries a low fee of .23%. There is no fee for holding individual shares.

EDUCATION IS KEY

My Response to Al.


Yes money is frequently misspent on new schools in the wrong place and on remodeling old schools while not spending on the technology equipment needed in our modern world. Once again, small mistakes are compounded into large mistakes when we insist on big group decisions. This is nothing but the old story that a camel is a horse designed by a committee.


A few days ago, I went to a beautifully renovated school. The building was impressive, but the students refused to quietly take an educational survey. The survey was done on paper because there were not computers for each student. For a teacher to teach, the student must want to learn; these kids could have cared less.


Give parents a voucher with which to select the best school, give the school the option of accepting the student and the kids who want to learn will go to productive schools. One method being used in productive schools is to use online resources to help the kids move forward at their own pace. For some reason, we insist on doing school the way the Soviets did refrigerators, there was only one brand, it was a lousy appliance but there was no other choice.


The irony is that the growing home schooling movement has been counter productive for the students who remain in traditional schools. The quality of ones education depends greatly on the skills and attitudes of ones peers; it is great to learn about diversity, but horrible to sit through a disrupted class. Home schooled kids do very well partly because their education is coordinated with kids from other families who care.


The class I really enjoyed teaching a couple of weeks ago was an honors class in international affairs. The students were interested in learning about what is going on in the world. Even so, when I strayed from what would be included on the test, they lost interest.


In other recently taught classes, I have faced serious challenges. Most of the students did not care about learning. I had to teach a few students while maintaining some semblance of order around them. These were frustrating and sad experiences. Most of the kids would have been better off working at McDonald's for the day.


My radical proposal to "fix the problem" is to fund preschool programs, giving more children a head start while providing only partial funding for high schools. The advantage gained is to teach children while they are like sponges, soaking up knowledge.


A tax increase would not be required for the preschool programs due to the savings at the high school level. Only the kids who put forth serious effort in middle schools would get "full scholarships" their first year of high school. A sliding scale would give other students partial scholarships, giving parents the incentive to learn what their child needs to do to get a full scholarship. Students would have to continue to earn their scholarships. Kids not willing to put forth effort in school should be encouraged to go to work at the age of 16 and come back to "adult high school" when they are ready to learn.


We maintain high graduation rates by giving away diplomas. We teach that it is acceptable to slide through life.


The data is compelling. Students in Catholic/Private schools perform much better than students in public schools. Home schooled students do even better. By their senior year, home schooled students rank 92nd percentile on reading and 88 on math. Yes, most of the home schooled kids would be better than average students if they attended public schools. The parents of these kids are much more likely to have advanced degrees. It is important to note that these parents are concerned about character education and not just "book learning".


While our country has traditionally been about equal opportunity, it is tipping toward socialism. Our children are not being taught basic concepts, such as free trade benefits both the consumer and the producer, because the concepts are not politically correct. Our politicians are focused on trying to give every child the same education, instead of the same opportunity.


I attended public schools as did my children. To the extent that I have influence over my grand children, I hope they will be semi home schooled. I intend to offer considerable time to assist with the task. It will require much effort to get them to group activities such as dance, music, sports and gymnastics.


During the past couple of weeks, the teachers in North Carolina have been well informed about the "wonderful efforts" of our State Attorney General to prosecute service station price gougers. Since service stations are in fear of prosecution if they let the "Magic of the Invisible Hand of Adam Smith" ration supplies, they have resorted to fixed limits on quantities available. For example, one station offers no more than $20 worth per fill up. Fist fights have broken out, cheats have paid people for their place in line and several station owners have had their lives threatened. Business people are afraid to travel because they may not have enough gas to get back home. In the mean time, people who do not need the gas refill their tanks to the brim each time they have room for $20 worth.


How silly? We have school teachers, who have never run a business or met a payroll, teaching our kids that it is unfair to charge the market price for goods! One result is that trillions of dollars worth of home mortgages were mandated at below market rates and our banking system is on the edge of total collapse. The "crisis" is not as bad as it has been painted, but, if the goose can use hyperbole to make her point, then why can't the gander?


I was surprised when the house voted against the Paulson Plan. I did not think the congress would have the guts to stand up this powerful man. What's next?


The administration and the congressional leadership is continuing to pressure the congress. However, there are many unused tools in the bags of the FOMC and the Treasury. Indeed, it appears that tools have been purposely left idle in order to put the most pressure on the congress possible. For example, FDIC insurance was increased from $40,000 per account to $100,000 per account something like 25 years ago and held steady ever since. Recently, the runs on banks have been partly in order to move excesses above $100,000.


If memory serves, the FOMC has the power to reduce bank capital requirements without the permission of congress. If the capital requirements were temporarily reduced, FDIC insurance increased and premiums set to go up significantly for banks with low capital balances two years from now, the liquidity crisis would be improved dramatically. Banks would have a two year window to right themselves before facing penalties.


Note that when the FDIC allowed Citibank to take over Wachovia, private capital was used. Sure, the FDIC took a 10% ownership in Citibank; the Wachovia shareholders were not bailed out. Here again, 12 billion dollars worth of capital was manufactured out of thin air by the stroke of a pen (taken from Wachovia shareholders as a result of the poor judgment exercised when the company bought billions of dollars worth of California real estate at the top of the market). The US tax payer was protected and the confidence of Wachovia depositors was restored. (I demonstrated poor judgment when I assumed the move from $59 to $15 per share was enough to reconcile the accounts.)


In the short run, Obama has made much political hay. He has gained several points in several battleground states. It remains to be seen if the public is open to understanding why we are in this mess. Most fingers of blame continue to be pointed toward wall street. The reality is that our government moved away from free market principles and demanded that trillions of dollars of high risk home loans be made. Like the Soviets, we decided that every citizen deserves a refrigerator if they will pay for it or not.

On Mon, Sep 29, 2008 at 6:40 PM, Al wrote:

In PA federal spending has been declining steadily as a percentage of the cost per student, so has state spending so we have had steadily increasing property taxes to make up the difference.
I haven't taught since 1975, but my daughter is a k-6 art teacher. I ran for school director in 1999, but wasn't elected. Best thing that ever happened to me! I favored a new high school and fewer renovations. The tax payers wanted the "cheaper" renovation program. So here we are today with a newly renovated HS that is overcrowded from the day it was completed along with an overcrowded middle school needing renovation or replacement and elementary schools that are renovated or as in the case of my daughter's school, being renovated. The district has borrowed to the state allowed limit so it will be awhile until the middle school can be addressed an our property taxes increase every year by several percent.

DEATH BY TRAIN

The CEO of a London based investment firm stepped in front of a train this morning. He was reported to be a dedicated and loving father and husband.


There were a couple of bank take overs in Europe over the weekend. This "crisis" has probably already reached its peak. There are billions of people hurting. The pain is great but it will make us strong.


Housing starts per 1,000 people in the US has reached lows not seen in my lifetime. The number is down to 2. The number was 6 in 2005. It reached 2.3 in 1982, 2.5 in 1991, and 3.1 in 1974. All of the low number years were great years to buy stocks, particularly surviving financial stocks. All of the low years were times of great consolidation in the financial arena. The difference in being the last to survive is an infinite number. The equity value of financial instruments at the turn will go from very small numbers to huge numbers.


It continues to be true that the turn is here. Even with huge amounts of equity being wiped out by the collapse of a bank here and an insurance company there, the financial sector is still showing relative strength. Basic materials are down over 10% in London and over 7% in New York. Natural gas companies are down 7.25% this morning, more than the average bank stock. On the way down, it seems silly to be proud of losing less money than the next guy, but when the bounce comes, it will be very nice to have made a lot more than the next guy.


Please pray for those families who are in the greatest financial stress today. Many families in Winston Salem are hurting this morning. Several of my friends have a substantial portion of their retirement accounts invested in WB stock. These friends are concerned about their jobs at a time when they have taken a serious financial hit. Citibank will need most of these people on the job, but many employees are in a state of shock.


I hope we will all use this experience as a spring board to greater faith, hope, strength and love. Tough times do not last but tough people do.

WACHOVIA -- A TINY RAY OF HOPE

Based on a Bloomberg article, it seems most likely that Citibank will buy Wachovia. Shareholders will not get much or any money, both WFC and C appear to need the help of the FDIC to make the purchase.


Wachovia owns $122 Billion of option-arm mortgages. Washington Mutual, Country Wide and IndyMac were all bankrupted by losses on these popular California mortgage loans. Any student of real estate knows that California real estate has a history of extreme volatile, like Myrtle Beach. Wachovia purchased Golden West at just the wrong time.



The people of Winston-Salem, NC, where Wachovia grew up as a conservative bank, will be hurt badly. Of course, they have already been hurt by the fall from last years price of $58.


The brightest ray of hope is that the bail out package will be used to save the bank. A thin thread indeed but something to hang onto.

Re: THE LOOONG SLOOOOW TURN

I appreciate getting the info about Alaska. I hope to visit the area soon.


You make good points, but I am still willing to bet on McCain.


The Intrade betting site has the odds at 58 to 40.2. McCain took the lead just a few weeks ago, but lost it during the turmoil over the bail out and during gasoline shortages brought on by hurricanes.


The big swing issues this election will not be the politics of Alaska. The fact that Stevens collected huge pork for Alaska will not hurt McCain as Stevens is likely to be convicted, and it is McCain and Palin who are campaigning for reform.


In the meantime, democrats cannot resist pork. The just passed budget bill included 2,300 earmarks, $6.6 billion of spending, on top of many other substantial "payoffs".


During each bail out progress report, democrats have pounded the theme that the bail out is a result of lax regulation on the part of Bush. John Adams was right, "Facts are stubborn things". "People are entitled to their own set of opinions but not to their own set of facts."


The bail out is the result of primarily democratic regulations that required banks to make loans in the worst of locations and to the worst of credits, the result of atrocious democratic policies and practices in regard to Fannie Mae and Freddie Mac and the result of ridiculous Sarbane-Oxley regulations in regard to mark to market accounting. Bush is on record, trying to reform Fannie Mae and Freddie Mac in 2003 and John McCain is on record, cosponsoring a reform bill in 2005. Each of these measures were blocked by democrats who fought fiercely for ever more lose lending.


Since hurricane damaged refineries are up and running again, gasoline prices are likely to drop to $3.20 within 10 days. Prices should drop more before the election.


The heavy advertising over the last few weeks of the campaign will tell a few stories.


1) How the refusal of democrats to allow the development of US energy has cost us dearly in several ways. With gasoline prices down to the $3 range, a vote for democrats will be seen as a vote for $4 or $5 gasoline. A vote for democrats will be a vote to reimpose the drilling moratorium that was in effect from 1981 to 2008.


2) How the interference of congress in free markets forced us into the loss of major banks, a housing melt down and a financial crisis.


3) How the win in Iraq will help us for centuries to come and how it will save soldiers lives for generations to come.


4) How the threats from Russia and Iran are best left to someone with a solid understanding of diplomacy.


Obama is often wrong on domestic issues but always smooth. He stumbles repeatedly when he gets into the area of international affairs. During these dangerous times, it would be extremely risky to elect an obvious rookie as Commander in Chief. Senator Biden was selected to bolster the ticket's international credentials but Vice Presidential credentials have never, to my knowledge, swung an election.


Take the case of Bush-Quayle in 1988. The Quayle pick was criticized from the word go. The tape of Lloyd Bentsen's famous statement that "You are no Jack Kennedy" has been played a million times, but Bentsen was not elected. Sure, Bill Clinton beat Bush but "Obama is no Bill Clinton".


In 88, Dukakis lead by 17 points after the democratic convention. The thing that hurt him the worst was the picture of him riding around in a tank wearing an over sized helmet. He lost the election because George Bush had international experience during a time of confrontation with Russia.


The skeptic in me wonders if Bush actually has a deal with Putin to ratchet up the heat just before the election. The kind of favor a guy like Putin would do for a small price.


Based on the current state of the economy, one would expect the democrat nominee to lead by 20 points. The poll numbers are extremely fluid; anything is possible, but it is amazing that McCain is so competitive in democratic strongholds. People from industrial states appreciate the need for low cost energy. America cannot expect to increase manufacturing jobs in America without increasing our energy supplies.


When Obama was running against Hillary, it was clear just how massive his tax increases would be. He has since moved and he continues to move to the right on taxes and on Iraq. Still, McGovern demonstrated that Americans are reluctant to vote for those who admit they plan to raise taxes. Many Americans were very slow to forgave George H.W. Bush for breaking his promise not to raise taxes.


McCain certainly has an uphill battle during this economic slowdown. He does have the advantage of being on the right side of several key issues.


As far as Palin is concerned, expectations have been pounded down. She may do much better in the debates than is expected.


In any event, when Bush dragged Quayle across the finish line with a landslide 40 state, 53 to 46% lead, he showed that the vice-president nominee is not very important. Bush would have easily dragged him across the finish line again in 1992 had Ross Perot not spent many millions of dollars to take 18.9% of the vote.


Even better than Quayle's example, is the one of James Stockdale as Perot's running mate. He did not know he was really on the ticket until a week before the debate. Because he did not wear his hearing aid, he was disoriented and confused throughout the debate. Bill Clinton became President with 43% of the vote, one of the lowest totals in history.


Finally, Obama leads in the popular vote polls because of huge leads in populous states such as CA and NY. As always, winning the electoral vote is the only vote that counts.

On Sun, Sep 28, 2008 at 10:54 PM, Al wrote:

Placing any bets on the outcome of the election before Thursday's debate should get better odds than 60:40. Currently Sarah Palin is dropping rapidly in the poles and a bad night at the debate will crush any chances of a McCain victory.

I have a cousin who lives in Wasilla and I visited there in 2005. My wife and I spent several weeks driving through Alaska sight seeing and talking with the locals where ever we went. I can truly say it is the most beautiful place I have ever been in the summer time (I'm not sure how I'd take the winters) and the people have a hearty self reliance befitting their surroundings.

In 1996 when she became mayor Wasilla was a town of about 5000 with the Alaska Railroad and the Parks Highway running through it. It had a municipal budget of $6.5 million and 53 employees. Wasilla is about 50 miles northeast of Anchorage in an area that is Alaska's next area for development, as Anchorage is nearing geophysical limits for its development. Wasilla has grown to about 6500 people since 1996 and developed a strip mall atmosphere along the newly widened Parks Highway (the road between Anchorage and Wasilla is one of the few four lane sections of road in Alaska, which has no interstate highways). The total population in the state of Alaska is that of a congressional district (there are 435 districts, each with about 600,00 people), although the land area is over twice as large as Texas. The two largest land owners are the federal government and Alaskan native tribes. The citizens of Alaska refer to rest of us as the "lower 48" and for the most part have very little interest in lower 48 life or politics. Gov Palin has reduced pork to Alaska from about $550 to just under $300 million last year. This is still the highest per capita amount of pork in any state. Every Alaskan resident (man, woman and child) receives an annual oil dividend, this year it was over $3000 and in many families accounts for a large portion of the family's cash income. I have not been able to confirm this as fact, but if I understood the news broadcast correctly, 104 cities in the US have higher annual budgets than the state of Alaska.

Alaska also has very high rates of drug and alcohol abuse and a higher than average per capita incarceration rate. Correctional facilities are overcrowded and state prisoners are sent to other states. Many of these things are to be expected from a state that calls itself "The Last Frontier".

Its nice to know that at age 72, John McCain can still appreciate a physically attractive younger woman, but after listening to Sarah Palin's recent interviews with the media, I truly must wonder if he'd rather loose an election than harm his country.

THE DO NOTHING OPTION--OUCH.

Far right leaning conservatives in the house, noted investor Jim Rogers and my friend Joe say the best bail out option right now is to do nothing. This is a moot point as a deal has been struck that will be presented to the house for a vote tomorrow. This deal will pass. This deal will authorize initial purchases of $250 Billion of mortgage backed securities. It authorizes two more tranches: one of $100 Billion and another of $350 Billion, provided the President declares these additional purchases are necessary and provided the congress consents by up or down vote. Still, it is valuable to understand why the do nothing option is a bad choice.


Hundreds of thousands of careers of honorable people and the investments of hundreds of thousands of honorable investors is at stake. These people did nothing wrong, other than to believe the stories told by their government representatives. The bankers were required, under penalty of law, to make loans in the most risky communities to high risk customers. The US government threaten to jail any banker who discriminated against any customer. Furthermore, US Government backed corporations bought trillions of dollars of these mortgages. Furthermore, Wall Street INVESTMENT BANKS, sliced and diced the risky loans and backed them with specially designed "certificates". The rating agencies declared that these packages of paper were solid because they contained relatively small amounts of the risky stuff (they ignored the consequences of the run away market that resulted from easy credit). Furthermore, the US Government gave an implied full faith and credit backing to the process.



The prices of homes soared because of the easy credit dictated by the US Government. After a time, it became clear that the way for lenders to make reasonable returns was to turn out loans as fast as possible. Government policies made the lending a no lose proposition and the failure to comply a criminal violation.


However, during the middle of the process, the government changed the accounting rules. The new rules required, under severe penalty of law, the marking to market of securities. When the housing bubble broke, banks were left with no option other than to declare massive unrealized losses. My Myrtle Beach example tells the whole story. An oceanfront condo that sold for $155,000 in 1985 was foreclosed and resold for a net of $95,000 during the recession of 1991 (with extra special terms offered by the selling bank). The same condo sold for $535,000 in 2005 as a result of easy credit. It is now valued at $265,000 or less as there are no bidders. The mark to market price is not determinable, but it is very low relative to the 2005 high. Beach condos are a special category. They are more volatile than regular homes and there are special lending rules that apply, however, the example they provide is useful in understanding the situation.


Bankers who trusted the integrity of their government should not be punished for their honest work and owners of over priced homes should be allowed the opportunity to spread out their payments in order to eventually recoup their investment. Holders of bank stocks should not be forced to anti up the total loss caused by the policies of government.



Forcing banks to sell to bigger banks right at the bottom of the cycle is not ethical. Banks that operated in good faith should be granted a little capital flexibility and a little time to recover. One fair approach would be to allow the paper to be marked to cash flow value rather than "dead market value". All elements are in place for the real estate market to heal itself. Building has virtually stopped. New supply has ceased. The old supply is being reduced. New roads and new retail locations are replacing some houses. Demand for housing is growing. Hundreds of thousands of young couples will be married in the months ahead and many young couples with children have already outgrown the apartments where they currently live. The downward spiral of home prices has been exaggerated and it is all but over, especially if a few easy steps were taken.


There are many somethings that could be done. With money available near historic lows, banks are ready to offer very attractive mortgage terms, provided they get relief on capital ratio requirements or mark to market rules. Many a discouraged potential buyer would be encouraged to buy a home should the banks suddenly be able to advertise the availability of low rate loans. Many a buyer would be willing to take over the payments on a foreclosed loan if there was a small increase in confidence. A small tax break offered to any home buyer would further stimulate demand. The cost of such a program would be nothing! after taking into consideration the increased tax revenues generated by the return of a solid real estate market. It would only take the sale of only a small percentage of homes to "prime the pump" and make the housing market strong. Many a person selling their current home would buy a new one elsewhere. A lot of pent up transactions will occur as soon as a small amount of confidence is restored.


Again, the Paulson bill is not a bail out bill or a rescue bill. It is a bill designed to quicken the pace of bank consolidation. The biggest banks would like to buy huge amounts of assets while real estate prices are in deep recession.


THE BIG ARE QUICKLY GETTING BIGGER!


Bank of America (BAC) was a 1.7 TRILLION DOLLAR BANK a couple of weeks ago. The purchase of Merrill will add another TRILLION DOLLARS OF ASSETS! We talk like the $700 Billion Paulson represents a lot of money but this one bank is about 4 times the size of the buy out proposed.


JPM (the combination of JP Morgan Investment Bank and Chase Manhattan Commercial Bank) was a 1.5 TRILLION DOLLAR BANK a few months ago. It became a 1.7 TRILLION DOLLAR BANK after it bought Bear Sterns. It actually jumped in size by much more than $200 Billion because the assets purchased were at rock bottom prices. Should the Bear Sterns assets recover to anywhere near the underlying mortgage values, JPM will make billions of dollars off this purchase. Last week, JPM picked up the largest savings and loan in the country, Washington Mutual (WM) for a song. JPM took on another huge pile of deeply discounted mortgages. Based on what is about to happen, when the government establishes a new, very low, mark to market price, JPM will have to report losses of perhaps as much as 30 Billion Dollars on this purchase. Here again JPM has added the potential for billions of dollars worth of profits. I submit that Jimmy Diamond knows more about the likely auction price than you or me. Maybe the write downs will not be as large as feared.


WM's shareholders got hosed due to the greed of others. WM was forced out of business by ridiculous accounting rules. How many other shareholders will lose out while the FOMC and the Treasurer keep the lid on capital ratios and mark to market rules?


In any event, investors should remember the famous seen in "Its a Wonderful Life" when Jimmy Stewart saved the savings and loan while "Mr. Potter" saved everything else. When others had lost their heads, the richest man in town was buying, just like Warren Buffet is today. BAC, Citi and JPM represent scores of other very rich men and they are also buying.


WACHOVIA?


A regular reader wants to know what to do with her shares in WB. In the absence of a bail out bill, WB could have survived as an independent bank or have arranged a very solid merger, especially true had there been temporary relief from capital ratios, easily grantable by the FOMC. However, it looks like the bail out bill is going through. Thus, it looks like WB will be forced to write down paper right at the bottom of the market. WB is thus in a scramble to find one or more merger partners or buyers, one who can withstand the short term hit of writing down more paper.


The "news" is that a bidding war has broken out between Citibank and Wells Fargo. This does not necessarily mean that current shareholders will get a nickel. The rumor that went around when GS and MS became bank holding companies was that there would be a combination of Wells Fargo, WB and GS or MS in order to form a bank large enough to compete with C, JPM and BAC. So far, we have seen no indication that GS or MS are ready to start bidding, other than the fact that each has raised substantial new sums of capital. Now that the bail out bill is likely to force the weakest banks to fail, there will be plenty of food for the sharks to consume.


Citibank is a 2.1 TRILLION DOLLAR BANK. It already owns the remnants of several investment banks. Wells Fargo (WFC) is much smaller, about $600 Billion in assets, but apparently virtually untouched by the sub prime crisis (influenced certainly by one of the major holders, Warren Buffet). Again, to reach the scale and diversity of JPM, C and BAC, it seems likely that a WFC-WB combination would be accompanied or followed by a further deal with GS or MS. Since the new WB Chairman has close connections with GS, the persistent rumor is that GS will be involved in any three way deal involving WB.


There are many other players. For example, BBT has grown up fast, partly through its steady campaign of acquisitions. Even so, it has only $200 Billion is assets. BBT is most likely to buy another regional or to do a merger of equals with another regional, such as Sun Trust or First City? BBT could possibly buy a bank the size of WB, but, having been conservative enough (perhaps smart enough) to have avoided the sub prime slime, it seems unlikely that BBT would try to swallow so much.


One of my good friends who is an officer at BBT says that Goldman (GS) and Morgan (MS) are not going to like the regulations required of deposit bankers. He is right, they avoided these regulations as long as they could. Merrill Lynch, Lehman and Bear Stearns avoided them as long as they could. Ultimately, GS and MS had no real alternative, they could join the prospering commercial banks or they could follow Merrill Lynch, Lehman and Bear Sterns on the bought out for less list. The name Merrill Lynch will still be around for a very long time, but the firm did not give up its independence on a whim.


WHAT TO DO IF YOU CURRENTLY OWN WB?


A 50/50 proposition! WB has the customer relationships that are desired by companies such as GS, JPM and MS. Ironically, democrats constantly talk about how the rich are getting richer while the reality is that a growing percentage of the worlds citizens can now afford 401-K and other investment accounts. In the old days, JPM dealt with only the very rich, those who controlled a very high percentage of the worlds assets. Today, big money is made off the trillions of relatively small transactions made by the billions of people who own savings and investment accounts.


When JPM picked up WM, it picked up 2,300 retail branches. What a switch for a firm that used to be 100% located in New York? Most interesting, it is not the real estate that was of great value to JPM. The account list was the prize.


As of February of 2009, TV signals of the past 60 years or so go dark. This huge super information highway will suddenly be available for 21st century banking. For decades, there has been the understanding that banking would one day become paperless and mobile. The infrastructure is just about in place. Millions of people already have their income directly deposited to their bank. Millions already make withdrawals with debit cards. Millions already check their balances and reconcile their statements online. Convert a small mobile computer (sophisticated cell phone) to a debit card and suddenly the need to visit a bank branch will be a rare event. Would it not be nice to easily check your bank balance immediately before and after buying your groceries?


The productivity produced as a result of mobile banking will be enormous. Small and large transactions will be completed in an instance. Call in a pizza order and hit the payment key to finish the transaction. No more allowing a waiter to take your credit card to a reader. No more trips to make deposits or to acquire cash. Eventually, no need to carry a wallet. No more copper pennies to steal your time or to wear holes in your pants pockets.


A LITTLE HISTORY


As I recall, it was in 1979 when the Credit Union, where I was General Manager, became the first financial intermediary in North Carolina to offer floating rate, Federally Insured, money market accounts. The next step in my plan was to offer extraordinary benefits to all credit union members. The caveat was that members must agree to direct deposit of their checks and to access their accounts primarily through debit cards. I lost that opportunity because I strongly disagreed with several board members who wanted our credit union to become a charity for low income earners. Twenty-nine years later, the movement toward direct deposit and debit card withdrawal is about to take a significant leap.


Back in 1979, my study of cost revealed that each time a member came to the credit union to make a withdrawal, the cost was in excess of $2.30. The cost of a debit card withdrawal would have been only a few pennies. Today, the cost of an over the counter withdrawal is undoubtedly much higher at a prime bank location staffed by people making today's wages and benefits. On the other hand, the cost to make withdrawals through electronic means is moving rapidly in the direction of ZERO!


The fixed cost to set up a computer system to account for trillions of transactions is considerable, but the marginal cost per transaction is truly a very tiny fraction of a penny. The business of online banking is a very different business than branch banking. For some time to come, there will be many individuals willing to accept slightly higher loan rates and slightly lower savings rates in order to deal with a live teller. In the long run, economics always wins. The fewer the people willing to pay extra, the higher the extra required. Old timers will be slower to convert than the young, but eventually, the attractive savings and transaction rates offered by the largest banks will result in fewer banks. Eventually, there will be world banks.


SPEEDING UP THE PROCESS


Friday, solid banks such as JPM, BBT and BAC jumped in value. The financial index is showing strong relative strength even while there are hand grenades going off at the weaker banks. The passage of the "out of business bill" is going to speed up the consolidation process. At some point, there will be the breakout of bidding wars that run the prices of the small fish up. Indeed, this morning, we are seeing a significant decline in resource prices in Australia, a soaring dollar against various currencies, and stronger financial prices. I would not be surprised by a 300 point jump in the Dow today.


Here again, the timing of this bill is not an accident. More aggressive actions could have been taken months ago if it was the plan that is to lead the market. If it is the market that leads, then the plan was timed in order to take advantage of the turn. It is very difficult for an individual investor to time a market, but the Chairman of the FOMC and the Treasury Secretary of the USA certainly have powers to influence that we do not have.


The time to buy whole banks is just before a dramatic turn in the price of real estate. It took many months for the unsold homes on the market to reach 11 months supply. The unsold supply peaked three months ago. The peak might be tested this month as potential home buyers and the rest of us have been slammed by the beat of the "pending crisis drum". It has been implied and even said by some that if we do not do something quickly, another Great Depression or even Armageddon will be upon us. Who is shopping for a house under the beat of such loud drums?


The bottom line is that it is time to buy bank stocks. Spread out your purchases, because there will be losers and winners, but buy bank stocks. If you own WB, you have a tough choice to make. WB is likely to be bought. My guess is that current shareholders will receive something. I am hopeful but doubtful that the price will be $10 or more. The market should pop on the news that agreement has been reached. Further more, when an auction takes place, there can be huge surprises. My friends at BBT were surprised that JPM took such a hit to own WM. The analysis at JPM is that the short term loss will lead to a very substantial long term gain, why take the risk if one does not expect extra high returns. Citi could easily buy WB if it wants.


By the way, while this consolidation plays out, long term treasury rates and commodity prices should continue to fall. Bank leading spreads may stay wide, while banks try to recover losses and because the cost to replenish the FDIC is substantial. The continued pressure on economic growth should continue to pound on the price of commodities. Ultimately, the FOMC is likely the follow the 90 day t-bill rate down and cut the Fed Funds rate, currently at 2.25%. The 90 day bill traded Friday at .67%. It is likely to meet the Fed Funds rate somewhere in between the .67 rate and the current 2.25% Fed Funds rate.


Once the "going out of business bill" is in place, the FOMC will be in a position where it can release pressure by lowering rates when it wants. Market rates are very distorted right now, but based on TIP spreads, inflation expectations have fallen dramatically. The average of "yield curve brakes" are no where near where they were in July of 2007. The dramatic decline in inflation expectations, should result in substantially lower short rates from Europe to Australia and back around; but, only to the extent accompanied by further declines in the price of energy.


Now is not the time to DO NOTHING! Now is the time to buy banks.

A DEAL IS DONE

A bail out bill has been negotiated. The bill is being put on paper by staff during the night. Assuming the writing matches what each side believes was negotiated, an announcement should be made later today.


It has not been revealed to what extent the bill (TARP) includes the two features that have been pushed by house republicans:


1) That there be tax deduction limits on executive pay. Salaries in excess of $400,000 per year would not be tax deductible and there would also be limits to Golden Parachutes allowed under the tax code.


2) That the biggest of financial firms are to contribute to a Stabilization Fund, similar to FDIC or a reinsurance pool. By using the pool to insure a portion of the mortgages, the house hopes to reduce the size of the program to $500 Billion.


In regard to item one, as is typical, government regulation has lead to the need for additional regulation. Dan Ariely, author of "Predictably Irrational", tells the story well. In 1993, the government required companies to divulge top executive pay. At the time the average CEO made 131 times the average worker. Since then the average has climbed to 369 times! After the forced disclosure, being paid the most became the ultimate status symbol and pay packages were driven up. One of the Ten Commandments says "Neither shall you desire your neighbor's house or field, or male or female slave, or donkey or anything that belongs to your neighbor." But the government invited each top executive to check to see how his income stacked up against the other top executives. It is human nature to believe it fair to be paid as much as the next fellow. Back when no one knew what others made, 131 times average was enough, today even 369 times average is not enough. The new top executive at WM was paid $20 Million for 17 days on the job. The problem is that if we cap pay at an artificial rate, there will be unintended consequences. The amount owners are willing to pay their employees should be a private matter, however, there is rational to making excessive pay not tax deductible. The cap has to be put in because members of congress need cover for voting for this monstrosity. Oh what a tangled web!


Another thing not known is if the "affordable housing pork" was stripped out of the bill. As usual, pork was quickly inserted. In this case, the pork was supposed to go to slush funds controlled by city mayors, predominately democrats. Instead of using the proceeds from the sale of the bonds to pay back the borrowed funds, democrats prefer to add funds to the coffers of housing aid slush funds while increasing the national debt. House republicans are in revolt. Sooner or later, we must stop asking every tax payer to subsidize the politically well placed.


ARE HOUSE REPUBLICANS RELEVANT?


The bill has bipartisan support in the Senate. Democrats hold the majority in the house, where the right of filibuster does not exist. Theoretically, democrats do not need any republican votes to pass this bill. However, the American people are justifiably angry. If the congress were to pass this bill with few republican votes, democrats know that republicans would use the bill as a hammer every day between now and the election. Therefore, democrats will not vote for the bill unless there is a guarantee of a certain number of republican votes.


On the other hand, do house republicans dare to block the bill? If they did, Paulson would put another bank out of business by Monday morning. House members would be blamed for all the economic problems every day between now and the election.


Under the circumstances, house republicans must go along, but they must win at least a couple of concessions. The lower the total cost, the better the election prospects for house republicans and for John McCain. Proposals to cap executive pay have been made by McCain and Obama, so the path of least resistance is to include such restrictions in the plan.


THE SENSE OF URGENCY


The sense of urgency is because the "push to put banks out of business" feeds on itself. Banks, knowing that the auction may force them to book additional losses as they mark their securities down even more, are in a mad rush to swap securities at the FED Discount Window. Even though the FED Funds rate is only 2.25%, banks are paying the FED 3.75% to swap mortgage backed securities for t-bills. They believe that they will not be forced to revalue notes that are being held by the FED.


By the same token, banks are in a scramble to increase deposits. Yesterday, at least one bank was offering 4.06% for 90 day CDs, while the 90 day t-bill discount rate was .62%! From an earlier message, we know that European Banks are backing their loans with about 75% less capital than US Banks. Under the circumstances, this bail out bill is not necessary, US regulators could ease off on capital requirements in exchange for additional premiums to the FDIC. The problem could be solved by giving incentives to home buyers, without forcing bank consolidation. CitiBank is already a 2 Trillion Dollar Bank but it is going to get a lot bigger. Investors must realize that they should not attempt to fight a battleship with a row boat. The smart investor will hitch his boat to the battleship and go along for the ride. The safest plays include buying shares in the biggest of banks or buying shares in financial exchange traded funds. If you are good or lucky at picking winners, you can make a ton of money buying individual smaller banks.


GERONIMO -- ONE WHO YAWNS


After listening to the first presidential debate, it is appropriate to talk about Geronimo which means "one who yawns". Geronimo became a bitter man in 1851. While Geronimo and his friends were hunting for food, Mexican soldiers came to his home and massacred his mother, wife and children. For the next 35 years, he fought wars with Mexico and the USA. The massacre happened just after the Mexican American War, just after gold was discovered in California and just before the Gasden Purchase.


Geronimo comes to mind because Obama never tires of saying that we took our eye off Osam bin Landen by entering the battle in Iraq. In Obama's mind, the war on terror will be over as soon as we have killed or captured Osama bin Laden. Geronimo was just one of 75,000 Indians in his neighborhood. He was the toughest of foes but he was one of many. Osama is just one of 167 million Islamist in Pakistan. Obama's solution is to threaten the Pakistanis if they do not capture Osama for us. This strategy would have been like telling Santa Anna that he had to catch Geronimo or we would resume the Mexican-American war.


The unofficial name for the war on terror is "The Long War". There are millions of Islamofascist who would like to wipe out America. These groups have been winning through intimidation for 1,400 years. America did not lose the respect of these people after Bush invaded Iraq. Iranians have been calling us nasty names for as long as I can remember. The UN security council votes have tended to be 15 to 0 or 14 to 0 to 1. France is once again one of our strongest allies. Obama is simply wrong about the status of the US in the world.


Around 1852, as part of a deal to build a canal, the US agreed to spend 12 million dollars to protect Mexico from American Indians. The negotiators thought $12 million would be enough but US Generals estimated that $60 million would be needed. Wars always cost more than we think they will. A partial solution was reached by negotiating the Gasden Purchase. The USA agreed to buy 39,000 square miles of what is now parts of New Mexico and Arizona for $15 Million, provided we would no longer be required to protect Mexico. Mexico agreed! What a deal! Instead of spending $60 million to fight Indians, we would spend $15,000 to buy 39,000 square miles. The vote in Congress was two votes short. The deal was renegotiated. Mexico was in financial hurt. We could buy more than 1/3rd of Mexico for $50 million or we could buy 30,000 square miles for $10 million. We made a big mistake and bought just the 30,000 square miles. This was one of those times when the government should have gone into debt. We could have owned billions of barrels of oil and the land above for only a few dollars per acre.


A US Fort was built in 1856 in order to protect the area while railroads were built. Geronimo just kept on raiding Mexican and US forces. He hid out in the Robledo Mountains in New Mexico. He was once surrounded in a cave but he never came out. When he was spotted miles away, the soldiers searched for the back entrance. It has never been found. Osama is hiding in a little old range of mountains called the Himalayas. He is not very far from K2, the second highest mountain the world. Caves hide outs and networks were established in these mountains thousands of years ago. Obama cannot send in the mod squad and come out with Osama.


When Geronimo was caught, in 1886, it was a psychological win, but his capture was a tiny part of the total war. I could care less if we get Osama, provided we bring the war on terror to a successful conclusion.


It sounds alarmist, but, if Obama becomes President, the risk of WWIII will increase. The best way to prevent war is to walk softly while carrying a big stick. Osama wants to pull out of Iraq so the "savings" can be spent on domestic programs. Bill Clinton practiced a similar strategy. He whittled down our stick in order to enjoy more domestic programs. We enjoyed such great wealth during his term that it seemed reasonable to "give" every renter a home. The structure was put in place to force banks to lend the full asking price to the least credit worthy individuals. We are paying a price that is many times more than the $700 Billion TARP. Had the money spent on subsidized housing been spent to keep our intelligence and military strong, 9/11 would have probably never have happened.


Pakistan is allowing the USA to fire on known targets in Pakistan. They cannot admit that they have given permission but it is folly for Obama to make it sound as if he has the easy answer.


A DEAL IS DONE and it is time for change. It is time to reduce the size of government. It is time to talk Iran and Iraq into going to war against terrorist in Afghanistan, Pakistan and Somalia. In the years ahead, Iraq and Afghanistan and Pakistan will be major allies in the Long War. The package of benefits available and sanctions on Iran could ultimately swing Iran to our side. The $10 Billion from the USA and similar amounts from the Saudis given to Pakistan to fight the terrorist has been money well spent. Scores of al Qaeda leaders have been killed.


There are 157 known al Qaeda training camps in Pakistan. Obama makes it sound like a piece of cake to flush Obama out. He talks about building respect and relationships but he implies that he would invade Pakistan. Obama should note that the UN has not declared that Pakistan is in violation of international law. Had Geronimo hid out in Mexico, it would have been correct for the US to work with Mexico but in the absence of a deal, it would have been correct to let him be.

THE LOOONG SLOOOOW TURN

During the Great Depression, the Glass-Steagall Act was passed to separate commercial banks from investment banks. Commercial banks gather FDIC Insured deposits in order to make loans whereas investment banks raise capital through the sale of equity shares, notes and bonds. Commercial banks are tightly regulated, investment banks are more free wheeling.


In 1999, Phil Gramm was the co-author of the final "nail in the coffin" bill that killed the Glass-Steagall prohibition against being both. Combination banks and investment banks such as J.P. Morgan/Chase Manhattan and Citi Bank/Shearson/Smith Barney/Drexel/Salomon Brothers/Travelers and American Express were the result (I listed only a small portion of the institutions that were combined over the many years to make these huge companies, Citi is a 2 Trillion Dollar Company.)


Even many of the smallest commercial banks have become sellers of stocks and bonds. Bear Sterns and Lehman Brothers were two investment banks that remained until recent transactions. Goldman and Morgan Stanley were the lone holdouts until last week, when an era came to an end.


Back in the early 1980's, when the wall between functions was breached when Merrill Lynch and others started offering "all-but bank products", such as money market checking accounts and "pass through" certificates of deposit, my Dad was one of many who was upset. The people who lived through the great depression and WWII tended to be very security conscious. Their priority was the safe return of their money, not the highest rate of return on their money.


Many how live through the Great Depression and WWII had parents who lived through the horrors of WWI and the Great Depression. Today, Americans express great concern about the economy while they live in debt up to their ears. Today, Americans have little concern about the threat of Islamic Fascist because they have lived in a relatively stable world and a very stable USA.


Last night while watching the debate with three others, it was clear how my mind set has been colored by the experience of Vietnam. I was never a Gung Ho GI Joe. I always had mixed feelings about Vietnam but I am sure that generations before had mixed feelings about Korea, WWII, and all others. It is hard but necessary to accept that wars are sometimes necessary.


Today, it seems that the average American deeply discount the possibility of WWIII. I hope it never happens, but Islamic Fascist are building armies in dozens of countries. Our success in Iraq is an important beginning in the war against these murderers. When we can, we must win by diplomacy. Leftist have enjoyed poking fun about terrorist following us home from Iraq, but terrorism continues to spread, even though hundreds of thousands have died in Iraq, Afghanistan and Pakistan.


US BANK CONSOLIDATION


US banks are not under capitalized. As I wrote yesterday, Americans should be thankful for the health and strength of our banking system. America is the banker to the world. A significant portion of the wealth we enjoy in America is the direct result of the profits we make providing services around the world.


Compare the capital ratios of US banks to European Banks to see how healthy our banks are. (We will not get off on the tangent of the horrible shape of banks in places like Russia, where markets have been closed.)


The asset to equity ratio at a few European Banks are:


UBS 46.9:1
ING 48.8:1
Barclays 61.3:1
Lloyds 34.1:1


Our American "almost traditional banks" have much better ratios:


BAC 10.6:1
WB 10.8:1

BBT 11.3:1
WFC 12.7:1


Our combo banks have slightly more aggressive postures.


JPM 13.3:1
C 15.4:1


Even our investment banks have better ratios than the Europeans.


GS 26.6:1 before the $10B infusion and 21:1 after the infusion of capital.
MS 33.7:1 before a couple of significant infusions of capital.


THE LONG SLOW TURN


The democrats and the Russians have punted the ball down the field. For some time, it has been clear that the current ball game would end on or near October 1. A continuing resolution had to be passed, it could not be passed without drilling attached and the housing/financial crisis, caused by government intervention in the market place, made the prospects of Obama's tax and spend programs virtually impossible.


Today, the congress sent a 4 month, $630 Billion Dollar, spending bill to Bush; Bush is expected to sign. The spending bill will pushes the big battles forward to the next quarter. The bill permits off shore drilling while leaving the richest part of the Gulf of Mexico off limits. The leases for the new areas will not be let until 2011. As usual, the bill includes a lot of pork, including $6.6 Billion Dollars on "Pet Projects". If there was ever the need for someone willing to yield a veto pen, the time is now.


I suspect Bush went along with $23 Billion in disaster relief, $25 Billion in loans to car companies, double the subsidies for home heating and the 2,322 pet projects in exchange for assurance that TARP will be pushed through. TARP stands for Troubled Asset Relief Program (also known as the "big boy relief fund").


Every time I hear Barney Frank and others say the financial crisis is a result of inadequate regulation I want to scream. Frank was among those who voted to force banks into making loans to unqualified buyers.


The new "set-up" is that democrats are confident that they will control three houses after the elections. They were willing to suspend the moratorium on drilling for a few months until they will be more powerful. They did not pass an annual budget because they are foaming at the month at the prospects of big spending projects after the election.


Chances are high that some form of TARP will pass. It is likely that the republican house will get the size reduced but it is likely to pass. Over the next month, it will be the job of republicans to educate the people on the reason the ball out was needed. To the extent the facts get out, republicans will gain on democrats. My bet is that McCain will win the election and that republican losses will be small. According to the betting parlors, I am betting against 60:40 odds.


THE RUSSIAN STANDOFF


The USA and Russia has been engaged in a series of bluff and thunder moves since the invasion of Georgia. For example, the USS IWO JIMA traveled to Greece, near the entrance to the Black Sea, one of Russia's few warm water naval outlets before turning around.


Russia has cut deals to send oil from Kakiskstan and Turkmenistan through Russia and other supplies from Turkmenistan through Iran. The Russian plan is to become an important partner with OPEC. Russia wants to control as much oil as possible.


Russian ships have docked at Syrian ports, made deals to supply Venezuela with arms and, in general, tried to push US hot buttons. After a number of rounds, Russia and the USA have suddenly agreed to another statement to discourage Iran from building nuclear bombs. Russia and China refused to go along with new sanctions, but Iran is still being kept in the stew pot.


One of the important moves made by the USA was to back off in regarding to adding unilateral pressure on Iran. The USA has let Russia know that we will not do the heavy lifting. After all, we are a comfortable distance from Iran's nukes and Russia is not.


We also did a "double take" on Iran. If Iran wants to wait for many years before developing their monster fields of oil and gas, so be it. While Iran keeps trying to spin uranium ore, deals are being made by its neighbors for nuclear power plants and for oil and gas pipelines and drilling projects. Iraq made monster deals with China and Shell in regard to natural gas. I suspect that the deal between China and Iran was another deal to keep Iran barefoot and poor. China agreed to help Iran develop its natural gas fields a long time ago, but Iran is sitting while others are doing.


Iraq is preparing to increase production rapidly. Other western companies are likely to be involved in the near future. Brazil just keeps on finding more oil. World wide oil and equivalents will be up 5 million barrels per day this year (3 million or so after adjusting for depletion) and US product demand just declined 5.3% from last year.


DO NOT BE DISCOURAGED!


This turn is slow. Iran is being allowed to stew, the US is focused on the banking bail out and democrats in control are content to wait until after the election. The passage of TARP will not cause the banking crisis to be suddenly over. The investment game in the weeks ahead will be the "guess who is going to be bought game". A corollary will be, how much will the buyer suffer in the short run.


All the while, commodity prices will slide. The broad averages will struggle to make progress as gains in some sectors will be offset by continued declines in energy, basic materials and capital goods.


The next bounce by McCain will be accompanied by a good move in the market. Keep in mind that most of the polls are biased toward democrats. One of the reasons republicans seem to always close so strong is because they were not so far behind in the first place. Dukakas had a 17% lead going into the home stretch run.


This turn has been slow but it is real. Take advantage while you can!

BAIL-OUT OR PUSH-OUT

A number of "news" outlets have started calling the $700 Billion Dollar Bail-Out "The Rescue Package". Is it a Bail-Out, Rescue or Push-Out?


Commercial banks, savings and loans and insurance companies are being pushed out of business. The short answer to Al's question about bad bank management is that banks faced huge penalties and even criminal prosecution if they did not adhere to the Community Reinvestment Laws. The rating agencies and the banks were fooled into believing sliced and diced mortgage paper, being packaged and sold by the investment banks, was AAA credit. Now these big banks will buy up the smaller banks that have been duped.


There is a consolidation in progress. The $700 Billion will force this consolidation to move at a quicker pace. Forcing a bank to sell while the fire is burning down the town is not a Bail-Out or a Rescue, it is a Push-Out! The "big boys" stand ready to scoop up assets, like JPM scooped up WM a couple of days ago.


John Allison's letter to Congress was on the money. This crisis (as phony as the democrats hype about pending doom from global warming) could be solved by restoring sanity to the mark to market rules and by using only a portion of the $700 Billion to provide tax credits for home purchases. It is the dead housing market that is killing the banks. The Paulson Plan will simply allow the big banks to get bigger.

HOW DID WE GET IN THIS MESS?

Al raised several good questions yesterday. Between now and the election, we are all going to hear a lot about the Community Reinvestment Act, the Act that caused the housing bubble.


The following link is to a youtube video that supports McCain for President. It offers some of the details that got us into this mess. It leaves out some things, but it is a factual video, well worth watching.


The link is: http://www.youtube.com/watch?v=H5tZc8oH--o


The above link does not appear to be working. If not, the video can also be found on the power line blog at: http://www.powerlineblog.com/archives2/2008/09/021622.php

Re: THE BIGGEST BAIL OUT IN HISTORY -- PRIVATELY FUNDED

Great questions and points made by Al. I think his comments highlight an extremely important point, one that is seldom made.


The fact of the mater is that our banking system is the envy of the world. Banking is one of the things American does great. In fact, if you look at the growth of revenues for business sectors over the years, you find that US banks have gotten not just bigger, but better in almost every way. Our banks employ millions of people and they make it possible for our businesses to grow and for our businesses to hire ever more people.



One of the four necessary components Peter Bernstein says is necessary for a vibrant economy is a sound banking system. The struggles in countries such as Russia, Iran and China are partially the result of not having the relatively free and powerful banking system that we have. Only in recent years have European banks begun to shed the archaic rules that prohibit growth.


Politicians and "news critics" like to point their fingers at bankers and saddle them with the blame for our problems. I know at least a couple of dozen bankers who are the salt of the earth; good men and women who serve their community well. People who, in their daily lives, demonstrate high ethical standards and honor beyond reproach.


When Al asks how did the banks get into this situation? Was it bad management? One must conclude that if it was bad management, there was bad management in the majority of the banks. The reality is that the bank managers were mislead, snookered, just as badly as the rest of us. Were there some crooks, who knowingly made bad loans? certainly. Obviously, had anyone known for sure the outcome of the policies in place, that person would be a multi-billionaire today. Politicians and pundits are pointing fingers at people who have or who are at risk of losing their jobs and accusing them of being bad people. If those pointing their fingers had had a clue, they too would now be billionaires. There are a few people who had great foresight and they made a lot of money but the managers at the banks that are in trouble did not know.


If one only looks at the people who did extremely well during this debacle, one would have to include the executives at Goldman and JPMorgan, who all made millions in bonuses over the past several years. Their success does not make them crooks. If one were to point a finger toward the one person who seemed to be most aware of the trouble ahead and the one who benefited himself and his firm the most, one would have to point toward Hank Paulson. Again, awareness of a problem does not make him a crook.


As far as many of the people who pushed Fannie Mae and Freddie Mac to be ever more aggressive in purchasing no doc and other high risk loans, their hearts were probably in the right place. Here there were many politicians, lobbyist and executives who got wealthy off a semi-government corporation, which is a terrible idea in the first place. Most who supported these entities had good hearts, but a poor understanding of economics.


I am among those who have applauded efforts to help the poor become homeowners, but I have never been in support of excessively loose lending practices. It has been proven time and again that loose lending is a huge mistake. In Proverbs there is a verse about running from a loan like a Gazelle from a Cheetah. The admonishment does not say to never make a loan but to be extremely careful if you do.


Furthermore, it is not the job of government to perform charity. As a former credit union General Manager, I always draw on that experience when it comes to charity. While credit unions have a stated goal of service, it is easy for a credit union board to confuse the objective with charity. Making a low cost loan is a service which requires careful execution as there is a fiduciary duty to recover those funds. In the old days of the Credit Union movement, neighbors were required to help neighbors in the establishment of credit. Had a credit worthy person or entity been required to cosign the low down-payment loans offered by Fannie, an experienced person or entity would have been there to carefully consider the terms of the purchase price and the loan. Later, when trouble came, they would have been quick to work with the lender to work out a long term payoff plan. The problem would never have gotten so large. The great majority of loans would have been more sound in the fist place.


It is always tempting to raise taxes on some so that charity can be given to others. Such plans do a disservice to the both parties. The poor do not want handouts, they only want a fair chance.


Those of us who study cycles sometimes wonder if cycles are not pushed to extremes by the powerful, in order to take advantage. While at Goldman, Hank Paulson developed the concept of mixing a few weak credits with mostly strong credits and calling the package triple A. He has since reigned over the collapse of his nemesis at Bear Sterns and he has broken the legs of the government corporations, Fannie and Freddie, that have been in competition with Goldman. While I do not accuse Paulson of any wrong, I prefer to make sure that he nor anyone else is given the power over $700 Billion which could be used to pick losers and winners. The formula for evaluating the mortgages needs to be determined up front, if at all possible.


I must say again that the great majority of bankers in America are principled people. I do not believe this melt down had to happen. I believe the mark to market rules, instituted after the Enron debacle, should have been adjusted months ago. I believe bank capital requirements could have been reduced just a little to give time. Give the lenders time to set up work out agreements and for the market value of homes to turn and this crises would be over. As Lamar noted, it is the cessation of building homes and the gradual growth of demand for homes that will ultimately make almost all of the homes in America worth much more than their current mortgage balance.

On Fri, Sep 26, 2008 at 1:38 PM, Al wrote:

I would like a better understanding of this "crisis", but many of the statements being made on and by the media seem at odds. The hue and cry is that banks are not in a position to make loans and our credit system will fail. How do banks make profit? They lend money for a larger amount of money than it costs them to borrow money (deposits, fed loans...). Why are banks in this position? Is it bad management, insufficient regulations, lack of enforcement of the existing regulations, excessive costs or old fasioned greed? TS Paulson says $700 billion check made out to him with no strings attached, is needed to "solve" the problem. The FDIC has become a business broker which is resulting in the reduction of competition in the financial sector. The public is not buying the "collapsing economy and we must bail it out at any cost" fear mongering by the Bush administration at a ratio of over 3 to 1. The longer it is taking to reach a settlement, it seems the less the taxpayer will be on the hook for direct payments, but less competition will exist when the dust settles and many financial stocks will have tanked. As Jack has pointed out, there are other, possibly much better ways to solve this "crisis". Banks must lend money to survive and changing the current rules along with providing government support will put them back in the lending business. My opinion is that if congress would do nothing else but protect the depositors and go home, most of this "crisis" would be solved by private money. But it is an election year and it is likely that huge amounts of public funds will be pored into Wall Street, the ghosts of old J.P. and the rest of his robber baron cronies will be at the post election party.

Al

A BIG TURN IN PROGRESS!

Today, all the news is about the financial crisis but the markets tell a totally different story.


By S&P Sector:


Basic Materials down 4.77%
Energy down 3.13%
Financial down .81%.


The turn is staring you in the face. I hope you take advantage! A deal might be made over the weekend. If not, it should be made soon.


Jack

FW: John Allison - Letter to All Members of Congress.pdf

A regular reader and friend sent me the attached link to Chairman John Allison's letter, a letter written to all members of congress. It is a great response to some of the questions raised by Al.


Of particular note is the idea to attack the problem from the bottom up. By granting tax credits for the purchase of a home, the demand for homes would be raised. The people on main street would save the bankers on wall street instead of the other way around.


Allison did not say this but the tax credits could even be granted to those willing to assist an underwater homeowner to stay in his home. His payment would not be fully reimbursed but he would in effect become a friend and mentor to his neighbor.


Americans are good people. Give us a chance to work with one another instead of forcing us to take sides in acrimonious battles fought in congress!

Click here to read the letter.

Re: DEAL OR NO DEAL -- A CRUNCH IN LONDON

I am willing to make a substantial wager that McCain will be our next President. Like the best of politicians, he is smarter than he looks. Jimmy Carter a country hick, Ronald Reagan a pretty boy actor, Bill Clinton another country hick, George Bush unable to pronounce nuclear are just a few examples of men that made it to the Presidency. They either had great handlers or they themselves were quite brilliant, you choose.


McCain is on the side of the great majority of Americans on this one. The great majority are upset with democrats and republicans who advocate spending $700 Billion on a Wall Street Bailout. Many of those who are upset are swing state, Ronald Reagan democrats.


McCain has a realistic chance to win in formerly democratic states such as Michigan, Wisconsin and Pennsylvania, to name three. Harry Reid probably did McCain and congressional office seekers a great favor today. His attack on republicans as the cause of this problem was way over the top. It was primarily democrats that supported Fannie Mae's efforts to lend to one and all for all of those years. It was McCain who sponsored reform legislation 3 years ago.


I have no bet to offer but I believe the democratic pickup in the Senate will be less than 3. This is the bill that could change the pickup in the house. Again, the republican congress is on the side of the great majority of Americans on this bill.


The distressed assets will change hands. It is not clear that they need to be owned by the taxpayers before they are sold to strong private owners.

On Fri, Sep 26, 2008 at 12:22 PM, bob wrote:

Politicians just can never help themselves. John McCain included. And so, the buyout of "distressed" assets does not get done as Hank Paulson suggests. Too bad. Senator McCain's latest plan, this alternative insurance scheme, well he HAS said in the past that he does not know much about economic.... That's obvious. Any third grade dropout could see it's not a sensible solution.


So,...



1. Senator McCain is on the verge of guaranteeing a Democratic victory in the Presidential elections and HUGE increases in House and Senate seats for the Democrats. A sweeping, stunning increase.
2. America will now enter a depression matching the breadth and depth of '29.

Where to invest? Unknown until we can determine if the new Congress attempts to solve the problem by inflating it away or if we simply put it in some sort of doomsday bond issue and hunker down in a safe place.

This problem is worse than it looks.

A FINANCIAL CRISIS, BUT

In early trading, we can see that we are in a financial crisis, but.


Energy stocks are down 2.37% and Basic Materials are down 2%, while Financial Shares are down 1.89%. Progress toward a deal would set financial stocks onto a long term run.

THE WINNERS AFTER THE TURN IS COMPLETE

Once the financial stocks have bounced, consumers will feast and then tech stocks will have a great run. A study done by ABI Research concluded that there will be 200 million "ultra-mobile devices" in use within 5 years, up from 10 million today.


What is an "ultra-mobile device"?


At the Gigom web site we find: Dell computer believes that the ultra-mobile device is a ultra small computer with a cellular data plan attached. Intel believes it is an ultra small computer with VoIP capacity. Qualcomm believes it is a large, feature rich cell phone.


While my personal belief is that the 200 million figure will prove to be low, a survey shows that most people do not see the big shift that is in the making. Those who dreamed of the electronic future back in 2000 were burned, now they are cautious. Most people see little utility in computers and cell phones over and above email and standard telephone calls. The deal that Visa just struck with Google and Nokia shows there is much more coming.


Visa has written software that allows bills to be delivered to cell phones and for payments to be authorized by cell phone. The skeptical will see yet another Armageddon in the works, but this is the type of software that will change your life. It is productivity in action. Millions of people sit down once each month to write checks and mail payments. Send these electronically to a persons hand held computer and much work will be done on the run; many will allow standard bills like utilities to be drafted automatically. After years of movement toward paperless money, a great leap forward is in the works. The savings from making change at the check out counter will be significant, but this system is more than a fancy debit card. It is a debit card with a GPS enabled computer attached. This is not a recommendation to buy credit card companies. Credit card companies did well as the see-saw to banks during the down phase.


The roll over from commodity plays to financial plays is keeping the spot light off technology. The focus on financial stocks will last a good while but technology is going to be on the same "hike", a few paces behind consumer cyclical shares. In October, odds are high that consumers will buy gasoline for less than $3 per gallon. Consumers will not buy an ultra-mobile device with their savings from the first tank of gasoline, but they might from their savings on their first winter fuel purchase.


Of course, from the Google point of view, the ultra-mobile device is all about advertising. Google and Visa will offer maps of where the specials are located. Even the little mom and pop store is likely to accept Visa. Visa would be happy to become the interface between the store and Google advertisements. A lot of steps will be saved by people who use their GPS enabled ultra-mobile device to find the nearest Starbucks or Dunkin Doughnuts. In many instances, the consumers will not use cell phone minutes to find these locations.


For me, the ultra-mobile device will be one that uses free WiFi as its first data communication option, paid WiFi as its second data option and cell phone minutes as a last resort. This seems to be the model being developed by Google and T-Mobile.


As I have painfully admitted, I was very slow to come to the realization that the administration was willing to engineer an economic slowdown just before the election. The mid-cycle correction was converted into the end of a business cycle. I was lost for a while but I am now back on the trail. The turn we are going through is not fun but it is real. Right now, there is great pessimism about the prospects of a deal. The markets are going to open lower. If there is evidence of progress during the day, the market will turn during the day. Chances are that a deal will be completed over the weekend. Tech will be strong relative to the S&P over the coming weeks. Financial shares will be strong relative to basic materials and energy.


The average world wide interest rate is going to decline in the months ahead as commodity prices continue to fall. Ironically, the departure of Russia from the UN 5+1 talks has allowed the USA to go into a "rope a dope" strategy in regard to Iran. Iran had a lot to win by making a deal and Russia had a lot to win by working with the USA but the USA loses less than Iran or Russia if deals are not done. While there is evidence that Iran is trying to make nuclear bombs, there is also evidence that they are having trouble mastering the technology. If they succeed, Russia and Iran's Middle Eastern Neighbors will be more at risk than will the USA. The USA would still like to "make a deal" but our team has shown a willingness to throw balls into the courts of Iran and Russia and to wait for them to make the next move.


Under these circumstances, the fear factor will continue to seep out of the price of gold and oil. Iran is not likely to let the trillions of dollars worth of deals available to wither on the vine.

DEAL OR NO DEAL -- A CRUNCH IN LONDON

Yesterday, a game of "Deal or No Deal" was played. With John McCain on a plane headed for DC, democrats declared a deal had been reached. They did not have the votes, they knew they did not have the votes but they announced the deal was done. Of course, McCain repeated his standard line that he is in DC to serve his country and not his political future. (Yeah, right!) If he misses the first debate, to save his country then it will be a worthwhile sacrifice. McCain is the better choice for president but he needs to give it a break!


By declaring a deal when there was no deal, democrats made McCain out to be the bad guy. Paulson went along with the charade because he is eager to make "his deal". The alternative plan, floated by house republicans, would require banks to pay a premium to the government in exchange for insurance that would allow mortgage backed paper to be revalued. In other words, the people would not buy 700 Billion Dollars of Paper from the banks but would insure some portion of it and collect insurance premiums for that insurance. It sounds like a good idea, but Paulson's initial response was that it will not work. Rightly or wrongly, he is clearly invested in his own plan.


I missed the name of a knowledgeable and rational participant on CNBC last night but the gentleman made an excellent point. He noted that it would be rather easy to devise a formula for evaluating the damaged paper using the discounted cash flow model. I must admit that this sounds much better than the amortization of loss proposal that I endorsed only yesterday.


The clamor to get this done yesterday has come close to panic; time is certainly short, but we should not be stampeded into a panic. There is great value in allowing the best ideas to float to the surface while taking the time to get the deal done right. Yesterday, a regular reader endorsed the Paulson plan on the basis that Paulson is a highly respected, highly successful financier. Paulson as the former Chairman of Goldman, having already announced that he will return to the private sector in January, has a "special interest". I have always been a little skeptical about giving anyone a $700 Billion blank check. The fact that we have no details about how the Treasury would value the paper, under the Paulson plan, asks us to write this proverbial blank check.


The congressional leadership has declared time and again that they will not write the blank check. The solution crafted is to have an over-site board. The trouble is that an over-site board can verify that things are being done according to the plan and have no effect on how the paper is being evaluated. Do we want to give any one person $700 Billion Dollars that can be used to choose winners and losers? I do not. If I were a representative, I would vote NO! Tell me details on how the $700 Billion is going to be allocated fairly and I might change my vote. I thank the reader who suggested I should be more involved in the decision, but the reality is that many people much smarter than I are already working very hard behind the scenes to craft the best solution. A ground swell of voters can influence the final decision, but only a select few can actually alter the plan.


WHAT CRUNCH IN LONDON?


The market in London and the futures markets in the USA are taking a hit this morning. However, once again, financial stocks are showing relative strength! As regular readers know, the financial stocks are expected to turn up well before the bottom of the markets. This morning, once again, basic materials, capital goods and materials are getting hammered. The prices of gold and crude oil are down again.


Low and behold, over in China, interest rates have been cut. As regular readers know, interest rates and commodities "take long hikes with one another". In the past, I have written about trading correlations and R Squares. I have recently come up with the idea of describing correlations as "community walks or hikes". I started this analogy by saying that gold and the dollar are like the two legs of a tall man, they don't move in perfect harmony, but they arrive at their destination at about the same time.


The benefit of the concept is to understand how silly the constant declaration of pundits; when they say that gold is going up because the dollar is going down; when they say the dollar is going down because gold is going up. When the tall man heads in a certain direction, his legs, gold and dollar, will move in a certain direction, but looking at the direction of one leg or the other does not tell us why the man is going in a certain direction. I am reminded of the admonishment of Dr. Efird who routinely says that if you ask the wrong biblical question, you will get the wrong answer.


Commodities are falling because we have reached clearing prices. Clearing prices occur when prices reach levels that cause significant shifts in supply and demand. In the current business cycle, the price of oil went higher than anyone expected before the clearing price was reached (if anyone says he knew how high the price would go he is a gazillionaire). Of course, there are still perma-bulls around who say that oil is still on the way up but it is actually pretty clear that clearing prices have been reached.


In the EIA report yesterday, we saw that US consumption fell by the largest amount in history. In percentage terms, US oil product consumption was down 5.3% below last year! From the same source, we know that in 1999, there were 102 million feet of oil and gas wells drilled in the USA, and that we are on course to drill 321 million feet of oil and gas wells in 2008. US drilling is up 307% in 9 years! and, next week the congressional ban on drilling will expire. It took a very significant change in demand to cause the congress to let go of this politically powerful drilling ban.


The price of crude is down $3 this morning. China lowered its interest rates a couple of days ago. The price of crude did not fall because China lowered its interest rates; the two things are simply taking a long hike together. China tightened its money 19 times from 2003 until a couple of days ago. Oil and gold have been at "the point" on this long hike since way back in 1999. While oil and gold turned around some time back, it took a few months before China's interest rates turned to follow the leader; a long trail of hikers are one by one reaching the turning point.


The lesson continues to be that the decline in the cost of commodities, which includes the cost of money, is going to give a different kind of stock a boost. For a long time, it has been the producers of everything from steel to bridges to oil that have done well. Now it is going to be the consumers of goods that will do well. Most businesses are "hybrids" of one type or another. Gold miners, for example, consume CAT machines and produce gold. Now that the price of gold is in a down trend, the demand for the gold and the CAT machines is falling. When banks borrow to lend, they are acting much like the gold mine that buys CAT equipment. In the current credit crunch, banks are caught by the normally profitable strategy of borrowing short to lend long. Banks own mortgages that have a certain value because they represent a stream of payments that goes out many years. Banks collect money to lend, primarily through short term instruments. The problem is that banks are not being allowed to value the mortgages based on the expectation of many years of payments.


The bottom line is that financial stocks are due for a major turn. Goldman Sachs just paid Warren Buffet a handsome premium for his help in raising $10 Billion. Goldman is raising money to buy deeply discounted mortgages, primarily by buying entire banks. It was only a few weeks ago that a Goldman analyst declared that oil is on the way to $200 per barrel. Investors should always be very careful to avoid bidding as high as the auctioneer suggests. Investors should do as Goldman does, not as Goldman says to do. Put another way, Warren Buffet is adding at least $5 Billion and probably at least $10 Billion to his investments in bank stocks. The situation at Goldman is now very much like the situation that recently existed between the Gold Mining Stocks and CAT. For about 5 years, it paid to buy gold miners even though they were paying out the nose to buy CAT equipment. One could have made money by buying gold, by buying CAT or by buying the gold miners. Now one can make money by buying deeply discounted, high yield junk paper, shares in banks, shares in Buffet (Berkshire), or in Goldman.


Last night, Washington Mutual bit the dust. JPMorgan, another strong player, "accepted ownership". The sharks are feeding. The little guys are in a scramble to avoid being consumed by the sharks before they have the power to negotiate a sale to the sharks. The difference in making it to the life boat is extreme. Depending on the final "tilt" to the final bail-out plan, the little guys will get help to defend the sharks or the sharks will have an even greater advantage. Obviously, the safer plays are to buy companies such as GS, JPM, Wells Fargo or BAC, the sharks. Obviously, the most money will be made by those who buy surviving "little guys". It seems strange but big firms such as Wachovia (WB) are among the "little guys" that are threatened by the sharks. I believe WB will survive, at least long enough to negotiate a good deal with a shark.


There are many other "little guys" that are not being chased by the sharks. These are primarily the banks that wisely avoided leveraged purchases of sub-prime paper. These banks should survive and prosper, BBT is perhaps a good example of this class.


We are back at square one. The whole key to the problem at hand is how to value the sup-prime paper. It is currently marked to fire sale prices. If the USA is going to avoid a great depression, then this paper is currently seriously undervalued.


The odds of a great depression are less than 1 in 10,000. Never-the-less, it is reasonable to mention the great depression at a time when the congress has been inching toward a $700 Billion bail-out plan without knowing how the values are going to be set. By holding back this information, the public is not allowed to value the merits of the plan.


The most probable scenario is that a deal will get done, a deal that will allow the sharks to feed on a number of owners of leveraged paper. The movement of the paper from the current holders to the government and then onto the books of stronger players will "solve the crisis". The plan will work but it should be fully fleshed out before it is approved. I believe a "new deal" will be struck by Monday morning. This time it will be a "real deal", one in which there are enough votes for passage.

LATE FRIDAY AT BEST

It seems to me that McCain has a lot to lose if the bailout bill goes through today. McCain has suspended his campaign and he asked the Election Committee to postpone the Friday night debate. The Election Committee declined the offer.


If the bailout bill were to be approved today, McCain would be forced to tuck tail and make it to the debate. If he is in Washington working on the bailout plan last Friday or until Friday night, then he will receive a "hall pass". It has been said that democrats have accepted a deal. Of course, there are not enough democrats available to pass the bill. The final vote will likely include no votes from both sides of the isle. Now that the democrats have reached acceptable terms with the administration, assuming that the rumors are true, then it is up to republicans to grab the tug of war rope in order to pull the bill back to the right as much as they can. Republicans are well aware of the needs of John McCain. They will be in no hurry to conclude this deal before the scheduled presidential debate.


My guess is that a compromise will be reached by late Friday or by first thing Monday morning. The stock market is locked into a trading range until it is clear that a bill will be reached.

Re: TALK OF A DEAL

Seven hundred billion is a lot of money but it is also a highly leveraged pile of money. The per person outlay is about $2,333, but the people do get "full value" in exchange for the outlay. Giving each person $2,333 to spend would not solve the insolvency of banks. The banking system would still be frozen up.


Like it or not, our world runs on a fractional banking system, in other words, the world runs off leverage. The assets controlled by the $700 Billion we are talking about is an enormous amount. Banks normally lever at about 12 to 1. Thus, we are really talking about "protecting" in the neighborhood of 8.4 Trillion Dollars worth of assets or $28,000 for each US citizen. Do we "invest" $2,333 per person to save $28,000 per person?


Again, using an example that is dear to my heart, if the government were to decide that Myrtle Beach is near collapse and it is in the public interest to "save Myrtle Beach", it would be a complicated process to decide which deeply discounted oceanfront condos are to be purchased and at what price. Condos which sold for $800,000 in 2005 have recently sold for $275,000. Would it be a bailout for an owner, if the government bought his $800,000 condo for $275,000? If the government bought this condo for $275,000, would it have good prospects for reselling it latter for more than $275,000?


The answer to the last question is 99% YES. Lamar's statement that the population will continue to grow and that this growth will ultimately absorb the excess in housing was an accurate description of what is going to happen over time. The question for the congress today is how to mark time until the excess inventory can be absorbed? The argument to allow the market to sort this out would be totally valid if it were not for the excessive regulation imposed by the Sarbanes-Oxley act. These rules require banks to mark down the value of "their oceanfront condos" from $800,000 to $275,000. If the bank is willing to hold these "oceanfront condos" until the market for them rebounds, why should they be forced to immediately declare a $525,000 loss?


The suggestions to use a smoothing technique such as a moving average of value or by amortizing capital losses over 5 years would take away the cyclical component that is killing the market. Banks are being forced to turn away solid business because they already have too much business on their books as a result of the excessive write down of values. The bank that is forced to write down $525,000 on a mortgage backed security must reduce its lending by 12 times $525,000. The one loss of $525,000 means $6,300,000 worth of car loans cannot be made.


The bottom line is that this problem must be fixed or we will have another great depression. Our economy is no where near the level of great depression, but it is being pushed hard in that direction by the bank freeze. Again, the problem must be fixed, but it needs to be fixed in the least destructive way. There will be costs involved. Prices will be paid. It is my contention that the least expensive way would be to allow the assets to be marked to a moving target, such as a 5 year amortization schedule. Before most of these assets reached the full discount, the real estate behind them would have been sold, refinanced or caught-up.

On Thu, Sep 25, 2008 at 10:57 AM, Mike wrote:

Jack,

think what would happen to the economy if congress divided the $700,000,000,000 equally between every adult in the country, and then took out ordinary income tax.

I don't think anyone would care about these banks after that!!

Mike

Re: POLITICAL THEATER

I generally agree. My variance is in regard to "energy policy". The policy we had was one to discourage domestic production, including off shore drilling and low cost nuclear. We have lost US investment and US jobs as a result of our restrictive policy.


It has taken $4 gasoline to push us back toward the free market mode, which allows the best strategy to win. It takes only common sense to understand that an energy source that requires a 30% capital subsidy to be competitive is wasteful. Paulson is highly regarded. He sits in a very powerful seat. Even so, yesterday, McCain said the administrations bill would not pass. If he is right, there are certainly good alternative plans.



I fault democrats and republicans for the triangulation strategies they each use. Mistakes made by one party are allowed to run wild for political purpose. The prime examples include the restriction of domestic energy production to encourage energy subsidy boondoggles and allowing the housing bubble to run without intervention.

On Thu, Sep 25, 2008 at 10:11 AM, Lamar wrote:

By the way I would never argue against Hank Paulson and Ben Barnanke. My fear about the bailout is the delay is caused by both many Congresspeople want to add their pork and political posturing . I am amazed the American people are stupid enough to put their faith in Congress who got us in this bloody mess.

TALK OF A DEAL

There is talk that a bail-out deal is all but done. It is ironic that the move by McCain to grab headlines, to suspend his campaign and to ride into Washington on his white horse in order to prepare a competing bill, might have been the pressure that pushed house democrats to go along with the administrations deal. The dems certainly do not want McCain to get credit for an alternative solution.


Again, I think there are better solutions but I learned about the concept of "muddle through democracy" a long time ago. Democracy is an ugly form of government; it zigs and zags all over the place but it is beautiful when compared to other forms of government.


George Will wrote about Gresham's Law of Political Discourse yesterday. Gresham's law says that bad money will always drive out the good. For example, back in the 1960's silver dimes and quarters were gradually replaced by copper/zinc clad coins. It did not take long to happen because I and thousands of others grabbed all the silver coins we could, as they were worth more than their face value.


Will's use of Gresham's Law as a political term was delightful. It is so true, loud political noise is heard round the world while it crowds out reasoned discourse and good news. I've been busy and distracted, so maybe I missed the news that the Iraqis have voted to move forward with providential elections. I've lost count but I believe the Iraqis have now completed 16 of the 18 political objectives requested by the USA. The evidence of political reconciliation can be seen in violence reports; violence on the Ramadan Holiday was down 87% from a year ago.


Given the political progress in Iraq, the USA, in cooperation with the UN, is preparing to assist in the buildup of a powerful national defense. The new Iraqi military will be much more than a bunch of guys with assault rifles. It will take years to equip and train them. When done, they could eventually join Turkey as the second predominately Islamic country to join NATO. The world is becoming a safer place, even while wars are being fought in at least a half dozen countries.


In Iraq, at least 25% of the provincial leaders will be women. The status of women and children is quite different in Iraq than in most of the Islamic world. Students in Iran who wear western neckties are beaten in the public square. Repeat offenders have been hanged.


There are still many questions to be answered in Iraq, such as parliamentary representation for minorities such as Christians. For the benefit of the global warming crowd, it is worth noting that for the first time, methane gas from Iraqi oil wells is going to be captured for use instead of flared into the atmosphere. Methane is one of the most abundant gases in our atmosphere and it is environmentally 10 times as powerful as CO2. If man is responsible for global warming, we can fix it!


We are in a period of relative quiet in regard to Iran, Afghanistan and Pakistan. After the bombing of Islamabad, the Pakistani government made a ferocious attack on several Taliban/al Qaeda locations. The enemy has been put on notice, the relationship between the Pakistani government and the USA will only be strengthened by attacks on the government. Iran certainly does not want to be fully surrounded by US troops.


IRELAND IN RECESSION


Ireland is the first European country to have had two consecutive negative quarters. Investors should always remember that the best time to invest is during recessions. Recessions bring down business costs, including the cost of oil and the cost of money.


There is talk of a deal, but a deal will not result in a quick rebound of slowing economies around the world. After a deal, a number of banks will still be in "trouble", many a troubled bank will see its share price increase as the sharks prepare for takeover. The war chests accumulated by companies such as Goldman and Morgan Stanley are for buying weak banks at fire sale prices, but the sweetest meat will be devoured quickly.


As is always the case, the economic slowdown will continue until well after the rally in financial stocks has run a good distance. Long bond rates will not hit bottom until the economic recovery is underway. Long bonds are likely to appreciate during the next several months but stocks are the investment of choice. Big cap basic material and resource companies will drag the broad averages down even during the price run up in bank stocks.


If there is not a deal already "done", one should be worked out by Monday. US markets have opened strong with financial stocks and utilities leading the way. Utilities are still being juiced in the short run by the fact that the congress has voted to spend 68 billion dollars to subsidize solar panels and wind mills. The American tax payer will pay for 30% of windmills whether he wants them or not. Large utilities will see their profits enhanced by tax credits for building expensive solar plants.


The Senate passed the bill with 92 votes. Republicans were eager to support "clean alternative and wasteful energy" once it was determined that the moratorium on drilling would be allowed to expire. The good news is that the private sector will ultimately spend many times the 68 Billion to develop our real energy alternatives.


The house bill is different but the differences should be reconciled quickly. As always, those last minute adjustments will not even be read by most representatives. The law that needs to be passed is a law that requires a 30 day delay between the construction of the final bill and the final vote. Both the representatives and the American people should know in advance what is being included in these monstrosities.

POLITICAL THEATER

The more I hear and read, the more convinced I am that the 700 Billion Bail-Out is not needed. The current problem is with the mark to market rules dictated by the Sarbanes-Oxley Legislation. A regular reader mentioned Dave Ramsey's solution. I looked him up and found an interview with Brian Wesbury. Brian and a few local bankers all agree that the mark to market rules are causing the freeze up. Changing these rules would go a long way toward solving the problem.


For now, we need not concern ourselves with how we got into this mess. It is important to fix the problem in the least destructive way. Newt Gingrich has suggested that a three year moving average be used to mark to market values. So far, I still like the 5 year loss amortization plan the best, but Newt's idea would work well.


To the extent necessary, the FOMC should make soft payment collateralized loans at extra interest spreads while easing up on capital ratios. This plan is nothing but an extension of the process that has already been underway. It is not high interest rates that is killing the market but the availability of credit at any price. Under this plan, the FOMC would make money for the taxpayers while leaving management decisions to the managers. The plan on the table gives the power to pick winners and losers to the treasury department.


The back and forth between Obama and McCain has been a site to behold. The win-win for the country would be for a negotiated compromise plan to be substituted for the current plan. Should the candidates help solve the issue, each could take credit.


OIL DOWN


A small divergence seems to be developing between the value of the dollar and the price of oil. Finished product supplies will remain tight until the rest of the shut down refineries come back on line, but crude prices should trend down. Gasoline prices should move down substantially as the refineries come back.

MANY WAYS TO SKIN A CAT, NONE ARE FUN FOR THE CAT

This morning, I mentioned that the bail out of banks could be accomplished without spending a nickel. Most banks have the cash flow to survive, if they were not being hit by the extra capital requirements caused by the mark to market rules. A change in the rules to allow the mark to market to be amortized over 5 years would unfreeze balance sheets and allow the mortgage market to get back to normal.


This afternoon, I read a neat plan offered by Allan Meltzer. He notes that Chile went through a similar crisis and solved it by having the government loan dollars to the banks. The loans accrued interest and acceptance of a government loan required the suspension of all dividends and company bonuses. The great majority of the loans were repaid and dividends and bonuses were resumed.


John McCain has asked Obama to suspend the Presidential debate, scheduled for Friday, so the Senators can participate in a bi-partisan debate on the crisis. McCain does not believe the bail out will pass in its present form. He believes that level heads can work out a plan that will pass.


The real solution to the problem will be a healthy real estate market. This market is being severely pounded as this debate drags forward.


Cats have nine lives, as does real estate. Real estate increases in value over time. The banks simply need time for the market to move forward. The administrations plan is one of setting up the big banks to buy lots of assets cheap.

POOR BARNEY AND BETTY!

Don't you feel sorry for poor old Barney and Betty. They live in a modest home, earn a modest living and pay their modest bills; and, they pay and pay and pay for government, government and more government. Their Congressional "Representatives" constantly spend more than Barney and Betty send, pushing up their cost of living. Barney and Betty are paying for things they would never buy if their "Representative" did not require it of them. Barney and Betty are paying through the nose for the home mortgage taken out by Fred and Wilma. Also, for 30% of the windmill that Fred put in his back yard. You are paying your share too!


BAILOUT -- WILL IT PASS OR SHOULD IT PASS?


The bail-out will ultimately pass, because Hank Paulson will put a few more banks out of business if congress does not go along. The bail out is nothing but another pork barrel spending project. With the stroke of a pen, the administration and the congress could solve the current financial crisis, without spending tax dollars. The best idea, so far, is to allow banks to amortize the decline in mortgage backed securities over a 5 or 7 year period. In other words, modify the Sarbnes-Oxley mark to market rules. The banks are only suffering because they do not wish to sell securities at fire sale prices.



As a property owner at Myrtle Beach, I am well aware of the temporary death of markets. In Myrtle, almost no ocean front condos are being purchased, relatively few are being rented. Does that mean these condos have no value? Of course not. I watched this same movie in 1974 and in 1991. There is no market now, but there will be a market soon. My Dad always got a laugh when real estate agents tried to sell him on the idea that you better buy ocean front now because the Good Lord is not making anymore ocean front property. During my life, I have witnessed Myrtle go from a 2 mile "strip" to a 60 mile "strip". Those who buy now, will see a huge gain within a couple of years.


In the same way that I have avoided selling beach property at fire sale prices, banks are reluctant to sell their mortgage backed securities. The fact that Paulson is cranking a siren and screaming fire in a crowded theater is not a good reason to sell. His old firm, Goldman, is accumulating a war chest in order to buy as much as it can. Besides, if all the current delinquent loans in America were to go into foreclosure, the net loss to all the banks would be less than the $700 Billion bail out. Paulson is setting Goldman Sachs, Morgan Stanley and other "big boys" up to make a killing.


Morgan Stanley and Goldman have just converted to bank holding company status. Each has just raised billions of new dollars in capital. Morgan got one chunk of its new capital from Japan. Goldman sold Warren Buffet a $10 Billion stake. Leverage $10 Billion through the FOMC and Goldman suddenly has an extra $130 Billion with which to go shopping. Goldman will buy banks selling at 15 cents on the dollar. The $130 Billion will buy $867 Billion of banks. The bounce from $130 Billion to $867 Billion or $737 Billion will be a nice profit on Warrens high priced loan of $10 Billion.


TO BE FAIR


To be fair, we must always remember that this crazy deal got started way back when. Paulson was not the one who set up the government corporations of Fannie Mae and Freddie Mac. Nor was he the one who let them run wild. Two years ago, Paulson was happy making $200 million dollars per year as Chairman of Goldman. He was not happy having to compete with government subsidized behemoths, but he was doing a great job of making money in a tough environment. He left his 200 Million Dollar per year job in order to "fix" the problem, for the benefit of Goldman and for the benefit of America.


In 1999, Bill Clinton in cooperation with the US Congress, pressured Fannie and Freddie to allow anyone and everyone to borrow excessively to buy a home. This train had such momentum that it did not even slow down during the 2000 recession, housing sales were strong throughout the recession. The Bush administration and the Republican Congress did little to slow the train down. McCain suggested tightening the rules on Fannie Mae in 2005 but he was ignored and most of the damage had already been done. Many people borrowed $200,000 to buy $150,000 houses in 2004 and 2005.


Poor old Barney and Betty, Fred borrowed $200,000 to buy a $150,000 house, the bank wants the $200,000 back but Fred does not have it. Barney and Betty have already contributed part of the $300 Billion that the government is using to reduce Fred's payment. Now the government will take the banks position in the hope that Fred will keep making the reduced payments.


THE ANSWER IS A SMALLER GOVERNMENT!


A lot of people think that all politicians are corrupt. The fact is that principled people, such as Thomas Jefferson and Alexander Hamilton, did a lot of "horse trading for votes", as do politicians today. The majority of the politicians who authorized excessive lending were not crooks, the bank that lent Fred the money was not crooked and Fred was not a crook.


The politicians compromised on a plan to "help the poor". Whenever the government gets into the business of charity, there are always problems. Governments should adopt the Credit Union Motto of "Not for profit, not for charity, but for service".


We will never get away from the art of compromise. We should not even try. However, we should severely limit the amount of money the government has to fight over and spend. Most importantly, we should keep the government "out of business". Regulation is needed but the government should not be in competition with its citizens. In the days of George Washington, government was too small. George had a tough time defending the country because funding was limited. We have not had that problem for a very long time. Now-a-days, no matter how much money the government has, it does not seem to be enough.


For just a moment, think about our arcane practice of mail delivery. We live during a time when a power bill or letter can be transmitted to a customer for a tiny fraction of a penny. Instead, we put these power bill and letters into planes, trucks and cars and drive them around at 100 to 1,000 times the cost. But first, trees are cut down to make the paper and toxic chemicals are used to make the ink and the paper. Pollution from the manufacturing of the paper and ink (and the glue on the stamp and envelope) and from the production of the trucks, airplanes and cars and from the pollution spewed from these airplanes, trucks and cars literally kills birds, fish and people. Pets and people die as a result of the traffic. Congestion and accidents are caused by cars stopped half-on and half-off of roads. We live during a time when people fight bitterly over "global warming fact and fallacy" while paying dearly to contribute to the "process".


If the post office were run as a private, non monopoly business, it would have been dramatically changed years ago and the savings would have been enormous. After careful analysis, the "new postal service" would declare a new plan. For example, the new plan might be that the price of postage would decline from 43 cents to 30 cents on January 1, however, home delivery would occur only once per week. The idea being that everyone would immediately save money. There would be a fuss but those who really must have daily delivery could rent a daily box at the local post office. Many people would quickly learn to get by on once per week delivery. Most of us would use electronic delivery more.


Even the once per week delivery would be a transitional step. There are already free computer classes available at public libraries. A lot of people who are frightened by the thought of operating a computer would buy one and be better off for having done so.


For hundreds of years, there has been a constant complaint that the earth resources are about to be used-up. The fact is that the smarter we get, the fewer the resources we use. For example, we heat food in a microwave oven for a very tiny fraction of the resources used in the old days and the older days. One fact is that we, unnecessarily consume billions of pounds of paper daily. Private enterprises still deliver newspapers but this arcane practice would die a much quicker death once most people started reading their bills and news on portable readers.


The headlines about the new G1 phone have generally said that this new phone is not a "game changer". The headlines were wrong. Today, only a relative few people check their email, surf the net, read books and news and get travel directions from their pocket computer phones. Soon there will be a large number of hand held pocket computer readers on the market, designed specifically to make mobile surfing practical and even necessary.


POOR BARNEY AND BETTY!


Yesterday, the Senate made another huge compromise. Democrats gave up on pushing for the continuation of the US drilling moratorium in exchange for a package of "goodies", 68 Billion Dollars worth of sweet candy. As a result, Barney and Betty will pay lots of money to the government which will give lots of money to "responsible businesses" which will install very expensive solar panels before advertising about how "responsible" they are. How perverted can the congress become? Does it make any common sense for Barney and Betty to subsidize GE?


How about the $7,500 that Fred will collect for buying a plug-in car? Should Barney and Betty be forced to help pay for Fred's car? A car that pollutes and is wasteful and inefficient?


OH WELL!


The good news is that the drilling moratorium is over. The supply of oil and gas is going to increase. Those who have been hoarding oil and gas have reason to reduce their inventories. They may want to wait just a little while.


The USA and Israel seem ready to turn a blind eye toward the 10,000 Syrian troops that are gathered next to the Lebanese border. The "pending invasion" is a part of the "plan". Syria is supposed to assure Israel that it can make peace with Lebanon and Syria and not have to deal with constant rocket attacks by Hezbollah.


The Afghanistan sorties being flown from the USS Ronald Reagan, which is parked in the sea below Iran, provide a daily and nightly reminder of the presence of US forces near Iran. Jed Baddin is probably correct in saying that Bush "needs" to do something about Iran. The UN 5+1 will meet again tomorrow to discuss the next step. Time is short. Tensions are high.


Even so, oil is in plentiful supply. Most of the US refining capacity lost due to hurricanes is back on line or about to come back on line. Democrats hope to put a new ban on drilling in force, after the elections. Not gonna happen!


Poor Barney and Betty are tired of paying to subsidize windmills. Taxes on oil and gas just went up again but enough is enough. The price of oil and gas will gradually come down. New supplies will continue to come on line while new nuclear power plants coming on line in numerous countries will reduce demand. Lower energy prices are ahead. Bank consolidation is ahead. The fight for congress to get out of town is no longer about drilling. It is now about another big pork barrel spending project.

WHO WILL BUY WHOM?

The move of Goldman and Morgan to bank holding companies are moves to be in the position to buy, not a few deeply discounted mortgages but a few banks!


The terms to be offered by the US Treasury for the purchase of deeply discounted mortgage backed securities has not been divulged. Banks that are forced to sale at deep discounts will be forced to give up huge potential profits.


Owners of beach homes know the situation well. Those who purchased a beach home around 2002 for $200,000 saw the value of that home rise to perhaps $450,000 in 2005. They have since seen distressed sales for similar properties for $150,000. The owners know that vacations will make a comeback. During recessions, one of the first things a family cuts back is its vacation time. During good times, families will get together at the beach and pay thousands of dollars per week for an ocean front location.


The person who bought a beach house at $450,000 in 2005 is deep under water. He might owe a balance of $350,000 on a home that can only be sold in the near term for $150,000. It may take 5 years for his home value to reach his mortgage balance but the "profit" of $200,000 is against an investment value of zero.


Zero is a fascinating number. Greek philosophers enjoyed debating this "nothing that is something". A very long time ago, a fellow jumped out of bed one morning in ecstasy when he realized that if you pair a zero with a 1 that you have given "nothing a significant value". The power of zero is seen in our every day lives when we are offered something "free". It is amazing how much we spend in order to get something free.


We stumble when we try to calculate our return on investment when we get something free. It is even more intriguing to calculate our return on investment when we get something for "less than free". The buyers of banks are getting good stuff for less than free!


Goldman and Morgan Stanley have come to the realization that they need to be in the commercial banking business. By becoming bank holding companies, they will be able to invest a small amount of capital, borrow more than 12 times the amount invested from the FOMC and buy mortgage backed securities that are marked to prices below their intrinsic value.


Got to run. Are you going to join Goldman as a buyer of deeply discounted banks?

HOT TENSION AND A COLD CONGRESS

The markets are trading down billions while the congress stalls. The huge jump in Gold was about more than what has been said by the media. Tensions are flaring in the Middle East. Troops are massed on the Lebanon-Syrian border. The 5+1 will meet on Thursday. The risk of war with Iran has increased as Iran has approached bomb making capacity.


Bush has issued two calls today for the congress to act quickly. How much further will the market have to fall before the congress acts? The bill is a 700 Billion Dollar bill. It stands to reason that it would face tough negotiations. On the other hand, the congress mush act quickly before the system breaks. Will congress make it out of town on Friday?

JONES IS ONCE AGAIN ON THE MARK

My "Old Merrill Friend" hit the bullseye again.

Doctor,


Amazing news over the last two weeks. The old guard of brokerage firms is vanishing. I believe the real problem for the "Old" Wall St. is the brain and talent drain from the rise of the hedge funds and private equity firms. They have supplanted the old trading desk actions of the Goldmans and JP Morgans. This is a good example of the old "Hong Kong" style of capitalism where the trading is unfettered by many oversights that a large country such as US demands. This revolution to the new traders is not a bad thing. Liquidity can be supported with current times the exception.


Hopefully we should see the financials doubled from here in five years. Not a bad move for the patient.

The only place he missed was in his projection of 5 years to double. Many a financial stock has already doubled from the bottom and many more will double in the next year or two.


TENSIONS MOUNT


The price of gold and the price of oil reflect the movement of battleship groups in the direction of Iran. Ahmadenijad has once again declared that he will not give up on the production of nuclear fuel and the IAEA has evidence that he has tried to make nuclear warheads. Germany, Russia and China are reportedly not convinced. Only a very few know what threats have been delivered by the USA. We know the battleships have been deployed but we also know they are taking their time.


Oil is in abundant supply but the price has bounced anyway. Inflation expectations, as measured by the bond market, are low. There has been a flight to safety in bonds and in gold. The World GDP continues to slow, the bounce from the resolution of the US financial crisis will not boost economies for weeks to come.


Invest in financial stocks for the long term and don't worry about the Iran deal. The financial deal will be passed no matter the situation in Iran. Also, the congress must pass a CR no matter what is going on in Iran. The tension in Iran is giving further assurance that the congress will not attempt to attach a drilling moratorium on the CR. Iran is now, in effect, on the back burner as the financial deal and the adjournment of congress will probably occur by this Friday. Bush and company will have about a month before the election to complete international treaties. If they are not completed, lots of pressure will be applied. McCain is viewed by 58% of Americans as the better choice for Commander in Chief.

THE $199 -- $300 COMPUTER

I find myself chomping at the bit in regard to $300 laptop computers. I do not need Vista. I am ready to own a small machine that has a very small hard drive; one that relies on Google for storage of data.


Last week, a Church near Charlotte was burned to the ground. The lament of the Pastor includes the loss of all his computer data, including many years of prepared sermons. Had the sermons been prepared as Google Documents, or if he had emailed the sermons to his free gmail address, they would have been saved and available from any Internet connected machine.



I am anxious to learn the details about the new T-Mobile Android phone. I am generally pleased with my cell phone service through Verizon. I prefer not to switch. If possible, I would love to take my Sim card out of my Verizon phone and stick it in an Android. I might even consider buying an Android as a hand held, WIFI, computer and forget about signing up for T-Mobile service. Here again, probably not possible for now.


The hand held computer, Internet computer, is on the way. Google continues to put new pieces in place. The Chrome Browser was designed to serve as an operating system. Most consumers have no need to own the massive programs offered by Microsoft. The $300 laptops do not come with a Microsoft operating system. What I really want is a machine that is a combination of a Kindle Reader and an Android phone. OK, I admit, I would like to see own many more bells and whistles on one device. The hand held computer is going to change the world. Change is coming. The first model will be out tomorrow. Samsung and others will have models out in a few months. If these machines make it simple as pie to carry ones Google accounts in ones pocket, they will be a blessing.

REAL ESTATE VERSUS MANUFACTURING RECESSION

While tough recessions effect both real estate and manufacturing, these sectors take turns bearing the brunt of down turns. This can be seen by when the turn in housing supplies occurs.


During manufacturing recessions, the months supply of homes for sales tends to start dropping early-on. During a housing recession, home sales do not pick up steam until the end of the down turn. Just at end of these downturns, there is a sharp drop in months supply.


Months supply was at 10.7% in June. In July months supply fell to 10.1%. Since July, the turbulence in the banking sector pushed fixed mortgage rates higher, until 8 weeks ago. In the past 8 weeks, 30-year mortgages rates have fallen from 6.5% to 5.6%. The effect of the bank bail-out this week will be to give confidence to buyers. The big turn in housing sales is here. Housing sales will not return to the crazy days of 2005 anytime soon, but sales are already higher than new completions. Inventories are already falling. A few decent months of sales will clear out a lot of mis-priced bargains. The time to get the best deal is now! Buy on a low cost variable rate loan to get the maximum savings. Wait a year or two before locking in to a fixed rate loan.

HOME INVENTORIES DOWN -- VALUES TO CLIMB

It took until 1976, two years after the end of the 1973-74 real estate recession, for home inventories to reach bottom. In 1993, home inventories finally reached bottom two years after the end of the 1990-91 real estate recession. The bottom in stock prices was made more than two years before the turn in housing construction.


In 2006, new home inventories hit their peak. Inventories have been falling for two years. Home builders have sold off land and laid off employees. The prices of homes are set like all other goods, by supply and demand. It will be another year or two before inventories reach bottom but home values will jump between now and then. The big catch-up will be that the spread between a used home and a new home will narrow. For those who need a home and are willing to buy a "used" home, conditions are the best in 18 years and will not be this good again for another 18 years!

THE TILTED BOAT -- BAD SHORT SELLING POLICY -- NO MORE INVESTMENT BANKS

The head of the SEC has asked every passenger on the boat to move to the starboard side. He knows the risks of operation have increased, he knows that the boat will list, but, politically, he did the right thing!


In the midst of a financial crisis, there are all sorts of calls going out for the government to steer the boats to safety. The congress suddenly knows the market seas better than the boat captains. Hank Paulson says a large number of boats have run aground, but a flood of liquidity from the government will allow most to recover.



The features of the proposed buy-out are anxiously awaited. The rational for banks to hold-on to all the deeply discounted mortgages they can has increased. Soon after the government starts buying mortgages, the value of all the rest should rise. The bank that gets by without selling any of its "junk" to the government, will make the highest returns. Banks are leveraged at only around 12 to 1 while investment banks and hedge funds are typically leveraged to at least 20 to 1.


The good news is that the market is punishing the meddling in the markets by the congress and the excessive leverage. It was the congress that pushed the market to lend to non qualified buyers. It was the investment banks and hedge funds that could not resist the temptation to leverage these mortgages to the hilt. It took both to create the super housing bubble.


THE END OF AN ERA!


Morgan Stanley and Goldman Sachs will end their long history as independent investment banks. They will join others who have become "regular deposit taking banks". By taking deposits, these banks will become regulated by the FOMC. They will no longer borrow at 20 to 1 leverage and the huge bonus payments for making big deals will end. (When Barclay buys Lehman, executives of this failed institution will share in a multi-billion dollar bonus pool.) Never-the-less, the risk of a future total collapse in the banking system will have increased due to the consolidation; a future mistake by the FOMC will put all banks at risk.


Congress and "news commentators" do not want to stop with the regulation of investment banks; they want to hang "evil" speculators (financial shoppers). I am very thankful for "shoppers". When I buy a car or anything else, careful shoppers have made the transaction less risky. The vendor who asks too much for his goods is likely to disappear from the market place. Another way to think of short sellers and speculators is that they are much like the "no pass" betters on the crap table; who bet against the dice, reducing the risk to the house. Speculators are like fire and water on a steam engine, you have to have both fire and water to make a steam engine work, you have to have a cooling system on a car engine.


Should a casino ban betting against the dice, it would dramatically increase its risk of loss. In the perfect casino, every single bet on the pass line or come bar would be matched by a bet against the dice. The casino would never lose a bet. It would take its small transaction fee, each time there was a roll of a 36 (on average, the house gets paid on one of 36 rolls).


Of course, casinos do not mind taking the gamble on the center table bets, where the foolish go against long odds. Professional gamblers avoid the long odds; the big money bets, including short sales in financial markets and "no pass" bets on the crap table are made by big money pros. Amateur gamblers need not bet against the dice and small investors need not sell short. Small investors can let the pros keep the market fair whild avoiding the "high fees" on the center table bets at the crap table and on the high fee strategies offered by Wall Street brokers.


However, the timing of the removal of short selling was perfect. The SEC, the FOMC, the Treasury Department and the Congress will all take as much credit as they can for the turn in the markets. The fact that this turn was due is of little consequence; the public is counting on government to save the day. The congress will "negotiate" with the administration this week but Paulson holds a full house against the inside straight draw of congress. Paulson will get 90% of what he wants. The congress will likely leave town this Friday after having passed the Nuclear 123 bill with India, a continuing resolution that does not include a drilling moratorium and the Paulson financial bail-out bill.


Before passing the "clean" CR, the senate will fail to pass four energy bills. Democrats will run on the platform that if they had a few more votes they could save the planet from ourselves. They will suggest that with a few more democratic votes all will be made well in the next session of congress. The major remaining questions are, "Will congress be running against the headwind of $4 gasoline?" and "Will the Iran--Russia--Middle East 'problem' be fixed?"


If the Iran--Russia--Middle East "problem" is not fixed, it will be left up to the next president? Clearly, all the bad guys in places like Pakistan, Afghanistan and Somalia are not going to be converted or eliminated in the next month. Tense times help John McCain's bid for the presidency. The USS Iwo Jima just concluded another "show off" stop in Greece. The technology apparent in this sophisticated battle group has received steady praise during its "pleasure cruise". The next destination is the mouth of the Persian Gulf. The gold and oil markets have already bounced, in anticipation for what might come next. Should the matter be resolved peacefully, just as the congress decides to get out of town by passing a clean CR, crude oil should quickly test $85 support. Four Dollar gasoline would give republican congressional campaigns a strong boost because democrats have demonstrated that they want higher fuel prices in exchange for more money to throw at clean but inefficient energy. An escalation in the conflict with Iran would give McCain's bid for president a strong boost. Tense times create a win-win situation for republicans. Republicans and all Americans need the banking crisis to be solved.


WORTH REPEATING


It is worth repeating that real estate recessions only come around every 18.3 years on average. Almost like clockwork, our last real estate recessions were in 1973-74 and in 1990-91. Furthermore, financial stocks make V bottoms during real estate recessions and move up strong long before the real estate recession is over. For example, the financial V made in the fall of 1990 was so strong that many bank stocks were up 100% by the fall of 1991, bank stocks had doubled in value while most people hunkered down to fend off Armageddon.


The market is showing evidence that it may be jerked down today; financial shares in London are down about 2%. There is uncertainty in regard to the bailout bill. Chris Dodd, Chairman of the Senate Banking Committee, is barking about alternatives as is Pelosi, Frank and others. Again, Paulson holds a full-house. He has the power to put another bank out of business if congress does not play along. He will get his bill this week and return to Wall Street in January. Are you taking full advantage of the financial turn?

401-K Accounts Moving Up

My recommendation to move 401-K accounts to the Russel Small Cap Index is working out well. The index has shown relative strength since March. This strength should continue. My call to avoid international stocks has been a very good call. It took longer than I expected for basic materials, capital goods and energy stocks to roll over and they bounced on Friday, but I would continue to avoid these as well.


Oil is currently in a 100 to 110 support and resistance ban. This week, the house passed a fake bill in support of drilling, the gang of 20 failed to propose a bill and Harry Reid moved forward with plans to call for votes on 4 separate energy bills. These votes are solely for the purpose of political posturing. A consensus has been reached that no compromise can be reached before October 1. Democrats are ready to temporarily throw in the towel. The off shore drilling ban will expire on October 1 but democrats will suggest that the ban will be reinstated in a lame duck session after the elections or early next year. The uncertainty will dampen the enthusiasm for the expiration.



THE JOB OF THE NEXT PRESIDENT


The way things are shaping up, it will be the job of the next president to deal with Russia, Iran and Drilling. The government of Russia is rapidly taking back control of business. Consolidation is taking place in America but nothing like what is happening in Russia. Russia's iron hand rule will once again give America advantages in commerce and in trade relationships with other nations. The actions of Russia against BP this year have once again shown that doing business with Russia is risky.


Iran and Russia have a lot to gain by making peace with the west. The people of both countries have suffered relative isolation for many years. Many Americans do not appreciate how wonderful economic and political freedom is because they have never experienced anything else.


THE DEMOCRATIC BOX


Democrats are stuck in the environment/energy box they created. By their willingness to support non-economical programs, such as ethanol, wind power and solar, they are stuck trying to sell the public on paying unnecessarily high prices for gasoline and heating fuels. It may work! The average American has been sold that energy grows free on windmills and corn stalks.


NEVER-THE-LESS THE TURN IS HERE


Regardless of the actions in regard to energy, the clearing price has already been reached. If the US does not drill, Brazil and others will drill all the more. The first of many planned nuclear power plants has been permitted in the USA. If the USA moves forward or if it does not, China, India and scores of other nations are moving rapidly forward with nuclear power. When China begins to produce electricity at 2 cents or less, all the more manufacturing will move to China. The price of goods and the price of oil in real terms will both continue to trend down. Lower energy prices will increase the value of mortgage paper held by banks, increase the spending power of consumers and lower the cost of making high tech products.


Keep those 401-K's invested in the Russel Small Cap Index and continue to buy stocks that will benefit from lower energy prices.


When the CR is passed without the drilling moratorium attached, Bush and others are likely to say a word of thanks for ending 30 years of silliness. There should be a strong drop in prices between now and the weeks after the moratorium is lifted.

THE MOST POWERFUL MAN IN THE WORLD

Hank Paulson is the most powerful man in the world. It is reported that he will request an unlimited blank check from the US Government to effect the program he is proposing. With dozens of major banks on the bring of bankruptcy protection, Hank said the word and the congressional leadership jumped. Democrats will demand a few "special provisions" but it is anticipated that they will go along with the basic plan, without adding many bells or whistles.


Bush used the bully pull pit to hammer for a focused bill and democrats have decided not to attempt to attach a second stimulus package. The bond and gold markets at first reacted in fear that the government might switch the problem from deflation to hyper inflation. The fact that democrats will not push for a Keynesian style stimulus package should be great news for stocks and lower bond yields and lower gold and oil prices.


You are living through historic times. Those who bought during the crises of old made a lot of money in the months that followed.

THEY'RE OFF! LONDON SOARS

The FTSE 100 is up 7+% this morning. The financial sector is up 17%!


The surprise is that basic materials are up 9%. Tech is the third sector, up 5%.



Gold is back down $50.


Negotiations on troops in Iraq are stuck. The UN 5+1 is meeting now about what to do in Iran. A bill in the congress to put a naval blockade around Iran was tabled. That does not mean that sanctions will not shut off supplies of refined oil products to Iran, and increase the risk of war.


In premarket trading, the bid ask on companies such as Merrill Lynch is up almost 20%. Yesterday Wachovia Bank traded $9.12 in the morning and it closed at $14.50.


Why are basic materials up so strong? Just as Generals fight the last war, stock investors buy last years stocks. A couple of days ago, a regular reader wanted to know if CAT is a good buy, he noted that it just made a 52 week low. I said, "Absolutely not"! CAT is a good company and it will go up in market rallies. However, monster machines are highly cyclical products. When a shortage of mining and construction equipment threatens to slow billion dollar projects, a used CAT will sell for double or triple its original price. When the demand goes slack, old machines will be cannibalized to keep a other machines running. Orders for machines can suddenly disappear. You do not want to buy on a 52 week low but on a 60 week low.


Basic Materials are the opposite of financial stocks but, again, investors are fighting last years war. The leading sectors in the months ahead will be financial stocks, consumer cyclicals and technology. The leading industries in those sectors will be companies that benefit the most from lower fuel prices.


A deal for the congress to lend US motor companies $25 billion to retool has prior agreement. Such a bill will be part of the goodies package offered up for a vote. Drilling, saving the autos, saving the banking system, and money for pet projects will all be part of the compromise offered. Incumbent representatives have a week to show the American people that they are doing the people's business. The fact that not a single appropriations bill has been passed, 10 days before the start of the budget year. This is a clear demonstration that politics has become more important than accomplishment.


The suspension of short sales, in London yesterday and in the USA today, is a way to say "not my fault". Suspension of free markets is a bad precedent to set; it will help the market in the short run but hurt much more in the long run. We will all pay a little bit spread out over years and years of paying in exchange for a short term bounce. Those in the know should be in the business of teaching rather than using such rules as a way of deflecting attention. McCain said that if he were president that he would SEC Chairman Cox. Cox responded that he would not listen to criticism while in the middle of a financial crisis, but a few hours later he suspended short sales.


The parallel situation is the shifting of blame by the congress in regard to the spike in oil prices. It was the congress that put US reserves off limits for the past 30 years, and it was the congress that pointed fingers at speculators. The reality is that speculators force markets to be honest. Speculators save consumers billions of dollars.


Of course, local politicians are quick to join-in the finger pointing during a crisis. After Ike hit, Roy Cooper, Attorney General NC, was quick to jump on service stations for price gouging, and to send notice to all of our children's school teachers. In America, we believe in freedom of the people until politicians can smell the chance to appear to be white knights. One of the best examples of harmful laws is price fixing or price gouging laws. Ironically, when OPEC joins to fix prices we get upset but it is OK when our Attorney General does it.


After a hurricane, ice is in great demand. By passing anti scalping or price gouging laws, the incentive of the free market to respond is smothered. In the absence of such laws, many a "speculator" would deliver truck loads of ice, some would travel many miles to get in on the opportunity. At first, the price would soar, increasing the incentive to bring more. The most valuable of commodities would be saved (perhaps including human life and limb). In short order, plenty of ice would be available. The price would plunge as the excess ice started to melt. Instead, victims must wait on bureaucrats to deliver what is needed, 10 days too late. The average price would have been lowered and the supply would have been increased.


Homeowners participate in the "short sale" market. We buy a home but then buy insurance to protect it. Selling short is as American as apple pie. Short selling, like oil companies, is an easy target for unknowing or unscrupulous media moguls and politicians. Politicians and their friends find it easy to shift the blame for high oil prices to oil companies. The reality is that Exxon has saved more consumers more money than any other entity on this earth.


Now that the turn is here, politicians are stumbling all over each other to show that they are doing something. For this reason, a drilling bill is likely to be passed. The bill to loan car companies $25 Billion will be passed. When I write that consumer cyclical stocks will be among the winners, I include Ford and GM. Still, the first part of the big turn is in banks, insurance companies and brokers.


One result of the turn in financial stocks will be a gradual growing in the availability of low cost mortgage money. Homes that are underwater will float again. Resort homes will go up 300% or more over the next 15 years. Equity invested will sky rocket.


Who knows how many bumps will be made between today and the actual passage of bills through congress. For my money, I still would like to see a clean drilling bill or no bill at all. I would not mind seeing the government shut down for the first few days of October. With elections so close, I suspect that a decent compromise bill will be reached.

A Rifle Shot or a Shotgun Blast?

At the end of the meeting between Hank Paulson and Congress, all parties talked about the bipartisan job ahead to pass a financial rescue package. Pelosi talked about a bicameral solution because children's textbooks around the country use that word to describe a country that has a two house legislature. It is always interesting to hear code words.

Hank Paulson was careful to talk about a concentrated effort to solve a specific problem. It is clear that he would like for the congress to pass a rifle shot bill to fix the imploding mortgage market and the democratic leadership would like a shot gun blast to attack all sorts of problems. When facing a bear, it is best to shot it with a deadly rifle.



Pelosi issued a statement minutes before the meeting saying that she is prepared to keep the house in session past the September 26 adjournment date if necessary to pass a second financial rescue package. This package would include porky pigs dressed up in help for the poor clothing. The Speaker and her friends will repeat the words over and over that main street needs help just as badly as wall street.

Pelosi calls for five provisions, assistance with home heating, food stamps, extended unemployment benefits, Medicaid payments to states and money for infrastructure. The administration and republican representatives will repeat the mantra that saving the financial system will save the peoples savings and retirement funds.

The bickering has already started.

The congress has planned to adjourn on September 26, but Harry Reid still has a long list of bills to be passed. He has suggested that a lame duck session might be needed starting on October 1. The congress is not likely to meet during Rosh Hashanah, which includes September 29 and 30. Will republicans stick to their guns and resist big government spending? With the crisis at hand, the pressure is on to cave. When push comes to shove, it is likely that the congress will vote for the big spending compromise package.

The market soared today on the rumor that Paulson would propose a plan. Taxpayers and feel the roto-rooter coming. As we all know, our gasoline taxes are supposed to build roads and bridges, the congress continues to take these funds to subsidize bus systems, train systems, bicycle trails and parks. All of these are worthy of certain levels of spending but the money should not come out of the highway trust fund and supplemental spending for bridges should not be needed.

SANCTION ROUND NUMBER 4?

China and Russia have shown great concern about this weeks IAEA report on Iran. Documents show that Iran has been trying to build nuclear missiles. Tomorrow, the 5+1 Group will meet again to discuss sanctions. The recent bounce in the price of oil was not about Hurricane Ike; it was about the increased risk of conflict. Same with the run up in Gold.

Condi Rice blasted away at Russia yesterday. She made it clear that Europe and the US are committed to the freedom of Georgia. She let Russia know that Russia will not be accepted into the WTO unless it stands down. The timing of the blasting was just before the meeting on sanctions. The US will continue to meet with Russia on issues such as Iran. It continues to be in all nations best interest for Iran to agree not to produce nuclear weapons. Because Iran is near both Russia and China, they have more to lose than does Europe or the USA.

Again, the timing of these meetings just when the congress must act on "drill, drill, drill" is no coincidence. The timing of the financial crisis is no coincidence. Just as the major decisions about Viet Nam were made during the recession of 1973-74, the timing of every thing from the invasion of Georgia to the possibility of strict sanctions has been carefully decided.


A BIG WEEK OR TWO?


The flood of liquidity being provided by central bankers should be enough to keep the wolves away until two or three deals can be completed. It is possible that a general agreement was reached between the administration and the congressional leadership before tonight's meeting was scheduled. You may recall that the prior financial rescue package was stalled until Paulson announced the need to include provisions about the GSEs. The fight for the next few days is probable about who gets the most spoils from the pork provisions.

In any event, stocks are very cheap and conditions are ripe for a major turn. It is true that housing starts are down to 1982 levels. It is even true that the number of housing starts per 1,000 families is at levels not seen since WWII. The doomers use these statistics to support statements such as "this is the worst financial crisis since the great depression". Smart investors will note that when housing starts were this low in 1982, mortgage rates fell and stocks took off.

Hank Paulson Rides to the Rescue

Hank Paulson has done a masterful job as Treasury Secretary. He lost $200 Million in salary per year by taking the job but he has set Goldman up for a great run over the next 15 years. Today, he rode to the rescue on his white horse while wearing his white cowboy hat.

The rumor is that he will now set up a government trust to take some of the "bad credit" off the books of the banks. Banks do not want to sell these positions while they are marked to a tiny fraction of their "next year value". The deal with the treasury will allow the banks to get back into the mortgage business while holding the right to repurchase the deeply discounted paper to be held by the trust.

Hank will get accolades for coming through in a pinch. The markets will be "saved" just before the election.

Meanwhile, back at the ranch, Condi Rice will light into the Russians. The big evil Russians are providing the perfect foil. They are too big and too mean to be handled "Obama the Weak". While the Gallup poll shows that the popular vote has swung back to Obama's favor, a lot of states are up for grabs. McCain is competitive in Washington, Oregon, Michigan, Wisconsin, Minnesota, Ohio, West Virginia and Pennsylvania. For a few months, I have suggested that McCain may win by 2 points (a landslide). Many a President has been elected without winning a majority of votes. I believe McCain will win the popular vote by a small margin with the potential to win the electoral college by a large margin.

Expectations are low, but big change is in the cards. Obama is running on change but a lot of the change Americans want will happen between now and the election.

SERIOUS ABOUT SUPPORT

Central bankers have shown that they are now serious about giving support to financial markets. The flood of money was important but the action in the UK to suspend short sales is even more important. Short sellers around the world have been put on notice.

It is widely known that the mark to market rules have resulted in a huge but temporary depletion of capital. The up turn will be violent because the equity in these leveraged securities will soar.


Russia has announced that it will gradually suspend oil shipments from all but its own ports. This is a big nothing but the price of oil jumped $5. The threat can cause harm in the short run but it is the same as a producer of cars boycotting the world. If GM decides to never sell another car, the world will not go car less.

12 days until the oil drilling moratorium is toast!

TURMOIL AT THE TURN

During the turn of 1973, there was trouble in the financial stocks and trouble in the Middle East. During the turn in 1990-91, there was trouble in the financial stocks and trouble in the Middle East. During the turn of 2008, there is trouble in the financial stocks and trouble in the Middle East.


Yesterday, 5 bombs went off near the US Embassy in Yemen; sixteen people were killed. Yesterday, UN inspectors presented evidence that Iran has secretly tried to alter the nose cone designs of rockets they possess. The modifications were for the purpose of replacing conventional war heads with nuclear war heads.



The market did not take kindly to the news. The price of gold jumped by the largest margin in recorded history. The price of oil jumped by $5 per barrel.


When did the US know and when did the UN know about the modifications to the missiles? I suspect this information has been known for some time. Over the past couple of months, speculators, well aware of the world wide economic slowdown, have become oil and gold sellers. Speculators in commodities tend to trade on extreme leverage, yesterday, they got their heads handed to them.


The obvious risk is that there is going to be a strike on Iranian nuclear facilities. I believe the odds are less than 20% but the latest international news, coupled with an outpouring of liquidity from central banks and treasury departments caused fear to rumble. The outpouring of liquidity, including from bankers in Australia and Japan, was enough to cause the fear of inflation to reignite. The reality is that inflation expectations are being decimated by the collapse of US financial institutions. These US institutions hold trillions of dollars worth of mortgage backed paper that has been written down to extreme levels. The heads of these institutions understand that the survivors will make trillions of dollars when the value of these securities bounce. The last bank to be sold out will be the poster child for coming close to making big money. In the case of AIG, it is known that the sub-prime portion of their portfolio is being carried at 20 cents on the dollar. A rebound in the housing market would cause these securities to quickly double and to likely double again. In a good market, these securities are worth 80 cents on the dollar.


One thing very different about yesterday's trading was that the bond market did not "suck the air out". The ten-year has been on a big roll but yesterday it was pretty stable. The implication being that the big bond rally is getting very long in the tooth. Yesterday, the short end of the curve collapsed, implying that some bond traders are now selling long paper and implying that the FOMC may cut short rates again. In the "normal cycle", the rally in the bond market should continue well past the market bottom and the big V in financial stocks should occur before the market bottom. The market is currently "testing" the previous bottoms.


There is always turmoil at the turns. It is common to see international tension at the turns. These can be the most confusing of times.


The House passed a silly posturing bill yesterday. Democrats are now on record for having voted for an oil drilling bill; a bill that will not pass the Senate or the pen of the President and a bill that if passed would prevent drilling from taking place.


The Congress has 12 days to get serious. Investors should take advantage of the confusion in the market place. Few people realize how little the wiggle room of congress. Should the international tensions cool about the same time that the drilling bans expire, the price of gasoline could rapidly fall to $2.50 or below.

CATCH UP COMING

The ten year rate is down to 3.43. If it stays at that level for a little while, the 30 year home mortgage rate should fall to below 5.3%. For a brief time, it may even fall to the high 4's. Wow! The monthly payment on a home is down to very affordable amounts.


In the same way, the wholesale price of gasoline is trading around $2.45 (back up from the lows of yesterday). If the price stays in the current range, the retail price should be to $3.05 in two or three weeks.



Better still, we have made a long term turn. The ten year is still on the way down and the price of oil is still on the way down. There is still a lot of catching up to do.


Looking in the rear view mirror, we see a financial wreckage. AIG, Lehman Brothers and Merrill Lynch are "gone". Morgan Stanley is rumored to be next. The surviving banks will be like all surviving businesses after a shake-out; there will be plenty of highly profitable business to go around. My brother likes to tell about the housing market in 1983. He was one of a few home builders who made it through the period of 21% interest rates. He made the most money he had ever made in 1983 and 1984.


This morning the London market is catching up with the big gains in the US of yesterday. The US market is facing a bounce in energy prices but this bouncing market is like a rubber ball that has been dropped from 50 feet, each bounce is lower than the previous one. The oil price will eventually settle to the marginal cost of producing the last demanded barrel. It appears that that will be as low as $35 sometime in the next decade.

Airlines Soaring, Financials Stable, Energy Down

The price of oil has fallen to $91. The price of gasoline should be below $3 per gallon in a few weeks.

Mortgage rates continue to decline. Real estate at a place like Myrtle Beach is about to get a shot in the arm, lower gasoline costs and lower mortgage rates will increase the occupancy and the rental rates while lowering the cost of operation.


Big news is being made in regard to Merrill, AIG, and Lehman while traditional banks are moving up in price. A regular reader sent me a comparison of BB&T and Wells Fargo the other day and both banks are solid. The big turn will be with the riskier banks.

In the past few days, I have become all the more aware of how "brain washed" the public has become. Very informed and intelligent people believe that half of all the oil in the world has already been used. Less than 8% of the known oil has been used. The trap is that half of the recoverable reserves using last years technology and last years price has been recovered.

I have talked about this turn for about 2 years, I hope you are taking advantage.

Even Bankruptcy Not As Big as Oil

Even though Lehman stumbled into bankruptcy and even though AIG was chopped in half, the financial index did better than the energy index, by a small margin. The relative gain by financial stocks over the past couple of months is an important point for investors to note. One should buy relative strength and sell relative weakness, especially at major turns. Consumer cyclical stocks fell much less than and the transportation index was down less than half the energy decline. The tricky thing is that there was a flight to the safety of health care and consumer staples, but this will prove to be a short term event.


I cheated a little. Since BAC agreed to a 70% premium for Merrill, the financial index held up a little by the potential for takeovers and by short covering. BAC clearly got the nod from the FED before taking on another trillion dollars worth of mortgage backed paper (two trillion worth once the crisis is over). BAC will make a trillion off the deal, but, without the support of the FED, the bank would be making a 50-50 death wish bet. It is true that BAC has successfully raised new capital to cover its losses dollar for dollar but it used a chunk of that capital to buy Country Wide.


A BRAVE NEW WORLD


Computers are one of the things that provide direct links from financial stocks to oil stocks. An amazing statistic is that Google now uses more than 1% of the electricity produced in a number of countries!


Google has applied for patents on floating data ships. These barges would be located 3 to 10 miles off the coast, they would generate electricity from wave action and they would save billions of dollars in cooling cost and in property taxes.


Microsoft is studying the idea of placing data centers in Siberia. Japan is considering building a data center deep in an old coal mine. In 20 years, Google is likely to be using 10% of all electricity while the amount of energy used in transportation will have fallen.


A SCARED OLD WORLD


Nancy Pelosi and company are running scared. Pelosi has gone from saying "there will never be a vote on drilling" to seeking a compromise. Even so, she is trying to pull off a slick trick. She now supports drilling provided that all the lease and royalty payments go toward alternative energy subsidies. This idea initially sounds good to a lot of people.


The problem is that it would take away the incentives and kill the drilling. No state would allow drilling, unless the state were to share in the revenues. Subsidies are a bad idea in and of themselves, but taking revenues from the states is nothing but an attempt to pass a drilling law without allowing for drilling. Unfortunately, long ago, the congress of the USA started ignoring the "necessary and proper rule". It is my hope that no compromise is reached as it is not "necessary or proper" for the federal government to pick winners and losers in the energy business.


NUKES AND MORE NUKES


Did I mention that nuclear power has caught a growth surge? Brazil now has plans to build one new nuclear power plant each year for the next 50 years! An existing plant in America just announced that it will seek the authority to expand its capacity.


Did I mention that plans are being made to produce 4,000 small nuclear plants on an assembly line? The best description for these plants is "nuclear batteries". Together, they will produce about as much energy as is currently produced by the 104 regular plants operating in America.


CHARITY BEGINS AT HOME


Joe Bidden earned an average of $245,000 per year for the past 5 years while he contributed an average of $370 per year to church and charity. On average, people, who earn from $100,000 to $200,000, give about $4,500 per year to church and charity (from Carpe Diem web). The attacks on Sarah Palin have slowed. The more we know, the better she looks relative to Bidden and Obama. It is starting to look like Pennsylvania will vote republican for the first time in 20 years. Palin and citizens of small towns all across Pennsylvania are clinging tightly to their guns and their religion.


SERIOUS STUFF


The US has agreed to sell 1,000 smart bombs (the bunker buster variety) to Israel. The congress has 30 days to nix the deal, but, in the absence of a 50% negative vote, the deal is done. In the meantime, Henry Kissinger and other former heads of state have said that it is time to negotiate with Iran without any pre-conditions.


The 2 + 2 = 4 on this is that Iran is to be given a final chance to come to terms before Israel is turned loose. Again, I do not believe an attack will be necessary, but the odds have never been higher.


Iran had hoped for a clean bill of "nuclear health" by the IAEA. However, the report is that Iran has continued to prohibit the investigation of its nuclear bomb program. Bush, Obama and McCain are all committed to preventing Iran from acquiring nuclear bombs. Of course, if Bush does negotiate directly, Obama will take credit for positive results. Hopefully, the threat of the bunker busters is credible. Iran does not want to lose its nuclear refining capacity and live for another 30 years under sanctions. The final deal has been all but done for a long time. Hopefully the realistic threat of Israel in control of smart bombs will be enough to move the deal forward.


The congress has 14 days to pass a CR. The financial crisis and the Iranian crisis will probably be "solved" about the same time as the drilling problem is solved, shortly before the November elections.


I'll be out of the office all day. I'll check the market during the day and email late tomorrow night. You are facing a wonderful buying opportunity!

JAPAN AND FRIENDS READY TO SOAR

Oil is down to $94 this morning. There should be no need to mention obvious winners such as airlines, truckers, mortgage holders, etc. When I mention Japan, I sometimes get a why? response. Again, Japan, as a country that must import almost all of the oil it uses, Japan benefits greatly from lower oil prices.


EWJ is a Japanese exchange traded fund. Back in 1999, when the US market was out the roof, EWJ made a high but not an extraordinay high of $16.30. At the April 2003 bottom, it made a low of $6.50. It rebounded to $15 by May of 2006, but has since fallen to $11.06. Today, the Yen is soaring on the news that oil is down $5 a barrel. Japan is going to see a good market run. The next EWJ peak will be 3 or 4 years from now. It is likely to be higher than $35.


The story for Japan is not much different than the story for other "opposites of oil". Of course, the "opposites of gold" will also enjoy the decline in commodity prices. A small amount of earnings, grown relatively steadily, discounted by bond rates of 3.5% becomes more and more valuable as the years pass. We are set up for a great market run. The "market bottom" late in the contraction phase will not be the bottom for all stocks. The bottom for many companies was made in January or March of this year. The broad market averages, which is heavily influenced by big cap oil and basic material stocks, will bottom soon.


Investors should buy relative strength. The pundits are talking about a consumer lead recession just as consumers are getting a huge break in the price of fuel and a huge break in the price of money. The break-out leaders will run a long way.

WHAM! BAM! LEHMAN BANKRUPT, BAC TO BUY MERRILL

The collapse of the big financial kings and broker-dealers continues. This morning, the London market is down 4% with the financial index down 7%. Futures indicate the DOW will open down about 325 points, the S&P down 44 and the NASDAQ down 50.

The bad news (as always) is accompanied with good news. The 10-year treasury is down to 3.5%, oil futures which have dropped $5 are trading around $96 per barrel and the Yen is soaring. Japan, with no domestic oil production, will be one of the big winners as the price of oil falls.


SHORT TERM VERSUS LONG TERM

The short term focus is on problems produced in the past and already solved. The sub prime slime hit the leveraged mortgage holders hard, but the decline in bond rates is a bigger deal for long term profits than the bankruptcy of Lehman or the sale of Merrill. The Lehman and Merrill will get the press coverage in the short run.

Lehman has stood for 158 years and is at risk of liquidation. Merrill Lynch will lose its independence and become a subsidiary of BAC. Merrill is indicated at a $23 open, it closed at $17 on Friday. BAC is indicated at $29 after a close of $34 on Friday.

The 3.5% rate is the game changer. In just two months, the average thirty year mortgage rate fell from 6.5% to 5.8%. The spread between the 10-year Treasury and the 30 year mortgage rate is still high. There will be additional declines in mortgage rates. Within days, mortgage rates should be at or below 5.5%, near the lowest levels seen since the early 1960's or the late 1950's. Trillions of long dated assets will increase in value as rates fall. Houses and long term fixed or increasing cash flows are worth more today than they were yesterday. The cash flow produced by solid growth companies is becoming more valuable by the minute.

The knee-jerk response is going to take stock markets down. In the London market basic materials, energy, consumer cyclical and financial stocks are all down 5% or more. The jump in bond values is the immediate offset on the see-saw but all ongoing cash flows are worth more.

Central banks are already responding. A 70 Billion Dollar Credit Line has already been made available. China just reduced its lending rate and its reserve ratio. The 1% reduction in reserve requirements follows something like 9 increases over the past 18 months or so. After the reduction, the reserve ratio is still an incredible 16.5%. The brakes are still being applied. Over the weeks ahead, country after country will gradually release the economic brakes. Short rates and commodity rates take walks together.

THE TANGO WITH RUSSIA

The tango with Russia continues. The US has added ships in the Black Sea; Russia will hold joint maneuvers with Venezuela. A deal with Syria will establish the first Russian Naval base in the Caribbean.

Nicaragra is the only country besides Russia to recognize the breakaway regions from Georgia. Not even Cuba has taken the Russian side. Russia has recovered from its 1989 collapse but it is not the same bad boy as the Soviet Union. Still, Russia is showing the US and Europe that they can be active in the Caribbean and the Mediterranean if we want to be active in the Black Sea.

Secretary Gates is in Iraq. Iraq is ready to talk with the US and with Iran. It is time for a final compromise on the deployment of troops in Iraq. I believe the deployment of troops deal is the last significant problem that is holding up the deal with Iran.

The IAEA is ready to release a report on Nukes in Iran. Iran is applying pressure in hopes of receiving a clean report. The IAEA is expected to report that Iran is demonstrating that the refinement of uranium is for peaceful purposes. A good report could already be in the hands of Gates and a deal could occur at any moment.

Letters found on a dead al-Qaeda leader show the degree to which al-Qaeda in Iraq has fallen. The leaders have become paranoid. This is understandable because leader after leader, from Afghanistan, to Pakistan, to Iraq has been struck by Predator Missiles from nowhere. It has even been verified that actors are being used to portray al-Qaeda leaders in Internet videos!

STOCK BROKERS and AL QAEDA LEADERS ARE IN THE SAME BOAT

Stock brokers are crying the blues. Many a career broker is out of a job. The rest are not sure which shoe will drop next. It is extremely hard for brokers to be optimistic in this environment. Their pessimism is apt to rub off on the few optimistic clients they have. We face a wonderful buying opportunity. Again, the talk will be all about the sale out of Merrill and the bankruptcy of Lehman. The jump in bond prices will be hardly noticed and the talk about the decline in the price of oil will be mostly about how it is happening as a result of the economic "recession or depression".

A GREAT WEEKEND

The Maple Springs United Methodist Men's Bible Study just had a great weekend at the beach. Six of us carried an ill man into the ocean to assist our pastor with his baptism. We enjoyed good food, fun, fellowship and spiritual guidance. I cannot report who won our poker tournament but it was not me. Wednesday we will start a 19 week video series on Acts. All are invited.

Lucky Numbers

Mortgage rates have fallen .7% in 7 weeks. The monthly payment on the average house has fallen by $120. Multiply $120 times 100 million houses and the money begins to pile up. More to come!

The Perfect Storm

It seems like the perfect storm is brewing. The financial markets are being hammered by the potential collapse of Lehman Brothers. However, most of the bad news is good news.

Dramatic economic slow downs in places such as Australia and England are forcing mortgage rates and fuel costs to fall.


A few months ago, the fear was that mortgage resets would severely damage the mortgage market. The resets are being done at low short rates in the USA or they are being refinanced at low long rates.

High short rates in many nations (Brazil just raised short rates to 13.75%) are forcing down inflation rates, as seen in the dramatic fall in the price of gold (gold has fallen from 1035 to 780 in just a few months).

The "take over" of the GSE's by the treasury department has increased the value of trillions of dollars worth of mortgages and mortgage backed paper. Banks holding marketed to market paper will have to mark the value up.

The near collapse of Lehman Brothers is the kind of thing that happens at market turns.

The failure of congress to come up with a reasonable energy plan is giving support to ending the ban on drilling in US waters. The drilling ban will die in 19 days. So far the only thing offered by congress is a Christmas Tree -- Pork Barrel Bill. Perfect for McCain and Palin to run against.


The 123 Agreement with Russia was pulled by the Bush administration. The pressure is on Russia to continue their prior movement toward a successful trading partner or they can continue their recent path of returning to the days of the Cold War. Bush has avoided a no vote by congress. The next president can resubmit the treaty if conditions improve.

Osama bin Laden is still on the loose seven years after 9/11, but three of his top commanders have been blown away during the past several weeks. Osama's (almost wrote Obama's) second in command blames Iran spies on the deaths.

The Air Force does not have enough trained personnel to plot bomb attacks, but the army is using digital, GPS binoculars attached to digital radios to call in ordinance. The ratio of deaths from friendly fire is dramatically lower than it was in the old days. The number of bombs used goes down as the accuracy of the bombs goes up. High tech pairs of binoculars have become laser guided missiles.

OPEC has announced a 500,000 barrel per day cut back in production, but Brazil just found another 3 to 4 Billion Barrels in an off shore well. Natural gas production in the USA is soaring due to tech improvements.

Stocks have been pounded by the pull of the huge rally in the bond market, but the 10 year is below 3.6% and is offering less and less competition to stocks as yields fall.

A Spanish airline just went out of business; one less competitor.

Obama regained his face time on the news networks by the artful use of the expression about lipstick on a pig. However, McCain suddenly has safe leads in a number of states, he has pulled into leads in several battleground states and it even appears that his coat tails could cut the gains expected by democrats in the house and senate.

Only 39 Senators have signed the letter of strong support for ending the moratorium on off shore oil drilling, 41 votes are needed. McCain and Lieberman could provide votes number 40 and 41.

I'm headed off to the beach for a retreat with the Maple Springs UM Men's Bible Study. I'll keep an eye on the market and will be back in touch on Monday.

FUTURES SUGGEST A GOOD MARKET

Because I have an 8 AM appointment, I will keep this short.


The market is set up for a bounce this morning. OPEC has reduced production and Ike is moving into the GOM so the bounce may be concentrated in the energy area.



Mortgage rates have fallen 4 tenths of one percent in two days. The prospects for clearing out the backlog of unsold homes continues to improve.


Natural gas is growing in importance. A number of new pipelines are proposed. Millions of cars around the world have been converted to burn natural gas. Home appliances are being sold which can fill 70 miles worth of compressed gas in 4 hours. Good enough for millions to save about $1.20 per equivalent gallon.


Another key al Qaeda leader has been killed in the mountains of Pakistan. Iran has been accused of giving the US the intelligence it needs to go after the bad guys. There have been 7 US strikes in Pakistan in the past 10 days and 5 of them have killed high valued targets. The latest was the gentleman that was offered the slot as Prime Minister of Afghanistan a few years ago. The message the good guys or die.


Vice-President Chaney just spent 4 days in Italy. Italy is the founder of the NATO-Russia Compact. With only 20 days to go before the US budget or a continuing resolution must be passed, there are a lot of irons in the fire.


The next 10 to 20 days could be rough. Central bankers are continuing to apply pressure. Gold is falling and bonds are soaring; sucking the air out of the stock market.


The set-up is all but complete. Expect strong action within 20 days.

BARGAINS AVAILABLE

Real estate bargains are available, but they are getting picked off. The "news" is that the foreclosure rate is going up. The fact is that clearing prices are being reached.

Hank Paulson will leave his government office and go back to the private sector at the end of the year. He has accomplished what he set out to accomplish. Goldman and the other investment banks will no longer have a half government-half private entity to compete against. Quasi government corporations have always been a bad idea. Entities such as the TVA and the US Postal Service are unfair to competitors and they smother cost saving innovation. Take a look at the change in the cost of a postage stamp over the past 50 years and you know what I mean.


A lot of people defend the post office. The fact of the matter is that the post office has hindered economic progress. How much gasoline do you suppose the US Postal Service uses in home delivery? The marginal cost all Americans pay for gasoline is higher because we insist on wasting gasoline to deliver the mail.


Americans love daily home delivery, but if the postal service were not a monopoly, Americans would love the instant delivery of mail via the Internet. Someday, perhaps when the price of gasoline hits $10 per gallon, the post office will cut home delivery to once per week. To assuage the emotions of the public, the cut will be accompanied by a sharp reduction in the cost of a stamp. Some years from now, parents will tell their children about how it used to be that a man would drive ones utility bill all the way to ones house. How silly?

Yesterday, Paulson put Fannie and Freddie Mac out of the mortgage hedge fund business. Hallelujah! He also cut off their ability to lobby congress! Hallelujah! Hurricane Ike is stirring up the waters of the Gulf. It was more than 50 years ago when President Ike warned about the Industrial - Military Complex that lobbies congress for the benefit of investors and congressional leaders. McCain strikes a cord with his "Country First" motto. It is time for the congress to stop voting for ethanol, wind, and housing subsidies. It should not be the roll of government to determine which businessman wins. Can you imagine the lobbying that would take place if there is a government run health care system?


Yesterday, the rate on Fannie Mae 30-year mortgage paper fell 47 basis points!

This has to be one of the largest one day drops in the price of a mortgage ever. The irony is that even after the drop, investors should buy second homes on variable rate mortgages. They should buy today with a variable rate and then wait about a year to refinance at a fixed rate. With yield curves still inverted throughout much of the world, there is going to be a continued fall in the price of commodities and a continued fall in the fixed rate cost of money.


Those adverse to variable rates should buy real estate now, at fixed rates. The supply of new homes coming on the market is the lowest in years. It will take a few years before is lots of new construction. The inventory of homes on the market, particularly in depressed resort markets such as ocean front at Myrtle Beach, is high because sales are so low. As the sales pace picks up, the supply on the market is going to decline rapidly, while the best bargains disappear.


The last time there were such good bargains in the second home market was in 1991!

Not that every home on the market is offered at a bargain price. Many people who bought high cannot bring themselves to reduce there asking price to current market prices. Those who must sell are taking a beating.


BUY FINANCIAL STOCKS


When the stock market turned, November of 1990, during the middle of the last real estate recession, Wachovia and other bank stocks showed relative strength and then real strength. By November of 1991, Wachovia's share price had increased by 100% before broad indexes of housing prices had turned up.


Today in London, the broad financial index is up 1.46%, the broad transportation index is up 1.63% and the broad basic materials index is down 1.06%. What more could the housing industry want? Lower materials costs, lower mortgage rates, improved consumer net income as a result of falling energy prices and limited new supply?

ARE YOU ENJOYING THE $$$$ RIDE?

The recent fear has been that the government is about to get much bigger and much more involved in our daily lives. The price of health care has zoomed upward as a result of Medicare and Medicaid. For more than a year, many if not most people have believed that the next president, Hillary or Barry, will nationalize the health care system and raise taxes to pay for health care and other government programs.

The reality has once again taken a different tact than the fear. This weekend, Hank Paulson put an end to the competition of government in the mortgage market. Ironically, the government will make big profits by "buying-in". The buy-in comes with the mandate that Fannie and Freddie slim down dramatically over the next many months.


As part of the "bail-out", the government will buy mortgage backed securities. The government will also make a profit off its ownership of Fannie and Freddie. Again, this will be a temporary arrangement as the deal requires Fannie and Freddie to sell off a huge portion of their holdings.

Another test is just around the corner. The government has meddled in free markets by picking winners and losers in the energy markets. If Jim Demint and his friends find two more votes, the government is going to allow the market to decide which resources to develop. The government will still auction leases, collect royalties and have a lot of influence, but it will not keep paying one system pork dollars while taking from the most efficient producers.

If McCain is true to his word, then he will vote against the pork barrel plans that are likely to be offered as compromises between now and October 1. McCain is for wind mills and solar and switch grass, as am I. The trouble is that McCain has show a willingness for the government purse to be used in distortive ways. For example, he has proposed a $300 million prize for the inventor of a "super battery". With no prize in place, billions of dollars are being spent to solve this riddle. Great progress is being made. The company that patents the solution will make a lot more than $300 million.

I am for alternative fuels but I trust the invisible hand of Adam Smith and I do not trust the heavy hand of government. In like manner, the company that develops the bacteria that will chew up coal, shale or switch grass and give off natural gas will have hit the mother lode. The average person does not realize just how incredible the science of genetics has become. There are many astounding examples of what is going to happen, but, the one I like to repeat is the 5 second 100 meter dash. A professor at SMU says he expects to live to see the 5 second dash.

Some immediately respond to such assertions as incredulous. The fact of the matter is that Gorillas have upper arms strength that is 10 times that of man and animals such as Chimpanzees can do things that man cannot. However, they prove the possibility. Who would have believed that mice can be caused to build muscle strength through gene therapy. Some of the science done with mice has already been shown to work on primates. We need government to set some rules, but not to over regulate this incredible new industry.

THE FINANCIAL RIDE

The London market, especially the bank stocks, shot up like a rocket this morning. It soared until the market closed early, "due to connectivity issues". I don't think the world is prepared for the dramatic recovery that is in progress. Leveraged paper is cheap and now being bought by the US government. Financial stocks are behaving like they did near the end of the 1990-91 real estate recession; they are sky rocketing.

The weakest of the weak are making the biggest moves. ETFC, for example, is up more than 12% this morning. I hope you are catching as much of the ride as you can.

UK BANKS SOAR

Bank stocks in England are soaring on the Fannie Mae take over. US
Futures are running.

FINANCIAL CRISIS ENDING

The takeover of Fannie Mae and Freddie Mac by the government will pump new money into the mortgage market. The Sub-Prime Financial Crisis is drawing its last breaths.

Asian markets responded with higher stock prices (Japanese Bonds traded lower). Japan is showing strong signs of economic recovery. Japan will continue to do well for as long as energy prices fall. Mortgage rates are falling. Houses are getting cheaper to buy at the same nominal price. The 10-year treasury note is currently below 3.7% which is lower than all but two or three times in your entire life.


NUCLEAR STUFF

The Nuclear Deal with India continues to leap tall hurdles; it should be sent to the US congress for consideration soon. The Nuclear Deal with Russia has been all but called off. The US has accused Russia of selling arms to Iran and Syria which have then been funneled to Hezbollah and other terrorist. Russia has threatened to assist and train Iran in the production of nuclear energy. US ships entered the Black Sea and others have docked at Georgia despite warnings from Russia. By taking control in Georgia, Russia has denied the Israelis of an airbase that is withing striking distance of Iran.

The US has sent messages and a follow-up messages to Russia. The day after announcing that the nuclear agreement with Russia might be withdrawn, the GE-HIT partnership (US-Japan) announced projected orders to build $60 Billion worth of nuclear plants. A couple of months ago, China made a billion dollar nuclear deal with Russia but China has ordered 100 of the Westinghouse Pebble Bed Reactors. The Russia-US Nuclear Agreement would open western markets to Russia but Russia prefers to fight for control over its neighboring states. The US is ready to negotiate with Iran without Russia's help.

Western Europe has declined to impose sanctions on Russia, as Russia supplies much of Western Europe's gas and oil. Georgia has filed a court proceeding through the UN.

Iran has ordered $35 million of military equipment from a Chinese company that is a subsidiary of an Israeli company! Iran surely knew.

The Al Gore crowd would "retire" fossil fuels within ten years. The reality is that if all the nuclear power plants in the world that are under construction, planned and proposed were to be built, the new energy supplied would be only 40% of the current usage of fossil fuels. Al either has a magic wand or an incredible imagination. There are 36 plants under construction and 97 planned that could possibly all be finished in about 10 years. There is little chance that the 221 proposed plants can all be finished in 20 years.

To accomplish as much with windmills is certainly a pipe dream. If it could be done, the costs would be more than double the costs of nuclear. The hit to the environment would be terrible.

Pundits keep saying that China will snap back after the Olympics. These guys have not read the business news from China. Recent reports say that more than 67,000 small to medium sized Chinese businesses went bankrupt in the first 6 months of 2008. The world wide slowdown is real. China has made the commitment to lower the production of air pollution. Business is taking a hit until nuclear plants can be built.

THE MCCAIN SURGE

Sarah Palin has given McCain a solid boost toward the presidency. Over the next 10 days, the electoral college maps will gradually roll over. McCain has already wiped out Obama's lead in the daily tracking polls. As individual state polls are updated, McCain should take a significant electoral college lead. Poor old Biden has been forced into the position of telling the media that Bush has followed the Biden plan and is now following the Obama plan. Yeah, right!

BUY BIO-TECH!

The news from Bio tech labs continue to be amazing. Cures for major diseases are just around the corner. The science of trans-genetics is showing incredible promise while producing weird stuff. Spider DNA has been implanted into goats. The goats "milk" includes abundant strands of expensive silk thread! Cows have been converted into antibiotic producers. The value of the antibiotics produced is far greater than the value of milk. The cost of milk is down because "new" cows produce 16% more. MS and diabetes has been "cured" in mice. The diabetes cure has been tried on monkeys and it works for them as well. Cancer cells are being attacked by gene altered bacteria.

Bio-tech start-ups tend to burn dump truck loads of cash and few produce successful products. The potential is so large that lots of stuff gets tried. Cures for major diseases will pay huge rewards. Buy the exchange traded funds to spread the risk.

CHINA IS NOT DONE YET

Yes, China is cutting back. No, China is not "done". Not long ago, the cost of clothes went down in America because of trade with China. Today, China is making ever more sophisticated products. For example, China is the largest cell phone exporter. This says a lot about future inflation as the cost of consumer goods will continue to fall.

One can see the trend gaining momentum again by watching the spread between the 10-year nominal treasury note and the 10-year TIP note. This spread has been falling fast and hard. As the price of resources, such as oil, continue to fall, inflation expectations
should continue to fall.

ENERGY FREEDOM DAY -- OCTOBER 1

Thirty-nine republican Senators have signed the Jim Demint letter. The promise made in the letter is to oppose any legislation that scuttles the expiration of the drilling moratorium. Two more votes are needed.

The "Gang of Ten" is now up to the "Gang of 16". There are now 8 republican senators who are willing to go along with pork barrel energy policies. Newsweek posted a big article suggesting that the American people are pushing for action now, compromise now. The vote is going to be close.

There will be a lot of horse trading going on in September. The nuclear deal with India should be a slam dunk but some will block it unless it is included in the "grand compromise". Of course, T. Boone and his investors (which include Nancy Pelosi) would like for congress to pass wind mill subsidies. Will the McCain message get through? The winning position for the republicans is to say no to pork, no to government spending and yes to drilling. We will see?

Turn in 2008

The following chart is of the turn in 2008.

http://finance.google.com/finance?chdnp=1&chdd=0&chds=1&chdv=1&chvs=maximized&chdeh=1&chdet=1220837126559&chddm=3990&cmpto=INDEXSP:.INX;NYSE:WM&cmptzos=-18000;-18000&q=NYSE:WB&ntsp=0

TURN IN 1991

The following chart shows how the pure home mortgage play, Washington Mutual, performed relative to Wachovia Bank and the S&P 500 at the turn in 1990-91.

http://finance.google.com/finance?chdnp=1&chdd=0&chds=1&chdv=1&chvs=maximized&chdeh=1&chdet=697496400000&chddm=190705&cmpto=INDEXSP:.INX;NYSE:WM&cmptzos=-18000;-18000&q=NYSE:WB&ntsp=0

Today, Fannie Mae and Freddie Mac were put into receivership. The US Government will buy as much as 100 Billion Dollars of preferred stock. The Government will supply lines of credit and it may buy mortgage backed securities directly.

This is the kind of action that marks major turning points. There is sometimes a "fake out" where the market moves the wrong way for a day, a week or two, but the action is in essence a clearing action. The government will ultimately make money off the deal. The initial preferred shares will pay 10% interest and the governments claim will be superior to other preferred shares and to common shares.

In the current cycle, financial shares have already shown relative strength. The "big move" is already underway.

GOOGLE CHROME

I am enjoying the use of Google Chrome. The new browser has neat features. At first, I was frustrated that my Google Toolbar and Google Bookmarks did not transfer. After a day of use, I find the new browser simple to use and very worthwhile.

A smart investor I follow is not excited about Chrome. He sees it as just one more free service to be offered by Google. Another service that does not add to the profit line.


Still, he likes Google because it has gotten cheap relative to
earnings and earnings growth. I like it for its potential.

I see a sea change coming. I believe groups, such as Churches, are about to take the next communication step. Google document sharing is about to hit the exponential network growth phase. When only a few members of a Sunday School Class share documents, there is a reluctance to distribute documents via the Internet. Once the majority discovers the ease and the savings, the whole group shares. Pretty soon, a related group such as a Men's Bible Study Group catches the network bug.

I really like the new Picasa face recognition feature. Technology is grand.

Tech stocks do well in the early expansion phase of the economic cycle. We are currently in the late contraction phase. Central bankers are sill using the bond market to suck inflation out of the system. When the bond market rally is over, traders will not be able to get out of bonds fast enough. They will pile into consumer cyclical stocks (everything from Auto's and Cable TV to Retailers) and then into technology. Technology is as cheap as it has been in a long time. Google is going to do well!

EXXON VERSUS AMR

Exxon is widely known to have been a great investment. Airlines are widely known to have been a poor investment. It really depended on the years you owned each.

Click on the link below to see what happened to the price of AMR in the 19 years it took from oil to go from peak to trough. The stock went up 2,000%.

A similar decline in the price of oil is underway. Airline shares are up an average of 60% in a short time. The move has just begun.

http://finance.google.com/finance?chdnp=1&chdd=0&chds=1&chdv=1&chvs=maximized&chdeh=1&chdet=1220040000000&chddm=2869693&cmpto=NYSE:XOM&cmptzos=-18000&q=NYSE:AMR&ntsp=0

THE RISING VALUE OF RENTS, DIVIDENDS AND FUTURE CASH FLOWS

The most important investment "secret" is a simple concept. Follow the concept in a disciplined manner and you are on your way to being a billionaire. The concept is easy, the discipline to follow it is the hard part.

The value of rents has risen and continues to rise relative to "safe" returns. In July 2007, the 10-year "safe" return of US Treasury Notes was 5.3%. Today, the 10-year "safe" return from Treasury Notes is 3.59%. The regular receipt of a 6% net rent in 2007 was just barely above the "safe" return; collecting rent instead of treasury interest was a lot of work for a minor gain and not worth the risk. The low return for high risk indicated that rents had to go up, safe returns had to go up or both. Both has been the result. The market price of rent houses went down while the value of the T-Note went up. The cash flow spread increased by 47% if we measure the T-Note rate against the 6% rental rates. The cash flow spread jumped 67% if we assume a 10% decline in the value of a rent house with no change in the rental income. ($6,000 divided by $100,000 is 6% but $6,000 divided by $90,000 is 6.7%.) Most importantly, lower construction combined with population growth will gradually lower the supply of rent houses and increase the demand for rent houses and thus lead to rent increases.


Investing well is not much more than the process of comparing returns to the "safe" rate.

The facts are clear, the guaranteed 10-year rate of return has been going down, which is making the relative value of rents, dividends and other cash flows go up. Stocks are a better investment today than they were in 2007 for several reasons, but the key reason is that they do not have to make as much to beat the "safe" rates.

HOW DO WE KNOW WHEN IT IS "SAFE" TO JUMP-IN?

Back in July 2007, there were sharks in the "cash flow water". Short term rates (sharks) sticking their dorsal fins out of the water. The safe 90 day treasury rate was just as high or higher than the "safe" two-year treasury rate, the "safe" 5-year treasury rate and so on. I regret that I temporarily lost discipline and took my eye off the sharks. I sold bonds to keep stocks when I should have sold stocks to buy more bonds. Mistakes are good, if we learn from them.

One of the traps that caught me was the focus on stock market earnings yields, by smart people such as Ed Yardini and Don Hayes. Short rates reached long rates by June 2006 but the market continued to do well. The explanation provided by Yardini, Hayes and others was that there was a wide positive gap between the earnings yield and the 10-year T-Note yield. Because "safe" rates were already near historical lows, it was tempting to believe that "this time was different".

The earnings yield is the upside down of the PE ratio. I have read in at least 10,000 books, news letters and articles that one should buy stocks when PE ratios are low (or when earnings yields are high). On the other hand, for more than 30 years, I have been well aware of the fact that one can easily get burned by "PE ratio investing". I have long know that the derivatives of "PE ratio investing", such as "PEG ratio investing" and "GARP Investing" can lead to disaster. It should have been obvious that what is true for individual stocks or groups is true for the market as a whole.

Long ago, I understood that the time to buy a stock or industry group is at its earnings trough, not at its earnings peak. Any investment system that relies on "good" earnings, is a dangerous system because stock prices lead earnings by many months.

Let's compare oil to high tech as an illustration. Back in 1999, a barrel of oil was selling for $10 to $12 while high tech companies were approaching peak earnings and oil drilling companies were struggling to stay in business. Suddenly, there were sharks in the water. Short rates reached long rates and even exceeded them for a time. The people who bought bonds avoided the collapse in the high tech market. By October of 2002, long rates had fallen dramatically and the broad market averages soared. Bond rates continued to fall until the ten-year rate reached 3.1% in June 2003 (the thirty-year reached 3.3%).

The investor who keeps 100% of his money in stocks all the time should have sold all of his tech stocks by March of 2000 and put some of the money into energy stocks. Today, we are looking at the flip side of the same coin. The peak in bond rates in February 2000, when the 10-year hit 6.8%, rhymes with the peak in bond rates in July 2007, when the 10-year rate hit 5.3%. Bonds had rallied and the market was set up for a big turn by September 2011, just when the terrorist hit.

The current huge bond market rally is not confined to the USA. The rally is even stronger in England, Australia and Canada. The most visible evidence of this is the collapse of their currencies relative to ours. These countries are our closest international friends. The EU is falling relative to the dollar but not as fast.

The bond market rally and the collapse of commodities will not be over until central bankers force the local sharks deep. Sell gold, oil and interest rates and buy consumers of these, such as financial stocks, consumer cyclical stocks and technology stocks (in that
order).

TIMING TIMING TIMING

If you were a republican vice-president, would it be neat to conclude a major foreign policy triumph just before leaving office and just before the next election? If you were a republican president, would it put you in good stead with the old money super wealth to time a major foreign policy triumph right in the middle of a major market turn, when a trillion dollars worth of mistakes will be made by the public? If you were a republican president would you push hard to ensure your legacy prior to leaving office?

It does not take a skeptic to realize that timing is everything.


The big turn is here. Money cannot get out of basic industries, capital goods, basic materials and energy stocks fast enough. The really big pools of money trapped in these areas cannot buy into the next phase of the cycle until they sell. The big guys have a tough time finding buyers. You or I can sell 100, 1,000 or 10,000 shares of these big companies in a split second. Trying to find a buyer for 1,000,000 shares or 10,000,000 shares is a another story.

The big rally in the bond market means much of the money received from the sell of stocks would like to flow into bonds. A year ago, a down day in the market saw energy stocks flat and energy consumers tank. Today, big oil companies are taking yet another big hit while airlines are holding up, the group has climbed 60% in no time.

Tonight, John McCain will unleash his energy message. He will take the congress to the wood shed. He will point out the absurdity of not doing anything because it might take time to produce results. The odds are good that the price of oil will fall more than three dollars per barrel tomorrow. Gold will likely break below $800. The price of oil is down $1.50 today and Gold is down $6. The big move is in the treasury bond. The 10-year is only down in yield 4 basis points today, but this 1% move is on trillions of dollars and it is a 10% move on leverage.

If a deal with Iran is concluded, you can expect gold to be below $600, bonds below 3.5% and oil below $85 before you can say WOW! The evidence suggest we are getting close.

WHAT IS DICK CHENEY UP TO?

The good folk at Stratfor.com are barking up the same tree as I. The nuance just added by Stratfor is the question, What is Dick Cheney up to?

Stratfor reports a sudden quiet in regard to Iran. Government chatter boxes have been tight lipped for two weeks. As I mentioned this morning, suddenly the USS T. Roosevelt is on a pleasure cruise, instead of a mission to Iran. Strange sounding sentences have been uttered by President Sarkozy in regard to nuclear refinement in Iran. The last 7 million barrels of stored Iranian oil was sold to Japan. Japan bought other oil from Iran. Sarkozy made the first European head of state visit to Syria in five years and Condi Rice is about to break a 50 year record by visiting Libya. Rice has told North Korea and Iran that Libya is the model they need to follow. It seems that Libya might be about to receive a nice reward for its settlement of issues with the USA.


NUCLEAR REFINEMENT NOT AN IMPEDIMENT!

The UN-IAEA negotiator has declared that Iran's refinement of nuclear fuel is no longer an impediment to direct negotiations! This action backs up the statement of Sarkozy. It backs up the earlier report of the Jerusalem Post that says that senior US negotiators are now involved.

A few days ago, I emailed Stratfor.com. I did not get a direct response, but the report they sent today shows they are now barking up the same tree as I. Before their report, I was aware that Cheney has meetings scheduled in several locations. Stratfor says that several of those locations would be suitable for direct talks with Iran. Of course, Cheney's visit to Georgia once again shows the connection of proposals dealing with Iran and Russia. This is all complicated stuff, but the pressure on all parties to complete these agreements is enormous. The deal I have been talking about for at least a couple of years is ever so close?

ANOTHER WALK AWAY

After Sarkozy's meeting with the PM of Syria and the mediator from Turkey, additional direct talks were scheduled between Syria and Israel. Just as we have learned to expect, the top Israeli negotiator has walked away. Parties from both sides of the Israeli question find it politically attractive to walk out on any meeting set up with the other side. The action of walking-out wins a few brownie points back home; it shows that the negotiator is not about to give away the store while showing that compromise is going to be necessary.

Walk-outs should not be taken too seriously. It took a long time to get direct negotiations lined up. It means the two sides have already agreed to the important stuff. The final meetings are more about show.

The US market is getting slammed hard today. The heavy losses are once again in energy and basic materials. Capital goods companies such as Caterpillar are getting slammed (a huge company down 6% in one day). This shows that the demand for machines to mine basic materials are no longer in great demand. Boeing Aircraft is another capital goods example of big stocks getting hit.

Investors who are convinced that the decline in oil and materials is temporary have been buying companies such as US Steel on the dips. The problem is the dips started soon after the 191 peak in June and it is dipping again today to $111. It takes a lot to move these giant companies and the US Bond market is the "big boy" that can make it happen. The 10-year is down to 3.66%.

TIMING, TIMING, TIMING

GO GO GO - THE END OF SOCIAL SECURITY -- SUCKING THE AIR OUT

Before last night, Obama's numbers did not add up. Now, the numbers are goofy but they come closer to adding up.

Last night an Obama spokesperson explained that the $1,000 rebate, for those people who do not pay income taxes, will come out of Social Security. He further explained that the people who earn from $150,000 to $250,000 will see stable income tax rates. Obama has repeated the $250,000 cut off while implying that families earning less $250,000 would see income tax cuts.


In the 1960's, when my Dad, earned the much higher than average income of $7,000 per year, he maxed out his Social Security Contribution by April or May. Back then, a family income of $10,000 was big. My Mother earned better than $3,000 per year and our family was "wealthy". We spent long hours growing and canning vegetables, we seldom ate away from home, we vacationed in a tent and we wore out our jeans and our one pair of week day shoes before we got more, but we were wealthy. It was clear to our neighbors that we were wealthy because we were one of few families to own two cars. $100,000 of income and $150,000 of family income sounds large but it will soon be small. Those who see the government as the source of economic strength can never get enough from it.

Under Obama's first plan, no one would ever max out Social Security payments. To wiggle out of criticism and to make the numbers sound better, under his latest plan, his Social Security tax increase would not start until 2019 and the increase would start with a "dough nut hole". By waiting to increase the Social Security tax for 10 years, he avoids having to count it at all.

If Social Security contributions were cut by $1,000 per year times millions of payers, Social Security would be in dire straights by the time Obama's "taxes on the rich" "saved the system". In other words, Obama would make a bad situation worse with a promise to "sock it to the rich" later. He has to play these games in order to make his misleading political statements fly.

Social Security has been a "bad investment" for a long time. Those who pay the maximum, receive returns of less than 2%. Obviously not a great retirement plan, but the hurt to 100's of millions of people has been offset by the help provided to a few million people. Social Security has been collected by a lot of children, whose parent(s) suffered early death(s), and by people who suffered disabilities. My grandmother was one of the lucky ones who made one small payment into the system and received 40 years of monthly checks, even though she was healthy and financially "well-off". Who can blame anyone of accepting gifts offered by the government? Warren Buffet has said he is willing to pay ordinary rates on his capital gains but, to my knowledge, he has not written the check. In truth, the government, all the people, are better off to allow Warren to invest the money and take just 20% of his profits.

While the original purpose was a forced retirement savings plan, most people are not extremely upset by the significant "leakage" in assistance to the unfortunate. The changes promised by Obama would convert SSN into a welfare system. We already know how that will work out.

In the short run, Obama's tax plan has been all over the map. His proposal has gone from dramatically increasing the tax on individuals who make $100,000 to miraculously coming up with billions of dollars to finance $1,000 reductions in contributions by middle and lower wage people. His program is a bit like the earned income tax credit on steroids. It is a rehashing of George McGovern's plan for government to guarantee all Americans a $40,500 per year income. McGovern's figure was $10,000, but my $40,500 includes an inflation adjustment of 3.5% per year. The main difference is that McGovern was upfront about the $10,000 payment whereas Obama hides his tax increases behind the rhetoric of $1,000 tax rebates. Fortunately the public was not fooled into believing McGovern could give every family a $40k income (without massive inflation or massive tax increases).

One of the problems with Obama's plan is that he does not use dynamic scoring. He avoids mentioning that raising the taxes US businesses pay on wages would send jobs to foreign countries. As marginal production costs increase, businesses would be forced to seek lower costs elsewhere. Obama also avoids the fact that higher taxes on businesses would be paid by higher prices of goods to consumers.

Obama is in love with the "European or Japanese Model". The following numbers show what his plan would achieve.

Recent per person GDP numbers are as follows:

USA $41,800
Japan $30,300
Germany $30,500
UK $31,500

The numbers include health care and all other benefits. Are Americans willing to see a an average income cut of 27% just to tighten the spread between the rich and the poor? (Besides, the spread between rich and poor is already lower in free enterprise countries.) Do we really want to go to a system where the incentive to work is diminished? Will government receipts really go up, just because tax rates go up? Has Obama ever looked at the Laffer Curve?

The 2007 figures show that new records have been set. Even during an economic downturn, personal wealth and income in the USA has set new records. A significant percentage of our population has been hurt by the downturn and particularly by high oil prices. Lower oil prices will give consumers much more than the $1,000 rebate checks offered by Obama, without raiding the SSN trust fund. The decline in fuel costs will boost the economy and further increase the wealth of the average American (only a few small places, such as Luxembourg, has a higher per capita income).

Other large countries have higher minimum wages, longer unemployment benefits and state sponsored health care but their unemployment rates average 3.6% more than US rates. In the USA, jobs are plentiful. Even during an economic slowdown, unemployment rates are less than 6%. The USA has a very dynamic economy. Jobs are constantly lost, but new jobs are constantly created. The best part of the story is that most of the new jobs are better than the old jobs.

PROGRESS IN IRAN

The risk of conflict with Iran continues to abate. Talks with Syria are set to continue, Sunday. Sarkozy, President of France, has publicly implied that additional progress has been made in talks with Iran. In the meantime, the USS Roosevelt, with its complement of 5,600 marines and sailors is now on a pleasure cruise. The ship will visit South Africa, while US negotiators go head to head with Iranian negotiators. This pleasure cruise is much closer to Iran than it was last week and it can change its mission if conditions change.

PELOSI, REID AND OBAMA

How sad? On national television, Pelosi, Reid and Obama have shown how partisanship can confuse, distort and destroy. Pelosi is now for building the new natural gas pipeline from Alaska but she is still opposed to drilling! She notes that natural gas is clean relative to fossil fuels! This was not a slip of the tongue, because she said it more than once.

Just in case some readers don't know, natural gas is a fossil fuel and it is found by drilling. Why would the USA build a 40 billion dollar gas pipeline, but not drill for gas? And, just in case some readers do not know, most of the gas found in Alaska is a byproduct of oil production. Oil and gas production go hand in hand.

Natural gas is the result of methanogen (tiny carbon eating bugs) digestion. Even when a well is drilled just to capture natural gas, the reality is that there is oil feeding the gas down there somewhere. Recently, Statoil was seeking a new place to drill when an employee said why don't we drill in one of our biggest and oldest gas fields? The field had produced gas for 30 years, but where did the gas come from? The company decided to increase the depth of some of the old gas wells. They struck 250 million barrels of oil. Coal bed methane is captured because there are similar bugs eating away at the coal.

Right now, the most productive oil wells in Alaska have up to 6 GE Aircraft Jet Engines attached, to pump natural gas back into each well. Some of the gas is used just to run the jet engines. This existing production will be sent through the new pipeline but it is not enough to justify the 40 billion dollar expenditure. Unfortunately, our speaker of the house does not have a clue. She and her friends in California have let millions of barrels of oil and trillions of feet of natural gas spew into the ocean just to prevent the "evil oil companies" to profit from it.

Last year, Harry Reid went on national TV to declare that the war in Iraq was lost. How sad?

Obama has been on national TV dozens of times with statements all over the map. He has wavered all the way from accepting defeat in Iraq to starting a new war with Pakistan. He says he would prevent Iran from acquiring nuclear arms without showing an understanding of how that can be accomplished. His solution is to talk the leaders into reason.

THE 25% -- 3%, LARGEST TRANSFER OF WEALTH IN HISTORY LIE

For commercial reasons, T. Boone Pickens, and for political reasons, democrats, keep repeating misleading statements. One is the 25%, 3% "lie". Another is the largest transfer of wealth in history lie.

There is at least an element of truth in the first "lie". The USA does consume about 25% of the oil annually consumed by the world and our stated reserves are about 3% of the worlds stated reserves. These reserves do not include oil in ANWR, oil in the National Strategic Petroleum Reserve, off shore oil that is legally off limits, and oil in numerous shale formations. It is commonly known that the USA has at least 3 trillion barrels of "non-reserve reserves". It is commonly known that at least 2 trillion barrels of these reserves can be recovered.

In addition to massive shale reserves in Wyoming, Colorado, etc. that are off limits, the Barnett reserves in Texas and the Bakken reserves in Montana, North Dakota and Canada and other massive shale reserves in Pennsylvania and West Virginia are being tapped. The US Geological Survey estimates the Bakken holds somewhere between 300 billion and 500 billion barrels of "oil equivalents". For the past 6 months or so, the increase in production from the Bakken has been about 10,000 barrels per month. The total production is up to around 200,000 barrels per day, still a very small number relative to 300 billion barrels.

There is no question, this "oil" is hard to extract. This oil was discovered in 1952. Just a few years ago, the cost of extracting this oil was greater than the cost of the oil produced. As a result, none of this oil was counted as reserves. Back when the price of a barrel of oil reached $60, the US Geological Survey for economically recoverable reserves in the Bakken to 3.4 billion barrels. Less than 1% of the oil in the Bakken is counted as reserves. Zero percent of the 2 trillion barrels in Wyoming and Colorado are counted.

We cannot count 2 trillion barrels of "rocky mountain shale" and additional billions of barrels off our coasts because the congress has declared it to be off limits. By the stroke of a pen and just a little exploration, we can dramatically change the 3% figure.

The transfer of 700 billion dollars of wealth is a total lie. We buy the oil the same way we buy building lumber to build houses. We only buy when the value of the oil is worth more to us than other goods or our paper money. I bought my house but I did not give away my money when I bought it and I do not give away my money when I fill my gas tank. I am just as wealthy after filling my tank. If I waste the tank of gas, I decrease my wealth. If I put it to good use, I will increase my wealth.

GO, GO, GO

The massive rotation continues. The US 10 year bond rate continues to fall, it just traded at 3.67%. The short term fly in the ointment is a bounce in guilt and bund rates. When the fall in rates resumes, mortgage rates and commercial bond rates will join the fall. Forget about any economic forecast you have seen, the power of the bond market is real.

The bond market knows that inflation is waning. As bond rates fall, many a bank balance sheet will see leveraged improvements to capital ratios. Junk bonds have already begun to rally. Financial stocks have rallied while gold prices have collapsed. Even utility stocks have been rolling over.

Utilities are tricky beast. As consumers of energy, the first instinct is to believe that they would increase in value when energy prices fall. As highly regulated industries, utilities are not allowed to make "excessive returns". As companies of extreme operating leverage, they cannot make money unless they can run flat out at high operating rates.

With the public and businesses doing all they can to conserve, utility operating rates are apt to fall just a little. With energy costs coming down, politicians are apt to demand utility rate reductions. All the while, the massive investments utilities have been forced to make, by congress, are about to turn into massive waste.

Think of all the solar panels being installed by utilities, not because they make economic sense, but because renewable fuel production has been mandated. To paraphrase Professor Don Boudreaux, a mandate is when the government makes someone spend money to do something stupid. If it made sense to do the thing, it would not require a government mandate. The total cost of the electricity produced by solar panels is many times the price of the energy being produced by fossil fuels.

The point for investors is that we have reached the late contraction phase of the economic cycle. During this phase, bond rates go down and financial stocks go up while the broad market averages are dragged down by declining resource stocks. Consumer cyclical stocks begin to rise well before the end of the contraction. This is also the point when real estate prices begin to rise and when companies that use lots of energy enjoy lower costs.

Yesterday, when explaining to a friend the reasons paper stocks have bounced, I suggested that he look at a long term plot of Louisiana Pacific relative to Exxon Mobile. The see-saw action is obvious. Still, we are fortunate in that we are not locked into resource sectors. Resource mutual funds are pulling out of energy as fast as they can and buying paper because, by charter, they are required to remain in the sector. Individuals can move into financial stocks, consumer stocks and consumer of energy stocks.

THE KNEE JERK AND THE SUCKING SOUND

The short run decision of the ECB and the BoE to hold short rates steady has resulted in the typical knee jerk reaction. Even long rates in the EU have bounced up.

The "big boys" with the aid of the "TV pundits" have taught the world to react to interest rate moves in exactly the wrong direction. The falsehood is that an increase in short term rates results in an increase in long term rates. The reality is that an increase in short rates in and of itself results in a reduction of economic activity, lower long term inflation and lower long term rates. Of course, rates are raised (or in this case held steady) based on the belief that they need to be high to combat inflation. Traders typically accept that the central bankers must know some secrets when they fail to lower rates when the economy seems soft. The reaction is knee jerk but it fades.

The collapse of the GBP (British Pound) has been temporarily arrested. The higher than expected short rate has resulted in a bounce in the GBP (a fall back in the dollar) and a bounce in long guilt rates. This bounce will prove temporary, unless the worlds economies are starting to fire on all 8 cylinders. The US economy is starting to hum along, but not on all 8 cylinders and many nations are approaching recession. Australia finally cut rates by .25% last week. Short rates there are still at 7%. The decision to hold EU rates steady is the decision to keep pressure on the brakes. This means the price decline of gold and oil is not over but it also means stock markets will temporarily struggle against the air sucking bonds. The US 10-year is down to 3.67% this morning. How low will rates go? The wind is being sucked out of the stock market by the bond market, but there is a stampede developing in the early cycle stocks, buy, buy, BUY!

THE RUDY AND SARAH SHOW

Last night, Rudy and Sarah were exceptionally good at contrasting Obama to McCain. Huckabee did a good job of warming up the crowd but Rudy was hot and Sarah was the hottest. Sometime ago, I predicted a 2% McCain win. I was out on a limb for awhile, but now I feel secure. By next week, I predict the daily tracking polls will put McCain in the lead. I predict that a number of swing states will swing by next week. The election is still two months away and the polls will continue to wiggle, but McCain should take a significant lead by next week, just about the time the congress comes back to discuss drilling and just about the time retail gasoline prices hit $3.33.

PAPER STOCKS UP - READER WANTS TO KNOW

A regular reader mentioned that I have said that Japan is now an oil exporter and that Japan imports about 100% of its oil. The following is my answer. Further down is the explanation of why paper stocks are up.

Both are correct, Japan is an importer and an exporter of oil. We have to be careful with words.


Japan imports about 100% of its crude oil. It refines the oil into oil products. In the past, it had to supplement its purchase of crude oil with the purchase of refined products from other countries. Today, it is a net exporter in the category of finished products. It continues to import almost all of its crude oil.

Japan was the miracle economy, similar to the China of this cycle, back in the 70's and 80's. Japan became the most efficient of manufacturing nations; it learned how produce GDP growth per dollar of energy used. Since the country has been energy efficient for many years, it was surprising that it had room to even become more efficient. The power of $147 per barrel oil is still being felt around the world.

The price will probably not reach $147 again for 20 or 30 years, but those who went without during the run up will have long memories. Just like the General who fights the last war, the public will fight high oil prices for many years to come.

Japan is just getting started. For example, car manufacturers are moving rapidly toward small battery powered or battery aided vehicles. Perhaps the most interesting initiative in Japan is the "mining of the oceans". Genetic engineering holds great promise for growing algae rich in uranium or rich in the sugars needed to produce bio-fuel. Japan is providing leadership in this area. The oceans of the earth hold millions of years worth of carbon fuel and billions of years worth of uranium fuel. There is no energy crisis, just a short term shortage.

THE PAPER STORY

The paper story is easy. Big mutual funds, in particular the ones that buy only basic material stocks are stuck in a falling market. They can minimize the damage by getting out of oil stocks and getting into paper, lumber and selected chemical stocks.

It takes a lot of oil to make paper, lumber and selected chemicals. When the price falls, the cost of production falls. In effect, these industries are consumers of energy. The stocks are moving up for those reasons.

POUND TAKES LEAD OVER AUSSIE $ IN RACE TO BOTTOM

The GBP (Great Britain Pound) has jumped in front of the AU$, in the race to the bottom. The fall of the AU$ was arrested by the cut in AU short rates from 7.25% to 7%. The BOE continues to resist moving rates down and the GBP continues to fall. Since July 23, the GBP has fallen from 215 to 192 against the Japanese Yen (JPY). Since August 8, it has fallen from 2.05 to 1.909 against the Canadian Dollar (CAD). Since August 12, it has fallen from 1.28 to 1.23 against the Euro. Against the US Dollar, the Pound reached 2.000 on July 15 and has since fallen to 1.772!

One can look at respective yield curves to see the reason for the fall.

Japan Curve
6-months .97%
5-year 1.01%
10-year 1.46%
30-year 2.29%

US Curve
6-month 3.1%
5-year 3.0%
10-year 3.74%
30-year 4.36%

Euro Curve
6 months 5.25%
5-year 4.03%
10-year 4.14%
30-year 4.54%

GB Curve
6-months 5.75%
5-year 4.4%
10-year 4.5%
20-year 4.4%

Note the high 6 month rate in GB. The English really have their foot on the brakes. They are braking so hard that the 20-year rate is lower than the 10-year rate and equal to the 5-year rate. EU central bankers are standing on the brakes too, but not hard enough to push the 30-year rate down to the 10-year. America entered its slow down long before England. The US brakes were locked at 5.25% from June 06 until August 07. The US has released but even now the US Libor 6 month rate is about equal to our 5 year rate. Treasury bonds in the US continue to rally. Junk bond rates are still very high, but about to fall.

Like an 18 wheel truck coming down the mountain, the brakes are starting to give off a putrid odor. The US truck has already hit the foot hill slopes and has let up, but the GB truck is still high on the mountain and the brakes are getting hot. GB needs to let up soon or their economic truck will stop in the middle of the highway and cause multiple wrecks.

Data from places like China is hard to get, but the reserve rate in China is doing the same work as the short rate in GB. China's economic truck has been speeding down the tallest of mountains for a long time. The bank reserve rate has gone from something like 7% to 16% in the past 18 months or so (I have a chart saved somewhere). China growth is going to slow from the 11 to 12% annual rate to perhaps as low as the 4 to 6% range.

The amount of fuel being used by these economic trucks is falling rapidly. Going down hill, they will certainly try to keep their motors running, but, even after they release the brakes, they will use less fuel for a long while. The US economy grew at 3.3% last quarter, but America has gone from using 22 million barrels of oil per day to less than 20 million per day.

One way the analogy to trucks coming down does not hold is that the harder the GB brakes, the faster the GBP falls. The danger in braking too hard is actually of speeding the fall. While Great Britain does not want to brake too hard, it is coming close. Housing construction in England is falling faster than in the US and industrial production has slowed and unemployment is on the rise.

Until there is a "wold wide weighted average release", bond rates and demand for resources will continue to fall. A bump up in the polls by McCain will bring rates down even faster (the veto pen threatens the big spending ways of congress). Prospects of a drilling bill in Congress will also bring rates down more. Investors should remember that the market runs well in front of the economic cycle. Big money investors will buy the rumor and sell the news. By the time the drilling moratorium is suspended, the bulk of the decline in oil prices and bond rates will be over.

THE BIG INTERNATIONAL RACE

The parties to the big international deal race is on the home stretch. Sarkozy of France is the first Western head of state to visit Syria in five years. US negotiators will meet with Sarkozy, Assad (of Syria) and Erdogan (of Turkey), in Syria, today and tomorrow. Top level talks imply that negotiations are down to the nitty-gritty. The leaked details include the probability of Syrian assistance in controlling Hezbollah in Lebanon, the return of the Golan Heights to Syria, pipelines and oil refineries in Syria and trade deals between the EU and Syria.

Russia just canceled a meeting about Iran's nuclear power plant. Russia took over the construction of this plant from Germany in 1994. Russia scheduled it for completion in 2000. The latest delay, once again, implies the cooperation of Russia in bringing the negotiations with Iran to a conclusion. On the other hand, the Jerusalem Post reports that high level US negotiators are in direct talks with Iran in regard to nuclear power. It is possible that Russia suspended talks with Iran pending the outcome of talks between the US and Iran.

After Russia invaded Georgia and after the EU and the US mounted strong protest, Russia countered with negotiations with Syria and Iran. The early rumor was that Russia has agreed to sell sophisticated missiles to both countries. Russia, Iran and Syria have all vehemently denied the reports. It is clear that these nations have a lot at stake in seeing the conclusion of negotiations.

Russia (Gasprov) has agreed to take over the French (Total) contract to help develop a huge natural gas field in Iran. Should this situation hold it will be a result of the negotiations. It is very possible that Iran insisted on having Chinese and Russian participation as opposed to relying on the west. Iraq and China are working on a major agreement to develop Iraqi fields. Iraq is showing great independence from the USA. It is clear that negotiations with Iran are intertwined with negotiations with Iran. It is good news that China and Russia will be involved in the development of these resources. The skepticism about the purpose of the US goes down as it becomes reality that the oil in Iraq and Iran belong to those countries and not the USA.

Robert Gates is ready to recommend troop withdrawals to President Bush. General Petraeus is ready, progress has been made. The latest development is that the US will turn the administration of the Sons of Iraq (SOI) program over to the Iraqi government, on a trial basis. The results of this trial will say a lot about the Iraqi government. Is the predominantly Shiite government ready and willing to fairly administer programs for the benefit of Sunnis? America must maintain a presence in Iraq until the government demonstrates the ability to work across the isles between the Kurds, Sunnies and Shiites. The risk of civil war must be reduced.

IRAN IS GETTING ITS WISH

Even while Iranians suffer through rolling electricity blackouts (the typical city loses power about 2 hours per night) and through 2 hour lines to buy gasoline, Iran is seeing some of its wishes come true. In negotiations, Iran has expressed its desire to be a "major international player". In recent weeks, there has been a significant rise in the number of international deals developing between Iran and the rest of the world. These deals include small and large countries in Latin America and Africa. Other deals with Japan, China, Russia, Norway and others have been negotiated some time ago or are under consideration.

If you have watched the price of Gold lately, you know that there are powerful forces at work. The risk of WWIII is abating, the risk of hyper inflation is abating or both. As we have seen time and again, in the modern world, we try to fight wars with economic tools. Reagan won the Cold War with Russia without firing a shot. Bush was not able to be so patient because terrorist brought the fight to the US and the rest of the world. Still, it is absolutely incredible that the US has fought a successful war in Iraq with a loss of only 4,200 US personnel. I pray for all families who have sacrificed for the good of their country.

Iran is getting its wish to be a world player, but the US and the rest of the world are seeing a diminishing threat from Islamic Extremist. Gates and Petraeus will recommend that some of the troops withdrawn from Iraq go to Afghanistan. It is a blessing that the Pakistanis are shouldering the bulk of the fighting in the high mountains. The stationing of the USS Ronald Reagan off the coast of Somalia is putting psychological pressure on the fighting there. One of the key Somalian al Qaeda leaders was taken out recently.

The words of Obama will not end the war on terror. Words backed up by the combination of economic and military pressure will.

After Gold peaked at $825 in 1980, it fell to $298 by late 82. It bounced to $497 in 1987 before hitting the modern low of $253 in 1999. This time, it reached 1025 in March 2008 before making the turn, it traded at $808 this morning. By the time Gold hit bottom, users of Gold such as INTC were raking in tons of gold.

SELL GOLD, OIL AND COMMODITIES -- BUY BONDS, FINANCIALS AND CONSUMER CYCLICALS. (MOST SHOULD SKIP THE BONDS AND GO DIRECTLY TO BANKS AND DURABLE CONSUMER PRODUCT COMPANIES).

BONDS SUCKING THE AIR OUT OF STOCKS

Yesterday's huge jump in 10-year treasury bonds, 2.86%, sucked the air out of the stock market. The move in bonds since July 07 has been better than 40%. The move since July of 08 is better than 15%. UK Guilts are soaring even more. Money is flowing out of Gold and resource stocks and into bonds.

The drop in long interest rates and in commodity prices is giving financial and consumer cyclical stocks a boost. Today, these two groups were only up .45% each, but still up on a down day. Over in England, big banks like BARC and HSBA are on a tear. BARC has moved from 260 to 363 in two months.

HOW LOW WILL BOND RATES GO?

The current yield of the 10-year treasury is 3.73%. Bond and stock market rallies overlap. For example, the stock market turned up on October 10, 2002 almost two years after bonds started moving. The market soared strongly after a retest of the October low in April of 2003. The bond market rally lasted into June of 2003 when the ten year fell to around 3.33%. The following months were great months to own stocks. Since so many countries are fighting inflation by holding short rates high, the bond market rally will continue, however, the bond market rally is already long in the tooth. This bond market rally started in July of 2007.

There will surely be a few bumps in the stock market road in the weeks ahead. Congress convenes again on September 8, another aircraft carrier departs for the Middle East on September 8 and OPEC meets on September 9. Western Europe has decided to delay a meeting to consider "punishment" for Russia's invasion of Georgia. The US has suggest it may scrap the nuclear 123 agreement negotiated with Russia and Australia has said it will reconsider its agreement to provide Russia with yellow cake (uranium). The British, after the Russian threatened to reduce oil and gas shipments to Europe, have suggested that they are ready to go all out to find other sources of natural gas.

Another potential bump looms in the negotiations with Iraq. Maliki has said he will submit the troop agreement to parliament in 10 days. The problem is that there is still no agreement to present. Maliki is attempting to push the USA around by suggesting that he will seek parliaments approve on a deal that is not acceptable to the USA. The USA turned over the 10th of 18 provinces to the Iraqi government this week. The Anbar province was controlled by al Qaeda two years ago. Progress continues but political progress is often more difficult than military progress.

In the meantime, according to the good folk at Strafor.com, the USA is negotiating with Turkmenistan and Tajikistan. If the US can secure airbases at these neighbors of Afghanistan and Iran, the need for troops to remain in Iraq will not be as great. The last thing America should do is depart from the arena after putting a big hole in the middle of Islamic Fascism. Hard won ground should not be surrendered easily.

The US has one base in Kyrgyzstan. It is negotiating for two bases in each in Turk and Taj. Russia will not be happy if either country agrees.

RUSSIA YES AND RUSSIA NO

Russia continues to cooperate with the west in several ways while walking a new path. The new prime minister has just outlined the "new" Russian policy. It boils down to saying that Russia is the only country permitted to negotiate deals with the former Soviet States. The US, Europe, Australia, China, Japan and others will continue to challenge the issue. In some cases, China in particular, will go along with getting the Russian stamp of approval on deals with former states. If China can quietly contract for more resources, they will not stir the pot. Europe has a strong interest in good and independent relationships with the countries that border both Western Europe and Russia. The primary motivation of the USA is to jump right into the middle of the terrorist camps so that terror can be divided and concurred. We want no confrontation with Russia, but we want international law to be followed by Russia.

By hanging out in the Arabian and Indian Oceans, the US 5th fleet can support actions in the hot spots of the Middle East. When the USS Abraham Lincoln and the USS Ronald Reagan sit within striking distance, no country is going to support or permit a plot on America that could be traced back to its soil. Another 9/11 can certainly happen, but the improvement in Americas intelligence capabilities in the past 7 years has been remarkable. Hardly a day passes without the death or capture of a terrorist leader. It is the steady rain on these terrorist that makes them well aware of the serious rain that would come down if America is attacked again. A presence on the ground must be be maintained until at least a couple more countries switch sides. By killing leaders and not masses of people, the US is making it easy to see who is on the just side of these fights.

Russia's Navy is not close to matching the US Navy. Its military strength is land based. Its Air Force is strong at home but not up to US capabilities, particularly from Air Craft Carriers. Furthermore, Russia has had its fill of Islamic Terrorist. It has fought battles with terrorist for many years. One of the reasons is to keep the drug trade as low as possible. As a result, Russia has supported the UN Security Councils measures against Iran.

BONDS ARE SUCKING THE AIR OUT OF STOCKS BUT

The allied players are not apt to release the brakes until the deal with Iran is secure. Even Russia will bark but its short rate is now above 11%. Russia, like the rest of the world, wants to keep the pressure on Iran until a deal can be made. It is still possible that a deal will include a settlement of nuclear issues between Russia and the west and in regard to Georgia and other former Soviet States.

The rapid fall in the price of oil, suggests that the brakes can be released. The quarter point move in Australia illustrates great patience. The bond rally should continue until the Euro short rates fall. The spread between the 6 month Euro Libor Rate and the US Libor Rate is about 2%. This gap will narrow. When it does, it will mean a whole lot of stock market fun.

Japan will be a major beneficiary of lower oil prices. The country imports about 100% of its oil. Investors should consider owning shares in big consumer goods companies such as Sony.

Another Straight Forward Gem From Professor Don

No Planning
Don Boudreaux

Here's a letter that I sent today to the Wall Street Journal:

Crusading for a national "energy plan" and upset that WSJ columnist Holman Jenkins isn't on board, T. Boone Pickens asks rhetorically: "My father used to tell me that a fool with a plan is better than a genius with no plan. So I ask, what's Mr. Jenkins's plan?" (Letters, Sept. 2).

Contrary to Mr. Pickens's assumption, an economy is not simply a gigantic business firm. An economy is both incomprehensibly more complex than is even the largest multinational corporation, and it has no specific, overriding purpose comparable to a firm's goal of maximizing profits - a purpose by which the performance of each employee and each investment decision is relatively easy to evaluate. So while plans and some measure of central direction make sense for firms, comparable plans and direction for an economy are poison. They prevent the on-going decentralized, competitive experimentation from which spring not only progress that is unplanned, but progress whose details could not have been foreseen before they actually materialize.

The Soviet Union famously had plans for its economy; the United States did not. Which country was the fool?

Sincerely,
Donald J. Boudreaux

MARKETS ARE RACING FORWARD IN "NORMAL MODE"

The month of September has historically been the worst month of the year for stock prices. It is a bad month because of uncertainty. Who knows what compromise the congress will make as a part of passing a massive federal budget, one that is fast approaching 3 Trillion Dollars?

This year is different in that the congress has not even attempted to pass a budget. Democrats have decided to wait until after the elections, when they expect to pass 100's if not 1,000's of new spending programs.

The decision to hold off on the budget does not take away the uncertainty. The congress must pass a continuing resolution, one that continues to fund programs at the same level as approved last year.

RACING TOWARD "NORMAL"

It took a very long time for this economic cycle to move past the late expansion phase during which MEI stocks do well. MEI is short for materials, energy and industrials. This economy stalled for a long time while games were played in regard to energy. It was hard to reach a clearing price when regulation prevented drillers from drilling, nuclear plants from being built, coal plants from being authorized and during the middle of a Middle Eastern war. Markets always reach clearing prices. Push the price up high enough and extreme measures will happen. At $4 per gallon, both drilling and walking to work were up for consideration.

Now, almost everything about the cycle seems to be normal or at least racing toward normality. In the normal economic cycle, energy stocks turn down before commodity prices start to fall and well before a strong rally in the bond market, followed by a rally in financial stocks. After the process is underway, all four things happen at once. Today is a normal day for this time in the cycle.

Basic material stocks are down 4.89% today. Energy stocks are down 4.58% today. Oil prices are down $6.70 per barrel today. Gasoline prices are down 15 cents today (gasoline retail, $3.30 in a couple of weeks). Gold down $24 per troy ounce today. And, the huge bond market is up about 1.5% today! Financial stocks, which historically turn up before the bottom the broad market averages which include the big oil companies, are up .8% today. Consumer cyclical stocks, which are historically the first horses out of the gate, after the market bottom, are up 1.2% today.

SEPTEMBER AND SCARY OCTOBER

Having lived through black Monday, October 19, 1987 and having read about the October crash of 1929, I understand that September has the worst performance partly because these crashes are always mentioned several times at this time of year. Despite fair warning to be buyers when fear is great, the average investor sales for irrational reasons.

Regular readers know that I believe the pending Iranian deal could prove to be one of the most important events in the history of the world. I can't say that a deal will be done, but I can say that there are many indications that a deal is close. I can't say what congress will pass in September or early October, but I can say there is great pressure on Iran and Congress. If the deal with Iran includes compromises with Russia, the deal would be enormous. If the congress allows drilling without the forced spending on all sorts of pork barrel projects, the market will be joyous.

Between now and then, the markets are trading as expected. Housing futures contracts turned up in July. Housing sales are up in 30 states. Home prices are rising in most markets. Financial stocks, especially some of the highly levered mortgage companies, have turned with a vengeance. Bond markets in the US, UK, EU, AU and elsewhere are rallying. Gold, oil, copper, wheat, corn and other commodities have fallen from dramatic peaks. Numerous countries, including England, Australia, Japan and Canada having pushed the brakes to the limits are ready to let up.

One of the reasons countries applied the brakes so hard was to send Iran the message that the world is willing and able to do without Iranian oil. Now that the point has been made, progress has been made in the negotiations. Japan and others are once again buying oil from Iran. A deal with Iran would allow these and other countries to let up on short money brakes. The $7 per barrel drop in oil is huge but the marginal cost of production of the last barrel needed is probably already down to $70. When the price of oil broke in the 80's and 90's, it quickly retreated by two thirds or more. Seventy three fifty is only half of the peak price. After getting over the bumps in the road, congress and Iran, the price of oil could be at $70 in a flash and as other supplies come on line, prices could easily get back to go back below $50. Now would that not be "normal"!

GO, GO, GO

Oil is down more than $7 per barrel this morning! The economic cycle turn is finally moving forward rapidly. The best investments are now the "opposite" of commodity plays.

Think of this as the hard goods--soft goods switch or the Gold to Financial switch. Instead of buying the producers of oil and other commodities, investors should buy the users of oil and other commodities. Another word for users is consumers.


The one day decline of $7 per barrel will save consumers about 600 Million Dollars PER DAY. The PER DAY savings from $147 to $107 is 3.4 Billion Dollars. So far, price reductions that have already occurred, will produce annual savings to consumers of 1.2 TRILLION DOLLARS.

Where and on what will consumers spend 1.2 TRILLION DOLLARS ANNUALLY? One obvious place will be at Best Buy. With the change over to digital TV occurring in February, millions of people will buy new TV's. Millions who already bought digital TVs will buy the next generation as volume production pushes prices down. Consumers will actually commit to spending of several TRILLION DOLLARS when they finance durable goods purchases. Car owners who have felt locked into fuel guzzling vehicles will spend to update their rides. Buy retailers!

Other consumers include truckers, airlines, electronic goods producers and virtually any company that produces goods or transports them. And, let's not forget that money is a commodity. As the cost of oil falls, the cost of money falls. Banks, savings and loans, insurance companies and finance companies that deal in money have seen a reduction in their cost of goods.

ABRAHAM'S ADVICE TO LOT SHOULD BE HEEDED

Don't look back to say that oil hit $147 and it will go there again. It will eventually but nor for a long time. Look forward to appreciate the reasons that the price will continue to fall.

In the early 1970's, the US went through the economically painful process of accepting the fact that pollution had to be controlled and that substitutes had to be found for newly expensive oil. Pollution controls were put on cars and coal fired power plants and nuclear power plants were built. It took many years for the car technology to catch up and it took many years for the nuclear power plants to be built. Stocks suffered; economic growth suffered; demand for oil fell. The Dow peaked in 1968 and did return to the peak until 1983. The pain was acerbated by the failures of central bankers. Poor old Jimmy Carter contributed to and got caught in the worst of times. He was simply not prepared to handle hyper inflation. Ronald Reagan and Paul Volcker came along just at the right time to fix problems.

In today's market, it took hosting the Olympics to sufficiently embarrass the Chinese into committing to reduced pollution. Some folk believe that China will continue to grow at double digit rates for the next couple of decades. There are powerful reasons to believe that growth in China will moderate.

The move to reduce pollution is one major reason. China will make the switch to nuclear power faster than did the USA but it will still take years. Adding scrubbers to coal plants will cost billions; producing the public good of clean air but reducing growth in the short run.

The second major reason is that population control has finally "kicked-in". The one child per family policy was first instituted 29 years ago, but it took years to be fully implemented. From 2000 through 2,004 there were an average of 20 million additional 15 through 19 year old teenagers in China. The number is now running at 1 million per year. Even today, there is an average of 1.3 children per Chinese family, but the number continues to approach one. The population growth reduction will have consequences for many years to come.

In America we have seen the "demographic pig being digested by the python". Big motor, fast cars were the rage when our baby boomers were teens, during the 60's; big homes and second homes were the rage when our baby boomers reached their 50's. China was having a baby boom but that boom is over. There is naturally a close correlation in population growth and resource growth. The slowdown in population growth will lead to a slowdown in resource demands.

Efficiency and substitution effects will further erode the growth in demand. Japan continues to be a great example.

Japan has reduced its use of oil to the point that it exports oil products. Today, the TV "news" about falling oil is all about a miss by Gustave, but Gustave is only a short term story. The "double news" out of Japan is much bigger, even though you probably did not hear a word about it.

Yesterday, it was announced that Japan decreased its purchases of oil, again. The country like so many others continues to become more efficient and to find substitutes. (Japan is close to commercial production of uranium by farming ocean seaweed.) Secondly, Japan dramatically decreased its purchases from Kuwait and Saudi Arabia and dramatically increased its purchases from Iran. Iran announced that it has sold the last 7 million barrels of oil stored in VLCCs. Some of this oil was sold to Japan. At the same time, the Christian Science Monitor reported that the US and Iran are moving toward face to face talks.

The purchase of the Iranian oil in lieu of other oil is at the least a "good faith gesture". It implies another compromise between Iran and the rest of the world has taken place.

The $7 per barrel drop is not just about the potential for a deal with Iran. The actual key is that the majority attitude has changed. While China has finally made the attitude change of reducing pollution, even at the cost of slowing economic growth, most of the rest of the world is finally coming to the understanding that increased supplies are the answer, not subsidies for wind mills, ethanol or solar. In America, for example, the majority of Americans are now for drilling off our coasts, politicians are generally ready to vote for measures other than expensive and generally non productive subsides. We will know more about the change in congress next week and definitely by Oct.

The public, perhaps, is starting to understand that subsides will only make more Billions for people like T-Boone without solving the problem. Americans overwhelmingly support drilling. The left and T. Boone are pushing wind hard, with or without appreciating that it is bad for the environment. At the same time, innovations continue. The latest technology example is better batteries. Researchers claim that they can reduce the payback on Lithium Ion batteries in hybrid cars from 8 years to 2 years. Several companies have built or are building new battery factories. A123 is the pure play but companies such as Bosch and Samsung are building plants as well. Should the payback fall from 8 to 2 years, then I will join millions of others in the purchase of hybrid vehicles.

Iran is converting cars to clean burning natural gas (under the threat of a gasoline embargo) while huge new supplies of natural gas are being brought on line in the US. Genetically engineered single celled creatures hold great promise for dramatic increases in natural gas production.

The bottom line is that lower demand in the face of increased supplies will cause the price of oil to ultimately fall back to the marginal cost of production and the marginal cost of production will be lowered by new technology. The current price supports all kinds of substitution. Jordan is known to contain at least 40 billion barrels of shale oil, the forth largest supplies in the world. The US is number one with an estimated 2,000 billion barrels of shale oil and equivalents. In other words, the US still owns twice as much oil as all that has ever been used. The reason to mention Jordan is that a deal is in progress to start taping this oil, using existing technology. By Oct 1 or soon after, the congressional prohibition on tapping US shale will be gone. Shale is difficult and expensive but the marginal cost, using existing technology, is less than $70 per barrel. $70 oil is the equivalent of about $2 per gallon for gasoline.

GO, GO, GO

The other talk on TV is about how oil is falling because of strength in dollar or that the dollar is strengthening because the price of oil is falling. This talk is a lot like saying that Michael Phelps won 8 gold medals because he has a strong right arm. It does not matter if he touched the wall with his left hand or his right, both arms arrived at about the same time.

England, Australia and Japan are just three of many countries standing at the economic brakes. These three have braked so hard as to be on the precipice of recession. The standing on the brakes reduces the demand for oil and it lowers the long term price of money.

Everyone seems to understand that when central bankers make money tight, the results are lower demand for money and thus less economic activity. It seems to be well understood that lower economic activity reduces the demand for oil. It is even well understood that higher short rates increase unemployment and decrease inflation rates. What is often missed is that higher short rates lead to lower long term interest rates. There is a tendency to make statements such as "interest rates are going up" while implying that an increase in short rates results in an increase in long term rates. The term interest rates should always refer to short rates because high short rates bring long rates down.

Big investors are interested in long term returns. Earning 5.48% on a one year Euro Swap is not generally attractive to the investor who is trying to average 15%. The primary reason to accept a 5.48% safe rate is in order to avoid the risk of potential loss. It is actually the long end of the yield curve that counts.

In the past year, the 30 year swap rate in the UK has fallen from 5.6% to 5.1%. The seller of the swap earned a bonus as the rates fell. His capital value jumped by about 10%. If you can make 5% in yield while enjoying a capital gain of 10%, that is much more attractive than holding short paper, even when short rates are higher than long rates.

While the 30 year swap in the UK has moved 50 basis points, the USA swap has moved only 30 basis points. Put another way, the 10-year US Bond now has a .7% yield advantage over the 10 year Guilt rate. The value of the US Dollar is soaring against the value of the Pound. Yes, since oil trades in dollars, the price of oil is going down while the dollar goes up, but both oil and the dollar are moving as a result of the pressure produced initially by high short rates. It is all a matter of timing.

The price of oil is moving down because the average short interest rate in the world is causing economic slowdown (the US lead the way with 19 months of high short rates before releasing). The rest of the world is close to releasing the brakes, but to return their currencies to par with the dollar will take several years of rate differentials.

Yesterday, the AU bankers reduced short rates by 1/4 of a percent. Short rates in Australia are still in the low 7's. This first move is tiny but it will be followed by others as economic conditions follow the expected path. By dragging their feet and keeping short rates relatively high, AU is enjoying lower inflation, lower long rates and a lower AU $. The lower long rates and lower $ is setting the situation for strong non inflationary growth. Check out the Libor 1 year spreads if you want to see how much tighter is the EU and the UK.

STRONG NON INFLATIONARY GROWTH!

What a nice way to end this story. The US is already set up for strong non inflationary growth. Other nations are about to join us. When will England release? When will the Euro bankers release? The market says soon.

Over the past week or two, the strongest investment returns have been seen in mortgage companies, in England and in the USA. Of the 30 largest companies, in the world, most have suffered significant losses in recent times. Many of these large companies are oil companies, including the monsters of China and Brazil.

From 1980 to 2001 the price of gold fell. From 2001 to 2008, the price of gold rose. The USB:GOLD ratio hit .118 in early March 2008. The ratio only made it to .12 in June of 1984. Gold was extremely expensive in March of this year. The US and the world are set for strong, non inflationary growth.