Tuesday, September 30, 2008


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.


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.

Monday, September 29, 2008


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.


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.


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.


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.


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.


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.


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.


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.


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.

Sunday, September 28, 2008


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.


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 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.


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.

Saturday, September 27, 2008


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 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 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 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.


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!


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.


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


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.


Friday, September 26, 2008


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.


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.


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.


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.


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.


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.


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.


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.

Thursday, September 25, 2008


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.


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:


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!!