Sunday, May 31, 2009

GM Prepares to Die...

...finally, at least almost finally, in a funny Chapter 11 bankruptcy sort of way...and, tomorrow, not yet today.

Tomorrow at 8 a.m. EST it will be final when GM admits to a bankruptcy judge what everyone and their mother (literally) already knew: GM is bankrupt.

Some quick notes on the filing and goals of The U.S. Treasury:

From Click that link for the raw data.

  • We The People will supply another $30 billion (initially) on top of the $20 billion we already have lent.
  • Goverments of Ontario and Canada will combine to lend $9.5 billion.
  • GM will have been lent $60 billion in the last six months, which is fairly amazing.
  • Restructuring to breakeven in a 10mm cars sold a year (domestically) environment (we're annualizing nine and change right now, which is down from about seventeen million at peak, I believe).
  • Will close 11 plants. Will idle 3 additional plants.
  • Will attempt to 363 to assets in a quick sale to strip liabilities and form GoodGM. Will be harder to do than in Chrysler given so many more constituents, but given the Federalis are pushing it, "resistance is futile", as they say in our Administration.
  • The Borg, I mean The Administration, has decided that future demand for cars will be smaller cars, so they'll be retooling to supply smaller cars.
  • Will honor all warranties.
  • UAW took a big haircut - allegedly even bigger than the Bush Administration was seeking (though the environment has worsened since then as well).
  • Ownership:
  • We The People: 60% plus appoint all the Directors other than the two (one
    each) Canadian and UAW appointees.
  • Gov'ts of Ontario and Canada: 12% and a Director.
  • UAW via VEBA: 17.5% (w/ warrants for 2.5%) and a Director
  • Bondholders: 10% (plus warrants for 15%)

The goal is to have one of the cleanest auto balance sheets in the world and a highly competitive cost structure.

I'll go ahead and say it:

  1. Sucks to be Ford (aka, "you next"); and
  2. Everything about this is totally consistent with my Grand Unified Conspiracy Theory (it's almost done, I promise).

Irving Fisher's Debt-Deflation Prescription Debunked: Too Big Not To Fail

We at TILB obviously fancy ourselves "smart enough" (why other than intelligence ego would we maintain a blog?) but certainly nobody will mistake our intelligence quotient for that of the eminent dead such as John Maynard Keynes, Karl Marx, or Irving Fisher. Each certainly possessed a mind with greater horsepower than we at TILB could ever hope to claim as our own.


These geniuses of persuasion and IQ still managed to err in a variety of ways, generally by failing to grasp the consequences of consequences; missing the derivative impact of their philosophies.

Despite that fundamental and underexplored shortcoming, each retains a great deal of credibility today. In fact, outcroppings of the most famous philosophies espoused by each are being implemented today in The U.S. with more gusto and philosophical fervor than at any time since the Carter administration or perhaps, more probably, since F.D. Roosevelt.

TILB doesn't have the intellectual capacity or, frankly, stamina to take on each of these titans point by point in one posting. However, we do intend to occasionally take liberty and rebut an idea here or there.

Irving Fisher's debt-deflation prescription Fisher wrote the magnum opus on debt-deflation cycles in his monumental 1932 Booms and Depressions and he summarized his key points in his essay The Debt-Deflation Theory of Great Depressions.

You should read the essay. It is brilliant in its core description of how a debt-deflation cycle coils then springs. Written in 1933, it was penned in the immediate aftermath of the most painful portion of The Great Depression and its perspective benefits (if that's possible) from Fisher's firsthand experience of The Great Depression.

Fisher's basic description of the cycle is that the unwind of a system wide, overly large volume of debt catalyzed by some period of cyclical downturn leads to an incipient deflationary pressure that becomes increasingly suffocating. This deflation actually makes the remaining debts bigger in real ("real" = inflation/deflation-adjusted) dollars. In essence, in this nasty cycle as debts are called or due, borrowers are forced to liquidate assets on a widespread basis. This broad based, rushed liquidation depresses asset values. Lenders, frightened by those declining asset values, are uncomfortable lending against this depreciating collateral and thus either hoard cash or lend on very expensive terms. This behavior both a) reduces the supply of money; and b) further pressures asset values leading to continued liquidations. This spiral ultimately consumes banks, corporations, and individuals in a seemingly unending wave of bankruptcy which leads to yet further liquidations. According to Fisher, ironically, even as these liquidations are happening, the resultant price and monetary deflation leads to a currency that continually strengthens at a speed that outpaces debts being paid off.

In essence, as long as the cycle persists, the real value of debts is growing even while the nominal value is shrinking, leading to persistent, ever widening circles of pain.

As great as Fisher's brilliance is in describing the damnable process of a debt-deflation cycle, he is as miscalculating in its prescription.

While we at TILB agree that his debt-deflation cycle can indeed occur, we suspect a) this cycle is less common and not as certain to occur as Fisher; and b) when it does occur, the cycle will happen faster and provide a sounder base for recovery to build from if allowed to happen naturally and without interference (unlike the 30s).

Fisher goes on to say that we need not even suffer the failure or spend time worrying about it. In his analysis, the problem is not a general over-production or over-capacity of something (such as housing and related materials, in modern times) but rather a shortage of money supply.

In essence, he believes the "deflation" portion of the "debt-deflation" is the dirty half of the process and if we could do something to arrest these deflationary pressures, we would be able to short-circuit the vicious cycle of liquidations begetting more liquidations begetting more liquidations.

His intellectual breakthrough (sarcasm dripping) indirectly birthed our wonderful Dr. Bernanke's moniker Helicopter Ben. Quite simply, Fisher prescribes that monetary authorities simply offset the deflationary forces of liquidations with the restorative powers of the reflationary printing press:

- A shortage of money supply has an obvious "solution": print money. Lots of it;
- Quite simply, reflate precisely enough to offset the deflation created by debt liquidations and lender hoarding.

Before Bernanke took the reigns, Fisher's directive was in fact what Dr. Greenspan obeyed when he gifted us his famed "Golden Era", even if his obedience was never explicitly credited to Fisher. The moral hazard laden slavish obedience to cutting off every economic downturn before it manifests as a debt-deflation cycle became known as The Greenspan Put (and now the Bernanke Put). Following Greenspan's lead, Helicopter Ben, armed with his lifelong study of The Great Depression, promised more of the same (much more, in fact).

All this is well and good and Greenspan/Bernanke did indeed seem to guide us through a Golden Era of prosperity and reduced economic cycle volatility. The problem, of course, is the consequence of this action.

Markets are crafty bastards.
The response to this stability and the value embedded in the Federal Reserve's gift of a monetary put option is to take advantage of it (as we've discussed before in this, one of our all time favorite postings).

The Fed's willingness to flood liquidity during any economic downturn and never charge a punitive rate of interest was effectively a thrown gauntlet. It is as if the Fed said, "you cannot create a problem big enough that reflationary, debtor friendly monetary policy can't fix it." The problem is that this is not a "fix", per se, it's a "deferral".

The standing policy of the Fed to continuously punish lenders through currency debasement for the benefit of creditors inevitably morphed into a de facto invitation to borrow. This constant deferral of borrower pain led market participants to reach down and seize the Fed's thrown gauntlet and mound leverage upon leverage. In particular, the financial and, to a lesser extent, residential sectors came to implicitly understand the Fed's wink and nod and sought more and more debt funding to serve their particular motives.

In essence, a generation of macroeconomic "bailouts" by the Fed led to a pile of debt so big that it is wholly plausible that even the Fed may not be able to handle it.

Too Big Not To Fail
This is the absolute inevitable consequence of the Fisher prescription to preventing an otherwise natural process. What else could happen? The nature of markets is to cycle. They will do whatever is required to fulfill their natural and necessary path. We cannot have a healthy economy that cuts off the left tail and simply performs at or above trend in perpetuity. The logical outcome of that would be for the slope of the trend to ever steepen such that it goes toward vertical or infinite prosperity (on a compounded basis, no less). Given the impossibility of that, particularly in a country as large as The U.S. with the demographics of The U.S., we can know that extending the slope of the old long-term trend into the future is all that can be aspired to. The longer we bounce at and above it, the more certain it is we must spend some time below it in order to create the trend. Constantly putting off the pain simply aggregates and concentrates it in the future.

So, the fundamental question is "have we reached a point where we spent so much time in lala land that the resultant debt load encouraged by the Golden Era is so large that the Fed cannot arrest its collapse; that the weight of our debt accumulated during our time spent over trend is such that the burden itself crushes us?"

Well, yes and no.

As long as our Treasury has the ability to issue debts payable in Bernanke Scrip, the Fed always will maintain the ability to monetize both Federal and private debts.

However, in this case the debt burden may be too big to do so without painful exigent consequences.

In past cycles, the immediate negative consequences of the monetization were largely unseen to the general public and thus, like good little mice, we were trained to eat and love the cheese. However, having picked up the gauntlet and consumed the cheese so many times now, we have been lulled into a false sense of security and have failed to notice that the current morsel is sitting inside a trap set spring forth and crush our spine.

The Fed's monetization process via: quantitative easing that's already happened; lending to private enterprise at non-punitive rates; and quantitative easing that everyone knows must happen in the future in order to fund the deficit this year and beyond (there literally are not enough real money buyers to absorb the incremental US Treasury and non-US sovereign issuances) have led market participants to the edge of dollar distrust.

While a bastion of relative strength in the past, the overwhelming issuance of freshly minted dollars required to offset the deflationary pressures of the natural debt-deflation cycle has begun to spook market participants and to contort behavior in somewhat predictable ways...

...and so we stand at the precipice. We are about to find out if we have reached that Too Big Not To Fail point. Symptoms of the failure will include:

- The Fed losing control of long bond yields
- Inability to arrest asset price deflation in traditionally levered asset classes (especially housing and CRE)
- Continued lack of demand for credit
- Continued lack of supply of credit other than from the Fed/Treasury
- Continued cycle of liquidations via bankruptcy, especially of banks and large corporations
- Continued rise in unemployment straight through the measured 10%
- A sudden weakness in the dollar relative to hard "currencies" such as gold, oil, or consumer products.

To date, nearly all of those symptoms have manifested in one way or another, but we believe the most damning symptom could be the first: if the Fed does indeed lose control of long bond yields, watch out.

The yield curve on any term longer than a few years has backed up a huge amount in the last few weeks. In fact, with the Fed's ZIRP still firmly in place, the 2s/10s spread has widened out to record width, surpassing Greenspan's early 90s gift to banks (please always keep in mind that is a taxpayer subsidy). From the Fed's perspective, the danger of long bond yields rising is that it has the potential to unwind a great deal of their efforts to improve credit conditions for term borrowers, especially home buyers/refi'ers.

Further, the back-up in rates will make it increasingly expensive for the Treasury to term out We The People's debt. For example, the party-agnostic CBO uses an average 3.0% Ten Year Treasury Note Rate for 2009 and 3.2% for 2010 for budgeting purposes (see PDF page 52 here - note they also are far too optimistic on tax receipts due to their delusional GDP and unemployment assumptions, which we've already blown past). With the 10 Year having backed up 100bps in the past two weeks to 3.61%, we are already in the process of blowing the CBO's budget (the 30 Year has similarly moved to 4.49%). It's worth noting that the 2s/10s spread is wide today not because of absolutely high 10s but because of artificially low 2s (due to the Fed's ZIRP). [data as of 5/27/09 close]

So that is the precipice. If longer rates continue to move up on the back of the enormous supply ($2 trillion deficit likely this year, as we predicted back in January when most people thought $1 trillion was likely), then the government will have three choices:
1) continue to issue the already planned volume of longer bonds at higher rates and blow through budget projections resulting in yet more debt needing to be issued and enduring a further credibility hit;
2) monetize the debt by having the Fed step in as a buyer of unlimited volume at a pre-determined level (say 3.5% on the 10s) and risk rapid debasement of the dollar; or
3) move down the curve toward the short end where rates are cheaper but take on roll risk of epic proportions.

My guess is some combination of All of The Above with a lean toward #1 and/or #2.

This is either Custer's last stand and we are about to be ambushed or it's a beautifully executed rear guard gambit by our Fed and Treasury, maintaining a strong-enough dollar while financing the deficit and arresting a credit crisis all at once.

My suspicion is the former.

If I am correct, there is a serious potential for all hell to break loose in the next year as the dollar gets obliterated from a purchasing power standpoint putting the Fed in one hell of a bind. They either deal with the dollar's weakness by tightening - which may precipitate a financial panic and prove Bernanke a liar for his apology to Milton Friedman - or they actively debase, calling into question the dollar's reserve currency status, punishing savers to help borrowers, and setting loose the inflation to end all inflations...which of course will ultimately force them to tighten.

In essence, under either scenario the Fed will have to tighten against their preferred policy. It is simply a question of when they do it and what type of pain we are interested in taking between now and then. Admittedly, this is not an attractive set of choices. I do not begrudge Bernanke his roll in history.

So this brings us back to Fisher's prescription.

The obvious flaw is that it actually encourages the "debt" half of the "debt-deflation" equation to grow. It encourages debt to grow and grow until it is too big. The side effects of trying to print our way out of the problem have the potential to be drastically worse than the damage from just taking the pain in manageable, natural increments along the way.

Fisher's prescription of never allowing a cyclical debt reduction process prevents the size of system wide debt from ever moderating and instead moves us inexorably down the path toward Too Big Not To Fail.


Let us know what you think!

Reflections on Chrysler and the Adjustment of Creditors' Rights

In honor of GM's pending doom, what follows is an email forwarded to me from a friend of my older brother. He's an experienced restructuring expert. It takes a lot of the discussion surrounding the Chrysler "issue" and condensces it quite nicely.

Before we get to that, I will offer the one counterpoint that I've heard to all of this that at least gives me pause. The counterpoint is that, in the end, all of the creditors accepted the re-org voluntarily (defining "voluntary" in the broadest possible sense). Further, while there has been outrage about the UAW receiving 55% of the re-org'd company as a junior creditor, they in fact did not receive 55% as a junior creditor; in essence, the U.S. Treasury received it and chose to give it to the UAW which is completely within their rights.

Anyway, here's the excellent email I was referencing:


I’m not sure if many of you have been closely following the developments in the Chrysler bankruptcy. As a restructuring professional, this is of tremendous interest to me and many others in my general line of work. Much has been made of one of the highest profile bankruptcies in history, especially the recent negative press surrounding a group of hedge funds and other lenders (collectively the Non-TARP lenders) that initially refused to accept the proposed pre-bankruptcy restructuring plan promulgated by Chrysler and the United States Treasury. Despite all the coverage, I fear very few people actually have a reasonable understanding of what is transpiring in the case. To a large degree I think the media is focused on the wrong aspects of this case. In light of that, I felt it was appropriate to share with you my views on this situation. Please keep in mind that these are solely my opinions and not those of my employer.

I believe the outcome in the Chrysler case is a national embarrassment and a major blow to creditor rights in this country. And while I’m sure the topic of “creditor rights” is not something near and dear to your hearts, creditor rights are incredibly important to the everyday mechanics of our economy. Anybody who borrows money to purchase a house or car, or uses a credit card, is impacted by creditor rights. The rights that creditors have against borrowers who cannot pay their debts are the underpinning of lending, and credit is the fuel of our economy.

I cannot understate my personal disappointment with what has happened in this case. While the proposed transaction is presented as a sale of Chrysler’s assets pursuant to Section 363 of the Bankruptcy Code, it is clear to me that this “sale” of Chrysler to “New Chrysler” is no sale at all but instead a sub-rosa plan of reorganization that violates the rule of absolute priority by providing a far lower recovery to secured creditors than they are entitled to under applicable law. Simply put, I believe the law is being subverted.

In terms of distributions of cash from the Chrysler estate, first lien creditors stand to get $2 billion in cash, or approximately a 29% recovery on their claim, while second lien creditors and third lien creditors (most notably the United States Treasury) receive zero recovery. It should be noted that Treasury injected $4 billion of TARP money into Chrysler on January 2, 2009 for that third lien claim. Within five short months, Treasury took a complete loss on that investment in terms of the recovery it will receive from the Chrysler estate.

It should also be noted that while secured creditors are significantly impaired, the Chrysler estate will be making significant levels of payments to a host of unsecured creditors such as vendors and dealerships that rank behind all secured creditors in terms of priority.

In order to consummate the purchase of the Chrysler assets and operate thereafter, New Chrysler will receive $6 billion in funded debt from Treasury in new senior secured debt. Aside from this debt, New Chrysler will also issue a note in an amount of nearly $4.6 billion to a Voluntary Employee Benefit Association (VEBA) of the United Auto Workers. The VEBA will also receive 55% of New Chrysler’s equity. Treasury and the Canadian government will receive 8% and 2% respectively.

While I am not advocating that Chrysler be liquidated, it certainly could be liquidated for more than $2 billion even under the worst assumptions, and generate a higher recovery for the first lien secured lenders. And if for some reason that wasn’t the case and the Chrysler assets are worth something less than $2 billion, then all of the following must also be true:

(i) It makes no economic sense for Treasury loan $6 billion to New Chrysler

(ii) Depending on the priority of the note in New Chrysler’s capital structure, the $4.6 billion note to the UAW’s VEBA may be worthless

(iii) At present, the equity to be held by Treasury and the UAW VEBA in New Chrysler following the sale must also be worthless

But the reality is that Chrysler is worth far more than $2 billion. Unfortunately, because of the way this transaction is being structured, the value of Chrysler that exceeds $2 billion is not being subjected to the typical waterfall of priority, where secured creditors are paid in full (beginning with the first lien lenders) before any significant recovery is provided to unsecured creditors. Instead, the assets of Chrysler are being stripped from the Chrysler estate for a price of only $2 billion, with a significant portion of that excess value flowing to unsecured creditors (most notably the UAW).

The Non-TARP lenders who hold first lien debt objected to this treatment, and in my opinion, rightfully so. In response to their protests, they have been repudiated by various members of the press and several politicians, including, most notably, our President. Rumors are rampant concerning a variety of threats that were levied at the Non-TARP lenders. Meanwhile, the other holders of Chrysler’s first lien debt, many of which received taxpayer money under TARP, have been lauded for consenting to this transaction. It strikes me as backwards to vilify those parties that are standing up for their rights under the law while other financial institutions, buttressed by taxpayer dollars, are so willing to consent to a far worse deal than they are entitled to under the law.

And try as I might, it is impossible for me to ignore the potential political ramifications of this transaction:
- Treasury is a multi-billion dollar secured creditor of Chrysler that will take a complete loss on the capital infusion it made into Chrysler earlier this year.
- Treasury has recently provided a multi-billion debtor-in-possession line of credit to Chrysler.
- Treasury was in the middle of all of the negotiations between Chrysler and the proposed “purchaser”, New Chrysler, and it would appear that Treasury had a significant role in arriving at the $2 billion purchase price paid to the Chrysler estate in return for Chrysler’s assets.
- Treasury is providing several billion in financing to New Chrysler.
- Treasury will have an 8% ownership stake in New Chrysler.

But the UAW, a huge political supporter of the current administration (and an unsecured creditor of Chrysler), somehow gets 55% of New Chrysler. I fail to see a contribution from the UAW that justifies receipt of a $4.6 billion note and 55% of the stock issued by New Chrysler when compared to what Treasury is receiving. However, I do see Treasury on all sides of this transaction with massive potential for conflicts of interest. One would think that with all these potential conflicts that Treasury would be steadfast in ensuring adherence to the law. Unfortunately that does not appear to be the case.

Given the fact pattern, I am inexorably drawn to a few depressing conclusions:

1) Treasury is orchestrating a public taking of the Chrysler assets from the Chrysler bankruptcy estate for far less than those assets are worth and transferring them (and their value) to a new entity which has as a principal stakeholder a union that is politically aligned with those who control Treasury.

2) It is unclear what it means to be a secured creditor if this kind of treatment can occur in bankruptcy.

3) This entire problem could have been easily avoided if Treasury and “New Chrysler” had just decided to pay a fair price for the Chrysler assets from the Chrysler estate and allow those proceeds to follow the applicable waterfall of absolute priority. Relative to the amount of money that has been spent or committed to date by the administration, paying an additional $10-15 billion is essentially a rounding error. One has to be very concerned that the administration would go to this degree of public trouble over an amount that could easily be otherwise swept under the rug. Which means…

4) They will do it again.

Saturday, May 30, 2009

Greenlight Capital's David Einhorn at Ira Sohn on "The Curse of Triple A"

[HT Manual of Ideas]

Greenlight's deservedly praised David Einhorn spoke at the recent Ira Sohn Conference (notes from which we broke first to the blogosphere) on "The Curse of the Triple A."

In it he discusses our current economic dilemma and official policy approach, why he thinks we're here, the mistakes the government is making, and what he would do if given the power.

He goes on to discuss how every financial institution that had a AAA rating, excepting for Berkshire, abused that rating during the credit inflation which contributed to the dire circumstances we face today.

That dilution of the AAA brand leads him into his short Moody's thesis.

He concludes with a $6 million charitable donation generated from his profits shorting Allied Capital: $3 million to the Tomorrows Children's Fund (the beneficiary of the Ira Sohn Conference) and $3 million divided between two of his own charities.

Here is a snippet from the speech:
Hope is a nice human emotion, but does not make for good public policy.

Now we have the Obama administration, which disappointingly seems to be following the same path as the Bush administration. The basic strategy appears to be to try to bring us back to 2006 by propping up asset prices and reflating the credit bubble, subsidizing bank creditors and shareholders, and delaying needed bank recapitalizations, while hoping for an economic recovery.

The official view is that what is good for banks is good for the economy. I question this view..."
Click here to read the whole speech.

While we do not agree with every statement Einhorn makes, it is excellent overall and deserves ten minutes of your time.


Read it and let us know what you think.

TARP-stuffed Lender Wells Fargo has the Gall to Oppose a Bid for BK'd Men's Clothier Hartmarx...

...a heavily unionized company that makes The President's suits, no less.

Wells believes a liquidation will recover maximum value. They seem to have forgotten that secured lenders have no rights.

Shockingly, politicians have decided to lean on their newly learned bankruptcy expertize as they opine on Wells Fargo's decision.

U.S. Rep. Phil Hare, a Democrat who represents the district that includes Rock Island, called Wells Fargo's statement "at best cynical and at worst deceitful." The bank misrepresented Emerisque's bid, Hare said.

Illinois Gov. Pat Quinn has said it is "only right and just" that Wells Fargo agree to a sale. Illinois Treasurer Alexi Giannoulias promised to cut off state business with the bank if it liquidates the company.

Right and just, indeed. How dare they decide how to pursue recovery from an asset they de facto control? Evil bastards.

Click here for more joy.

Long GGP: Bill Ackman's Ira Sohn Presentation

Bill Ackman of Pershing Square presented at the Ira Sohn Conference on why GGP is a great probabalistic investment.

I have no idea how the man pumps out 70 page Powerpoints like this so easily, but it never ceases to amaze me. Every time I read/see one, I want to obey its message.

By far, his most convincing presentation ever was "Is MBIA AAA?" at last year's Ira Sohn. While I'd seen his arguments against MBIA over the years, adding in the step by step tutotial on the insured structured finance assets and the mortgage reset waves were phenomenally descriptive. I went home and shorted it and ABK the next day.

The first time I met Ackman, just prior to publicly launching Pershing Square, I walked away thinking he was one of the best investors I'd ever met. While he's made some mistakes, I stand by that initial impression.

In any case, here is his presentation on why GGP may be a multi-bagger. He presented this a few days ago at Ira Sohn.

GGP Presentation 5.27.2009 GGP Presentation 5.27.2009 Terry Tate Buffett

Friday, May 29, 2009

I Just Bing'd the Babysitter

Hat tip to Todd Sullivan for pointing this out, but what was Microsoft thinking when they decided to name their new search "Bing"? Part of the charm of Google is its use as a verb. for example, "I just Googled the babysitter [to make sure she'd has no criminal history]." Replacing Googled with Bing'd leads to all sorts of great comedy.

Try it yourself and let us know what (or who) you look forward to Binging!

Thursday, May 28, 2009

Ira Sohn Best Ideas

The Ira Sohn Conference is a wonderful annual charity event hosted by a few huge fund luminaries that benefits a childrens' cancer center at a hospital near NYC. At the dinner, a number of big name hedge fund and long only investors pitch a small handful of their best ideas. Past conferences have had Bill Ackman present his famous "short MBIA" idea and David Einhorn his "short Allied Capital" and "short Lehman" ideas (much to Erin Callan's dismay!).

This year's conference includes presenters (among others):
- David Einhorn
- Bill Ackman
- Jim Chanos
- David Sokol (Mid American CEO - BRK subsidiary)
- Peter Thiel (Clarium Capital, but also founder of PayPal and investor in Facebook)
- Steve Mandel
- Paul Singer

Anyway, here are notes from today's presenters that I received by email from a Wall Street dealer:
This is a summary of ideas expressed at the Ira W. Sohn Investment Research Conference today. The Ira Sohn Research Conference Foundation is dedicated to the treatment and cure of pediatric cancer and other childhood diseases.

NOTE: The notes below were taken in real time, but we apologize in advance for any transcription errors. THESE ARE THE OPINIONS OF THE SPEAKERS, BTIG DOES NOT AGREE OR DISAGREE WITH ANY OF THE STATEMENTS.

Peter Thiel, Clarium Capital
Thiel is taking a long term time horizon and contrarian perspective as to whether this is a financial crisis at all. He asserted that productivity growth is the key to increasing the standard of living. Thiel explained that there are 3 ways to create productivity: Additional Leverage, Globilization and Science & Technology. We are witnessing the results of the Additional Leverage. Thiel believes the virtuous effects of Globalization are behind us. Instead of the disinflationary influence it has had over the past two to three decades, inflationary forces will take hold as nations compete for resources. In the area of Science and Technology, Thiel believes that things are not healthy in the ever expanding universe of human knowledge. Major research is turning out to be fraud and there is actually less progress than there appears to be in science. Technology, the application of science and also has not made much progress. Examples include the venture capital community, which has not made money in 10 years, there is no money being made in IPOs and the poor conditions of the State of California.

Thiel believes this is not a new problem and this has been going on for a very long time. 1969 may be the year that progress died. Innovation has been barely enough to keep up with global constraints. Thiel referred to the Tech boom of the late 1990s as a fraud. He questioned how you get high returns in a world with such little innovation. You get the high returns through high leverage. High leverage is a symptom and cause of failed innovation of the past 40 years.

Thiel believes there will be no V shaped recovery until the productivity issue fixed. He also noted that he believes the U.S. Government is nowhere near being on the right track. And he would fade the recovery trade, we will see inflation in assets we need (commodities) and deflation in assets we own. He believes the U.S. is radically misdiagnosing the problem. Washington is dominated by lawyers and economists and not the scientists that are necessary to correct the problem. Thiel referred to the situation as the myth of technological progress and asserted that most innovation we have received is hype. He discussed large cap tech names in a pejorative manor stating that betting on established Technology companies like Cisco, Microsoft and Intel is a bet on no innovation. He thinks we should be looking for companies that are truly innovating, of which there are only a handful.

Joseph Healey, HealthCor
Healey outlined the great demographics behind the Health Care industry while analogizing the current Health Care reform movement to the Hillary Care movement of the early 1990’s. Healey noted that Health Care is projected to become 20% of GDP by 2018. Advances in Health Care have increased life expectancy from 47 years in 1900 to 78 years today. Uncertainty about the Administration’s push for Health Care reform is creating an overhang in the group, similar to Hillary Care overhang in the early 1990’s. From the time Clinton took office to the time Hillary Care was quashed in 1994, Health Care underperformed the market and when Hillary Care was quashed, Health Care drastically outperformed. Once reform begins to take shape and there is clarity to the situation the stocks will improve. He believes the overhang created by this uncertainty creates a good investment opportunity.

Healey discussed 3 companies that he believes have significant upside potential. First, he discussed Valeant Pharmaceuticals (VRX). The cornerstone for Healey’s thesis was the potential for its epilepsy drug, retigabine. Glaxo has partnered with Valeant on the drug. Wall Street has significantly underestimated the upside potential for the drug. Healey noted it is his belief that if Glaxo does not acquire or take over the company, then the stock has potential to rise to the $40 to $50 range. The second stock Healey discussed was Hologix (HOLX), which he believes has potential to double from current levels. He described it as one of the most compelling new product stories in the MedTech group. The business is 70% consumables with a razor-razor blade model and has a Free Cash Flow yield of 10%. Healey’s final idea was Life Technologies (LIFE), where he noted the 8% Free Cash flow yield and upside potential of 60% from current levels.

Mark Kingdon, Kingdon Capital Management
Mark Kingdon opened up with a slide on Bank of America titled “An extraordinary opportunity?” Kingdon noted that Bank of America (BAC) is trading 5x normalized earnings. He discussed the severity of the Government’s SCAP (Stress Test), which he noted was rigorous. Kingdon noted his firm’s analysis arrives at a Tangible Book Value of $11 per share for BofA. Kingdon noted the franchise businesses of BofA and its position as the largest Commercial and Retail bank. Kingdon arrives at Normalized Earnings per share is $2.24 using inputs of 1.2% for the loan loss provision and net interest margin of 2.75%. The loan loss provision is quite high based upon net charge offs over the past 20 years, with the exception of a short period of time around the S&L crisis and the current environment. Kingdon believes the net interest margin of 2.75% is conservative and should expand since the Fed has created a steep yield curve and there is less completion in banking industry. His firm’s analysis leads Kingdon to believe that BofA has potential to rise above $20 in a year.

Steve Mandel, Lone Pine Capital
Mandel started by noting the two components he looks for when seeking a margin of safety: price paid and strength of business franchise. If given a choice of one or the other, Mandel’s preference is strength of the business. In the current market, great franchises have been stagnating while cyclical rally is occurring. Mandel believes that Strayer Education (STRA) is one of those companies with a superior franchise. There is a huge, underserved demand for working adult secondary education and traditional universities not set up to serve these customers. Strayer’s graduation rate is above community colleges and its student loan default rate is low. The Company has partnerships with corporations to educate employees. Strayer’s operating margins are in the mid-30% range. The company needs little capital to operate and grow its business. In 2008, only 20% of $100 million in cash flow was necessary to grow business and the balance was returned to shareholders through various means. Mandel believes sales and profits should grow 8x over the next 10 years. Currently, the company is trading 25x this year’s earnings and 20x next year’s earnings. Those multiples should contract quickly as the company grows. The $2.5 billion market should be much larger by the time STRA is a fully national company.

Jim Chanos, Kynikos Associates
Chanos’ presentation was titled “For profit social services from the trough to the slaughter house.” Following the 30 year deregulation boom in Health Care, Education, Financial Services, Defense and Government Services, the Government will be looking for payback. Health Care faces significant reform. Education is becoming a right and not a privilege and that will cut into margins. Investors find themselves questioning the very foundations of society. The Administration believes Health Care and Education are civil rights and part of its legacy. Chanos refers to the groups at risk of seeing their profit margins cut by Government reform as Capital Offenders.

Chanos highlighted For Profit Education where federal funding represents 73% of revenues at the top 4 companies. The margins for the group are 27% much higher than the 12.5% of the S&P 500. Instructional costs as % of revenues declining, not reinvesting in educating the students. Government funding has fueled double digit student growth. Students at these proprietary schools are saddled with more than 58% than students at traditional school. The companies valuations leave no margin for error.

Chanos also highlighted the challenges to Health Care. Margins in the group are approximately 50% greater than that of the S&P 500. Big pharma spends 3x more on advertising than they do on R&D.

Currently Health Care represents 16%-17% of GDP that is 2x that of the rest of world with worse outcomes. There are 45 million Americans without health insurance the administration’s attempts to insure these individuals will cut into margins. Health Care gross margins range from 30%-70% and operating margins are 50% better than the S&P 500. Government will look to take these actions to contract margins. Chanos is shorting Lincare (LNCR) where margins are still among the highest in the industry. He believes it will be poster child for what is about to happen to the Health Care industry.

Peter Schiff, Euro Pacific Capital
The U.S. Government is interfering with the free market forces trying to fix the economy. We lived in a phony “bubble” economy. The Government is trying to reflate the bubble. Americans are trying to rebuild their balance sheets and save to build wealth. As any drug addict knows if you stop using drugs you will go through withdrawal. Government is making the situation worse. We don’t need any more stimulus, we are suffering from the stimulus we have already been given. Alan Greenspan and Federal Reserve got everyone drunk on easy credit. Government has created moral hazard, i.e. Fannie and Freddie. The housing bubble was Fed and nurtured by the government. America is broke and our creditors are acknowledging that.

What is going on in the global economy will not last and is beneficial to the rest of the world. Foreign nations will retool factories and create products for themselves. Our ride on the global gravy train has come to the end. The whole service sector economy has to go away. If companies are not profitable they need to go out of business. Nobody talks about the productive jobs the Government destroys by saving jobs at GM or AIG. The damage this time around can be far greater than Hoover and Roosevelt created during the Depression. Hoover attempted to bail out the economy and business, Roosevelt only followed his failed policies on a much larger scale. Bush has followed bailout policies like Hoover, now Obama’s is following Bush’s failed policies only on a much larger scale.

Japan was in a good position when they busted, we are in the opposite position. We can’t solve a crisis that is the made of borrowing and spending by more borrowing and spending. Our creditors will stop lending to us. Inflation is going to run out of control. Ultimately that inflation is going to cause prices to go through the roof. We will not be able to purchase items to go on store shelves. This not a major collapse, it is a restructuring. The decoupling concept is here, but the US is not the engine it is the caboose.

You need to own assets in countries where economies will thrive and prosper like Asia, and stay away from US assets. This is the beginning of an inflationary depression.

Lee Hobson, Highside Capital Management
Lee Hobson of Highside Capital presented two straight forward investment ideas, one long and one short. Hobson cited the opportunity in emerging markets where low (wireless) telecom penetration = high growth potential. Hobson noted countries who introduced wireless technology later have faster growth curves and adoption rates thanks to cheaper technology. Hobson like Millicon International (MICC) to play this trend. Cellular service in emerging markets proven trend that offers affordability and high utility to the consumer. He equates it Coca cola 50 years ago. Building a strong internationally recognized brand among consumers who crave the product. MICC sells their service internationally under the Tigo brand. The product is accessible, affordable , available (strong networks) and serves the consumers need to communicate. Millicom has a 25 year emerging market history. They serve growing less developed countries with a total of 290 million people. Wireless penetration ranges from 10% to 80% in their markets –in developed markets penetration is above 100% (multiple phones). The company trades 3.6x forward EBITDA and is growing cash flows at 20%. The companies growth can be self funded an it can grow secularly for a long time with consistency.

Hobson suggested betting against auctioneer Ritchie Bros. The company is an auctioneer of used industrial equipment. It earns a 10% commission rate on what the auction price. To grow earnings they need to grow revenues. The company is trading 29x earnings and 16x EBITDA. Earnings growth accelerated over the past 5yrs transitioning from from single digits before to high teens. Company has a 15% market share and company claims it will grow through market share gains.

Hobson states the real growth driver for the company has been equipment price inflation (as a result of the building boom). The company also did a significant amount of capital intensive site builds, but their “same store sales” only grew at a rate of 2%. The volume trends of the business are not likely to be countercyclical as the company suggests. Company had to spend 90% of cash flow to grow revenues but in both the slow and fast growth environments their capacity increase CAGR was 6%. Commercial Construction lags the economy, non residential orders and are backlog collapsing. Management is selling stock and made sales as recently as last week. EPS likely peaked in 2008

Paul Singer, Elliott Associates
Investor have become accustomed to the post war solid growth model. It is likely the solid growth, stable inflation model is gone. There will be a period of deleveraging in an environment of high inflation with areas of deflation. Certain elements of current environment concern Singer. Singer discussed regulation and fears this era of anti capitalistic behavior. He expects a global scheme on the limitations of leverage. Hedge funds did not blow up the world, regulated entities did. Singer is concerned about the treatment of investors in the secondary market for debt. He fears restrictions on the ability for investors to exercise their rights will prevent the flow of capital to markets.

Singer discussed the rule of law. He noted it is devilishly hard to preserve private capital for a long time. Rule of law is a necessary but not sufficient condition. The color of money can change over time. Capital will flow to where it is treated best. Arbitrary actions that circumvent the law for the purpose of achieving a short term government objective will have long term consequences. Rule of law needs to win over the rule of enlightened elite. The government is elephant in the room- hope it the government cares what the room looks like after it is done stomping around the room. It is important to get through this challenging time with our time tested principles intact.

Bill Ackman, Pershing Square Capital Management
Bill Ackman laid out an in depth case as to why the equity shares of General Growth Properties (GGWPQ) are a good investment despite being in bankruptcy. It all breaks down to the company’s assets are greater than their liabilities. Through several potential workout agreements or a court appointed “cram down” the equity should greatly benefit from the likely scenarios. As far as a business General Growth’s malls have over the country 24,000 tenants. The company has 73 “Class A” malls, and high profile names like Faneuil Hall and South Street Seaport do not even garner that high rating. At General Growth 50 of the 200 malls create 50% NOI. Malls historically generate high stable cash flows. General Growth has fixed rates on 83% of debt. This is a business where inflation is an asset. In losing Circuit City the company lost a tenant paying below market rents. The company’s problems result of the CMBS market collapsing. The credit market shutdown prevented them from rolling their debt. They have the second highest occupancy of any mall company. The NOI is actually from the levels where the company’s market capitalization peaked.

Ackman made the analogy between General Growth and the stuations that occurred at Alexanders and Amercao (U-Haul). These were bankruptcies where assets are greater than liabilities. During bankruptcy a creditor entitled to their claim but no more, and in this case the equity will be left with value. Ackman suggests two potential options- either an extension of current debt 7 years or a debt for equity swap. He notes either scenario would create approximately a per share value emerging from bankruptcy $20 go to $35. Another option would be if the bankruptcy court forced a “cram down.” In this event Ackman exhibited precedents where the company’s interest rates would be lowered creating a better scenario for the company. Ackman notes the likelihood of forced liquidation by the court is minimized because of the extreme pressure it will place on the commercial real estate market and other REIT’s.

David Sokol, MidAmerican Holdings Company (Berkshire Hathaway)
Sokol is not seeing the Green sprouts- but that is not surprising to them. Government intervention can draw this out longer than necessary, but is useful in some circumstances. Unemployment will rise north of 10%. They are not seeing much improvement in housing. 92% of loans they have seen this year are all conforming. Although there are in excess of 1 million household formations per year Sokol believes the backlog of 10-12 months is actually 2x that amount of yet to be foreclosed homes. Sokol expect it to be mid-2011 before a balanced home sales (6 month inventory) environment emerges.

In regulated energy the headwinds are greater than any time in his 30 year experience. Inflation and rising borrowing costs are challenging headwinds. The utility industry can handle carbon emissions restrictions, but the Cap & Trade legislation as currently written will drive up energy prices for consumers to levels that will be hard to digest.

David Einhorn, Greenlight Capital
The theme of Davd Einhorn’s presentation was the curse of the AAA. Obama administration is following the same policies of the Bush Administration. The administration is reflating the economy back to 2006 levels. For the economy to recover underwater entities need to restructure their debt. The willingness for banks to negotiate in this environment depends upon where the positions are marked. The Obama loan modifications lack the most important aspect of restructuring –debt reduction. The debate in the banks was too narrow with only two options discussed - Nationalizing versus Taxpayer Bailout. There is a 3rd option, debt or preferred equity conversion to common equity. Attempt to induce debt of equity conversions without creating a downdraft in the group. Banks are not materially more solvent today than they were two months ago. Regulatory forbearance has created this rally in banks. We should be overcapitalizing the banks and direct them to restructure the debt of their borrowers. The Government spending and guarantees put the U.S. AAA credit rating at risk. US debt need s to be managed responsibly.

Einhorn took to task Chairman Bernanke’s assertion that AIG failed because there was a hedge fund at the top of an insurance company. AIG failed because it was not a hedge fund, but a AAA rated highly rated regulated insurance company. This status gave false security to investors and counterparties. Hence the curse of the AAA, most of the institutions that ran into major trouble were AAA rated entities. Fannie, Freddie, AIG, Monolines , GE all were AAA rated. Einhorn says he is betting against Moody’s (MCO). He describes the situation as such if your highest rating is a curse of those who have it what value do you have? If your goal is to destroy the brand would you do anything differently than Moody’s has done. Why reform them if we can get rid of them? Ratings system is inherently pro-cyclical and destabilizing. Regulators can improve the stability of the financial system by eliminating the ratings agencies. Company is 19x estimated earnings, balance sheet is upside down with negative shareholder equity.

Einhorn and his colleagues at Greenlight announced they were donating $7 Million of their profits from the Allied Capital short to charity.

Visteon Turns the Page to Chapter 11

Oddly enough, Visteon is primarily a Ford supplier (not a bailout recipient...yet). Amazingly, the UAW jobs at Visteon seem less systemically important than UAW jobs at Chrysler. I'm sure Czar Ratner was even handed in his approach to these two companies.

As an aside, I suppose if Delphi could re-file for bankruptcy while it's already in bk, that's what it would do. As bad as life is (was?) for Visteon, it's worse for Delphi.
MAY 28, 2009

Auto Supplier Visteon Plans Chapter 11 Filing in U.S.

Visteon Corp., a former division of Ford Motor Co. and one of the country's largest auto suppliers, is planning to put its U.S. operations into Chapter 11 bankruptcy protection Thursday morning, say people familiar with the matter.

Visteon's bankruptcy is the latest casualty in the U.S. auto industry, which has been hit by the Chrysler LLC bankruptcy and awaits an imminent filing by General Motors Corp. Though expected for months, a Visteon filing could complicate matters for Ford, the one Detroit auto maker to so far avoid government aid. Visteon doesn't have any financing lined up from banks, and will have to lean heavily on Ford and other auto companies for cash to get it through a restructuring.

As of Dec. 31, Visteon employed 11,000 salaried workers and 22,500 hourly workers world-wide. It also had $893 million in unfunded pension obligations.

Auto-supplier bankruptcies have frequently caused unforeseen and expensive problems for auto makers, as suppliers can use the courts to reject contracts and demand higher pay for much-needed parts. Some suppliers are unable to line up enough financing from lenders, forcing auto makers to inject money to keep the companies afloat.

Visteon is by far Ford's largest parts supplier, and the auto maker accounts for one-third of Visteon's $9 billion of annual sales. Korean-based auto maker Hyundai Motor Co. is the next biggest customer, with 30% of Visteon's sales.

Parts from the Van Buren Township, Mich.-based firm lie at the heart of many Ford vehicles, making the radios for the Fusion sedan, instrument clusters on the F-150 pickups and climate-control parts on the new Flex crossover.

Ford is expected to provide some bankruptcy financing to Visteon, though specific details and the exact amount were unclear, said people familiar with the matter. It has been in talks with its secured lenders, but hasn't worked out prebankruptcy deals with lenders or bondholders, said those people. The filing is expected to be made in a Wilmington, Del., federal bankruptcy court.

Visteon received waivers from its lenders after if violated the provisions of its loans in March, after independent accountants said they doubted the company's ability to remain a going concern. One of those waivers expires on May 30.

Whether Visteon is able to restructure or is forced to liquidate depends largely on how much support Ford is willing to give, said Doug Bernstein, managing partner of the bankruptcy group at law firm Plunkett Cooney P.C.

"How dependent is Ford?" he said. "If Ford's not there to support, it could very well end up in a liquidation because I don't know who's going to finance it then."

Ford assumed $167 million in Visteon secured loans this month. Visteon hopes Ford will let it borrow against that loan for bankruptcy financing and also provide other lending as well, said people familiar with the matter.

Visteon has hired law firm Kirkland & Ellis as bankruptcy counsel and financial advisers Rothschild LLC and Alvarez & Marsal.

Visteon's bankruptcy comes at the beginning of what is likely to be a painful global contraction among companies that supply auto parts. With auto makers building fewer cars and taking longer to pay their bills, suppliers are burning through cash and finding banks reluctant to lend to an industry beset by uncertainty.

"Basically put, it's a high level of chaos right now," said Van Conway, president of turnaround firm Conway, MacKenzie and Dunleavy.

Visteon has failed to turn an annual profit since it was spun off by Ford in 2000. In 2005, the auto maker took back the majority of Visteon's plants. Since then, Ford has whittled those 17 plants to six.

Write to Jeffrey McCracken at
An uncontrolled liquidation would sure be fun!

Wednesday, May 27, 2009

Pequot Capital to Close

It seems Art Samberg wasn't able to put the insider trading bogeyman to bed. The hedge fund industry loses a legend.

Letter from Art.

May 27, 2009
To Our Clients and Friends:
I am writing to you, our loyal clients and friends, to let you know that I have reached the painful
conclusion that it is necessary to wind down Pequot’s business.
In the coming months, we plan to liquidate the Core Funds and return cash to investors while
spinning out Matawin under the leadership of Mike Corasaniti and Special Opportunities under
the leadership of Rob Webster and Paul Mellinger.
As you know, my trading in 2001 on behalf of the Core Funds has been the subject
of investigations by the SEC and US Attorney’s Office. Those agencies closed their
investigations in 2006 without bringing any charges, but Pequot nonetheless suffered from
adverse publicity. In late 2008, the government reopened its investigation. Public disclosures
about the continuing investigation have cast a cloud over the firm and have become a source of
personal distraction. With the situation increasingly untenable for the firm and for me, I have
concluded that Pequot can no longer stay in business as an investment advisor.
I am enormously proud of Pequot’s long-term track record. A client who invested in the Pequot
Partners Fund at inception earned a net annualized 16.8% return over 22 years vs. the S&P’s
8.5% return during this period. More recently, the Pequot Partners Fund has generated net
annualized returns of 10.1% over the past five years and 1.8% in 2009 through April 30 vs. the
S&P’s declines of 2.7% and 2.5%, respectively.
We intend to distribute to Core Fund investors a significant amount of cash by June 30, with the
remainder substantially paid out over the next few months, pending completion of the year-end
audit, liquidation of certain less liquid assets and payment of expenses. Details for each
individual fund will be forthcoming. Pequot will retain the necessary infrastructure to support
the wind down process.
The Matawin and Special Opportunities funds will become independent entities no later than
year-end, and we will take steps to ensure a smooth transition. These funds will have a robust
infrastructure and we believe they will be well positioned to deliver strong returns in the years to
come. Investors in these funds will receive information about the process shortly.
I know this news may come as a surprise to you, but I am convinced it is the right decision for all
concerned. I remain grateful to all who have contributed to Pequot’s success over the years.
This has been an extremely difficult decision for me, especially because of the impact it will
have on our talented and dedicated employees. The Pequot team is the best of the best, and I
thank them as I thank you for many years of loyalty and friendship.
Arthur J. Samberg

Tuesday, May 26, 2009

U.S. Treasury to Own 70% of Restructured GM; Provide $50 Billion of Additional Financing

We The People will now own the three largest insurers in the world (FNM, FRE, AIG) and the second largest automaker (GM) all while retaining de facto control of the 19 largest banks in the US. We also are the lender of first resort on virtually any asset that isn't pretty damned secure. Quite a remarkable turn of events these past 12 months or so.

Don't worry though, it's not socialism. It's just government directed capitalism, minus the private capital, minus the consequences, and with a strict authoritarian, tops down regulatory structure around winning and losing.

BTW, watch out if you're a healthcare company...just wait until one of these big ones gives Treasie Mae the opening it's looking for....

Per the NY Times:
- Treasury will provide an additional $50 billion in financing (on top of the $19.5 billion they’ve already received)
- UAW’s VEBA will get 17.5% minimum, another 2.5% in warrants and a $2.5 billion note
- Bondholders get 9% (ouch!)
- Existing shareholders get 1% (why on Earth?)

This whole thing is so fascinating(ly horrible). In the Chrysler deal, the Treasury gets 10%. In this deal, they get 70%. I’m guess Nissan/Renault or Honda ends up with a chunk at some point in the not too distant future.

For the record, this one is going to be a shit ton harder to 363 in bk than Chrysler because the bondholders are so disparate. The Chrysler cramdown was made possible by TARP banks controlling a large majority of the senior secured. As luck would have it, these TARP banks willingly went along with the Treasury's "restructuring" proposal. Further, the Chrysler capital structure was fairly straightforward thanks to Cerberus's recent ownership.

GM's capital structure, on the other hand, literally looks like an M.C. Escher drawing where there seems to be no ending and no beginning.

May 27, 2009
U.S. Expected to Own 70% of Restructured G.M.

DETROIT — The government will hold a large share of General Motors after the company emerges from bankruptcy protection, and will provide G.M. with about $50 billion in financing so that it can reorganize, people with direct knowledge of the situation said Tuesday.

The Treasury Department will receive about 70 percent of the new G.M., while the United Automobile Workers union will hold 17.5 percent through its retiree health care fund. The fund also would receive warrants for an additional 2.5 percent of stock in the new G.M., with a price to be determined later, potentially giving it a total of 20 percent.

That is about half of the stock that the U.A.W.’s fund, called a Voluntary Employee Beneficiary Association, or VEBA, was expected to receive under plans drafted this spring.

The figures were outlined to union leaders in Detroit, who met Tuesday to consider a new agreement between the U.A.W. and G.M.

Bondholders will receive a 9 percent stake of the new company and existing shareholders 1 percent.

G.M., which has already received $19.4 billion in financing from Treasury, would get an additional $50 billion or slightly more in debtor-in-possession financing, which it would draw upon during its reorganization.

The Treasury plans to create a new version of G.M. with its most attractive assets, like Chevrolet, Cadillac and some of its manufacturing operations. The rest of G.M. would be sold or liquidated.

G.M. is expected to seek Chapter 11 protection on Monday, the deadline set by the Obama administration for the company’s overhaul, although the initial set of papers could be filed during the weekend, allowing for the first court hearings next week, these people said.

The $50 billion-plus figure includes $7.6 billion that G.M., which drew an additional $4 billion in federal financing on Friday, told the Treasury last week that it would need to operate after June 1.

Assuming the government’s plans come about, the Treasury would own 70 percent of G.M. and share a 10 percent stake of Chrysler with the Canadian government, once the two companies emerge from bankruptcy protection. G.M.’s shares ended at $1.44 a share on Tuesday, up a penny from Friday’s close.

G.M. is awaiting the results of an exchange offer with its bondholders, who must decide by 12:01 a.m. on Wednesday whether to exchange $27 billion in bonds.

Few bondholders are likely to accept the offer, which called for them to receive about 41 cents for each dollar in bonds. G.M. has said it would seek bankruptcy protection if it does not receive 90 percent support from bondholders, which analysts saw as a near impossibility.

Greg Martin, a G.M. spokesman, declined to predict the outcome. He said G.M. would make an announcement before the market opened on Wednesday. “If the bond exchange is unsuccessful or any of the minimum conditions are not satisfied, then G.M.’s board will meet to discuss next steps,” Mr. Martin said.

The Treasury has continued negotiations with an ad hoc group representing bondholders with about 25 percent of G.M.’s debt, and may try to reach an agreement with this group before the company seeks bankruptcy protection, the people with direct knowledge of the situation said.

G.M. owes about $20 billion to the employees’ beneficiary association, which would take responsibility for health care benefits to G.M. retirees and their spouses.

The offer to the U.A.W., outlined Tuesday, would place 17.5 percent of the stock in new G.M. in the association. The health care fund also would receive a $2.5 billion note from the new company, as well as $6.5 billion in preferred stock paying a 9 percent cash dividend, for a total of $9 billion in cash.

The union also is receiving warrants representing 2.5 percent of the stock in the new G.M., with a strike price to be determined later.

In a regulatory filing last month, G.M. said it planned to give the U.A.W. $10 billion in cash and a 39 percent stake in the company to cover its shortfall. That would have left about 51 percent of G.M. under the Treasury’s control.

But the government decided it wanted a bigger share, these people said, given the size of its investment.

Moreover, bondholders were displeased that they were offered only 10 percent of G.M. for their $27 billion in debt, while the U.A.W., whose obligation was less, was in line to get significantly more.

The changes involve “painful, unprecedented sacrifices” for union workers, U.A.W. officials told members in a summary distributed to plant leaders Tuesday.

“Faced with this dire situation and realizing failure to meet the government requirements would surely mean the end of General Motors, your bargainers painstakingly put together modifications to the collective bargaining agreement to satisfy the Treasury Auto Task Force,” the summary said. “Considering the alternatives, we urge a ‘yes’ vote in favor of ratification.”

The plant leaders who met Tuesday morning in Detroit voted unanimously to recommend that their members support the deal.

The union persuaded G.M. to reduce the number of vehicles it will import from low-wage countries like China. G.M. agreed to retool two previously closed plants in the United States so that they can stamp metal for and build as many as 160,000 compact and small cars a year. G.M. also agreed not to increase production in Mexico by reducing production of similar vehicles in the United States.

Three assembly plants and one stamping plant would be put on “standby,” to be reactivated if market demand increases beyond current projections.

Nearly all of G.M.’s hourly workers will receive another buyout and early retirement offer. Production workers eligible to retire would receive $20,000 and a $25,000 discount voucher toward a new vehicle, which is similar to the terms that 7,000 workers accepted in March. Workers with at least 20 years of seniority who agree to give up future benefits would receive $115,000 plus a voucher, which is far greater than the March offer.

G.M. will assume ownership of five plants — two in western New York, two in Michigan and one in Indiana — operated by the Delphi Corporation, its bankrupt former parts division.

Retiree benefits will be reduced as of July 1, at the direction of the Treasury, the union said. At that time, pending court approval, retirees will lose vision and dental coverage, among other changes.

After Jan. 1, retiree benefits will be paid by the trust fund, which currently contains about $10 billion. G.M. had sought to move up the date when the fund takes effect but in the end agreed to keep the original time table, the union said.

The dwindling of the beneficiary association fund alarmed union leaders, who agreed to establish it in two sets of negotiations during the last four years. G.M. at one time thought that investments in the association would grow to cover its $70 billion liability, once the U.A.W. assumed control of the fund early next decade.

But the fund has lost 30 to 40 percent a year, instead of the 9 percent growth that G.M. initially anticipated, people with knowledge of the situation said.

Nick Bunkley contributed reporting

As always, we at TILB are willing to point out the ridiculousness of these efforts.
Keep your eyes peeled for my upcoming post, The Grand Unified Conspiracy Theory which connects a lot of the dots.

NYC CRE Office Vacancy Skyrockets - Rents Plummet

-- NYC Class A vacancies have doubled from 6.5% to 13%.
-- Lease rates have tanked from $150 to as low as $40-$50.
-- Subleasing is up to 40% of the available market
-- JPM is offering the largest sublet block, a whopping 400,000 sq ft at 277 Park.
-- I'm sure SLG will be up another 5% tomorrow.
May 27, 2009
Manhattan is Awash in Sublet Office Space


Few office towers have been left untouched by the flood of sublet space that has recently inundated the New York office market. In Midtown Manhattan — where many of the world’s largest financial companies are headquartered — three out of every four office towers now have sublet space available.

Brokers say that many sublandlords will probably need to bend over backward to sublease their space, given the sharp rise in vacancies.

In Midtown Manhattan, for example, 13 percent of prime, modern, well-located offices — which brokers often refer to as Class A space — was available in April, up from 6.5 percent a year earlier, according to Colliers ABR, a commercial real estate services company. And sublets now account for some 40 percent of the space available in Midtown, compared with 30 percent of the much smaller total that was available a year ago, the company said.

In some cases, the ink was barely dry on the original lease before the space went back on the market for sublet.

For example, Dechert, a global corporate law firm, has completed one year of a 15-year lease for the 25th through 31st floors at 1095 Avenue of the Americas, a 41-story office tower between 41st and 42nd Street, overlooking Bryant Park.

When the firm moved in last year, it intentionally took an extra floor, which it planned to use for future expansion, and from the start it has had a subtenant on the whole 31st floor. But that sublease expires in July, and the subtenant does not plan to renew. Since last year, the law firm has also had several rounds of layoffs, and it needs less space.

Judith B. Tellefsen, the director of real estate and purchasing for Dechert, said the firm would like to sublet two floors, preferably lower floors, which are each 37,000 square feet. “We are only partially occupying the 25th and 26th floors, and we could easily consolidate those lawyers on other floors,” she said. Ms. Tellefsen said that the firm would be flexible, though, if a subtenant wanted the 31st floor instead.

For companies whose space is not as new as Dechert’s, there might also be a need to invest in improvements in order to make the space more marketable — or else give subtenants a generous work allowance to redo the space themselves.

“Sublandlords should be trying to make it as easy as possible for the tenant to move in,” said Mitchell Konsker, a vice chairman at Cushman & Wakefield. He said that space improvements could be as simple as reconfiguring the furniture or painting the walls. In other cases, Mr. Konsker said, sublandlords might need to split up a large block of space into several smaller blocks. “Smaller blocks are moving more quickly now,” he said.

Peter Turchin, an executive vice president at CB Richard Ellis, said that sublandlords should put their best space on the market — even if that meant moving their own employees into less desirable space.

In some cases, Mr. Turchin said, a sublandlord might even need to hire an architect to show tenants how an office could be reconfigured, especially if the space does not have a reception area or a conference room.

Mitchell S. Steir, the chairman and chief executive of Studley, a New York brokerage firm that specializes in representing office tenants, said some sublandlords were offering more generous work allowances than many building landlords were giving to new tenants.

Mr. Steir said owners were offering work allowances of around $65 a square foot, up from $35 to $40 a square foot a year or so ago. But he said some sublandlords were willing to go as high as $160 a square foot.

“Obviously, the sublandlords are not in the leasing business, so they’re not looking at a return on investment,” he said. “They are only looking at how quickly they can get the space off their books.”

But real estate experts say the main way sublandlords are competing with office space that is available directly from building owners — often within the same building — is by slashing rents.

Robert Sammons, the managing director in charge of research at Colliers ABR, said that sublet space in trophy office towers along Madison Avenue and Park Avenue has been leasing for as little as one-third of what that space might have commanded in early 2008, at the height of the roaring market.

“A year and a half ago, this space might have leased for $150 per square foot,” Mr. Sammons said, while he has heard of recent sublets in high-end buildings in this office corridor with annual rents of as little as $40 to $50 a r square foot. “This is the most remarkable turnaround in pricing that I’ve ever seen in such a short period of time.”

He pointed to several large blocks of sublet space that recently came onto the market along the stretch of Park Avenue north of Grand Central Terminal, where many large financial companies have their headquarters and many hedge funds and private equity funds have also set up shop.

In April, two financial companies began offering sublet space at 399 Park Avenue, between 53rd and 54th Streets: Citigroup listed the building’s entire third floor, and Legg Mason listed the entire fourth floor. Each floor covers more than 97,000 square feet.

This month, JPMorgan Chase listed a large sublet at 277 Park Avenue, between 47th and 48th Streets. It amounts to more than 400,000 square feet, covering the 13th to the 17th floors, and the 19th to the 25th floors of this 51-story office tower. This is the largest block of space currently being offered for sublet in Midtown Manhattan.

“A number of these blocks of sublease space are quite large, so it’s much more difficult to lease them,” Mr. Sammons said. “And a number of them have relatively short terms remaining.

“A lot of this space might end up going back to the landlord,” he said, “if the economy doesn’t turn around soon.”

Monday, May 25, 2009

Armstrong Looks Strong in the Giro

These two paragraphs from the NY Times article on Stage 16 of the Giro d'Italia have me surprisingly optimistic about Lance's chances in the summer season.
“Fortunately, Lance helped me,” Leipheimer said. “Without him, I would have lost much more time. He saved me minutes. Let’s hope I can recover from this.”

The Astana team rode well for most of the day, but it could not sustain its power. Only Armstrong looked unbeatable. He had to drop back from a faster group to help the struggling Leipheimer, whose face, for perhaps the first time, betrayed his suffering.
Hard not to pull for Lance somewhere in your heart of hearts. Perhaps another run at The Tour???

Tu Ne Cede Green Shoots

In the first of a multi-part exclusive for Forbes, Nouriel Roubini penned (typed?) a nice, long article titled "Don't Believe The Optimists" addressing why he believes the famous Green Shoots are something more akin to Yellow Weeds.

First Roubini lays out his three primary reasons for forecasting this recession/depression drags on into 2010/11:
But while the rate of economic contraction is now lower than the free-fall and near-depression experienced by many economies in the fourth quarter of 2008 and the first of 2009, the recent optimism that "green shoots" of recovery will lead to the recession to bottom out by the middle of this year--and that recovery to potential growth will rapidly occur in 2010--appears grossly misplaced, for three noteworthy reasons.

First, the current deep and protracted U-shaped recession in the U.S. and other advanced economies will continue through all of 2009, rather than reach a trough in the middle of this year as expected by the optimists.

Second, rather than a rapid V-shaped recovery, growth will remain sluggish and sub-par for at least two years into all of 2010 and 2011. A couple of quarters of more rapid growth cannot be ruled out as we get out of this recession toward the end of the year or early next year as firms rebuild inventories and the effects of the monetary and fiscal stimulus reach a delayed peak. But structural weaknesses of the U.S. and the global economy will cause both a below-trend growth and even the risk of a reduction of potential growth itself.

Third, we cannot rule out a double-dip W-shaped recession, with the wings of a tentative recovery of growth in 2010 at risk of being clipped toward the end of that year or in 2011. This will result from a perfect storm of rising oil prices, rising taxes and rising nominal and real interest rates on the public debt of many advanced economies, as concerns rise about medium-term fiscal sustainability and the risk that monetization of fiscal deficits will lead to inflationary pressures after two years of deflationary pressures.
As part of Nouriel's efforts to make his case, he attacks the four pillars of the Green Shooters' case for a second half 2009 recovery:
Goldman Sachs--a firm that was more bearish than the consensus in 2008--is the most sophisticated exponent of the "green shoots" hypothesis. In a paper written in mid-March, the research group Goldman pointed out four economic variables/factors/green shoots that were signaling a bottoming out of the recession: (1) initial claims for unemployment benefits; (2) retail sales; (3) industrial production and (4) housing conditions. Out of the four, they recognized that initial claims were still high and ugly, but hoped that they would stabilize and contract soon, while they argued that the other three were already signaling green light. Unfortunately, the U.S. data from the last month have dashed the hope of green shoots and shown them to be yellow weeds.

First, initial unemployment claims were around 650,000 and fell toward 610,000. Goldman and Robert Gordon (a member of the NBER Business Cycle Dating Committee) even argued that, historically, the peak of the initial claims is always associated with the end of a recession, hinting that the recession was over by May or would be, at the latest, by June. Too bad this is not an ordinary recession--and too bad that bankruptcy/production cut-backs by Chrysler and General Motors over the summer are now likely to lead initial claims to another peak of 700,000 some time this summer, on top of adding another 300,000 job losses to the already mounting ones.

Even the bullishness that job losses will rapidly shrink is altogether misplaced: Yes, in April "only" 540,000 jobs were lost, as opposed to the 650,000 of March; but if you exclude the 70,000 temporary government worked hired by the Census, private sector job losses were still a whopping 611,000 in April, a figure as ugly as ever. Also, note that in the 2001 recession, job losses averaged 150,000 per month (not 650,000 as in recent months), and that while that recession was technically over in November 2001, job losses--being, like the unemployment rate, a lagging indicator--continued all the way through August 2003.

So while one could expect that job losses in the private sector may soon fall from the near-depression levels of 600,000 to 700,000 per month, even a fall of such job losses to a rate of 300,000 to 400,000 per month some time later in the second half of this year would still be massive--and much larger than in the 2001 recession. Even that slowdown in job losses implies that the unemployment rate will be 10% by the end of the summer, well above 10.5% by the end of the year and peaking around 11% some time in 2011. So on the unemployment front, there are no green shoots either in the present or in the likely near future: You can see only yellow or brown weeds.

Second, the optimistic view on retail sales and consumption was based on better-than-expected January and February retail sales. But after the free fall in the holiday season, and given heavy discounts, a temporary rebound was not unlikely. Again, too bad that all the talk about green shoots in consumption and retail sales was soon smashed by an ugly March retail sales report, which showed a sharp contraction, and a similarly ugly April report that showed falling sales and consumption.

The green-shooters forgot about the fundamental forces dragging down the U.S. consumer, who is shopped-out, without savings, debt-burdened and with rising debt-servicing ratios; who lost 50% of equity wealth from the 2007 peak; who has lost 25% of the value of his or her home (and remember, home prices are still free-falling); who cannot use his or her home as an ATM since home equity withdrawal has fallen from $700 billion in 2005 to zero today; whose income is challenged; and whose jobs are disappearing at the rate of 600,000 to 700,000 per month.

It is true that in Q2 of this year, there may be some relief for disposable income via tax cuts, refinancing of mortgages and the lagged effects of the fall in oil prices. But last year, the $100 billion of tax cuts was mostly saved rather than spent, as consumers were worried about jobs, incomes, wealth and running down credit cards and mortgage balances.

This year, those worries are increased by a power of two, and, like last year, at most only 30 cents on the dollar will be spent. Add to this dismal outlook the fact that $20 billion of refinancing savings is spare change, as household disposable income is well over $10 trillion and that gasoline prices are rising again (25 cents in the last month alone, or a 10% increase). So retail sales may recover temporarily in the May to July period--like they did in 2008 after the spring tax rebates--but that effect will fizzle out by Q3.

More important for 2010-2011, the contraction of consumption and its weak recovery over the medium term--and the need to rebuild depleted savings--will remain a drag on households for a number of years. So expect yellow weeds for consumers both in the short term and medium term.

Third, the argument that industrial production would soon bottom out in the U.S. and other advanced economies was based on the historical relations between the manufacturing ISM or PMIs (Purchasing Managers Index) and industrial production. In previous business cycles, ISM/PMI led industrial production by about a month: So when the ISM bottoms out, industrial production starts to bottom out a month later.

Since the PMIs started to bottom out in all advanced economies--at near depression levels--around March-April, the optimistic consensus predicted a near bottom for industrial production followed by a rapid recovery, as the sharp destocking on unsold inventories of Q4 2008-Q1 2009 would be followed by rapid restocking. But, for reasons we don't fully understand yet (possibly the severity of this recession caused by massive over-leverage), the historical link between PMIs and industrial production has broken down. Industrial production in the U.S. and other advanced economies is still sharply falling--albeit not as quickly as the near-depression rates of the previous six months--in spite of the PMIs having bottomed out and started to recover.

And while the ISM is now considerably above its near-depression level of 32, it is still well below the 50 that signals a continued contraction of the manufacturing sector. So far, the PMI has provided a "fake head"--a misleading indicator rather than a leading indicator--and industrial production is still contracting at painful (though no longer depression) rates in most advanced economies.

Finally, the bullish argument that industrial production will rapidly snap back to rebuild inventories once the recession has bottomed out is predicated on the assumption that final sales of domestic output will rapidly recover once they bottom out. So far, most components of final sales are still falling and have not bottomed out, and once they bottom out, they are unlikely to grow rapidly enough to require a surge in production: Consumption is still falling, residential investment is still free-falling, capital expenditure by the corporate sector is still free-falling and exports are still sharply falling. The only component of final sales that is modestly rising is government consumption.

Thus, the recovery of final sales that would herald a rapid recovery of production is still more in the minds and hopes of the green-shooters than in the reality of the recent data. In summary, there are ugly yellow weeds so far, rather than green shoots, as far as industrial production is concerned.

Fourth, the green-shooters pointed out to the sign of stabilization of the housing recession. Let us leave aside that the optimists, including Ben Bernanke, Alan Greenspan and 80% of sell-side research, have been repeating the refrain that the housing slump will bottom out soon since early 2007 (while totally missing the bust that started in mid-2006)--and have been proved wrong quarter after quarter for all of 2007, 2008 and 2009 to date. The reality is that, in spite of all the talk of green shoots in housing, there is very little evidence for it so far, and home prices need to fall at least another 15% to 20% before they bottom out.

I was the biggest bear on housing in the middle of 2006, when I predicted the worst housing recession since the Great Depression, a fall in housing starts and sales of 50%, and a fall in home prices of 20%. But even the biggest bear on housing turned out to be too optimistic: Annual housing starts did not fall 50% (from 2 million to 1 million) but to 500,000, or 75% from peak--and they are still falling. New-home sales fell even more than starts and are now hovering--for single-family homes--around depression levels of 350,000. Home prices have fallen, based on Case-Shiller, by 25% from the peak, and they are still falling at an annual rate of 20%.

Of course, after three years of the most severe housing depression ever, quantities in the housing markets are so low (75% to 80% from peak) that they may soon bottom out: Both starts and new-home sales are now well below long-term averages. But even quantities may not bottom out until the end of the year for two reasons. One, residential investment was still falling at an annual rate above 30% in Q1 of 2009, and both starts and building permits are still falling. Building permit and starts need to stabilize and start growing again for a while before home completions--the measure of supply of new homes--bottom out a few months later and then start to recover. So, residential investment will be a negative drag on GDP at least until Q4 of 2009, if not later.

Two, some measures of price affordability are better now, but many others are not: Real home prices and price-rental ratios suggest the need for another 15% to 20% fall in home prices; and actual prices are still falling--at an accelerated, not decelerated, rate of 20%.

This is important because today, 0% down-payment mortgages of the housing craze are out. Anyone who wants to buy a home needs to put down 20% of equity. But why would anyone want to buy a house today--even one that he or she could afford--if home prices will fall another 15% to 20% before they bottom out, effectively wiping out any new-home equity by 2010? It is rational to wait until home prices have bottomed out before buying, a behavior that will keep new- and existing-home sales low, even if prices are now more affordable? Note, also, that 50% of existing-home sales are now distressed sales--either short sales or foreclosed properties. Thus both new- and existing-home sales are still showing sharp decreases in prices.

The inventory of new and existing homes is so large--even if marginally smaller than a year ago--that massive downward pressure on home prices will continue through most of 2010. You could stop producing new homes today, and it would take almost a year to clear the inventory of unsold homes. No wonder the Case-Shiller index is still showing home prices falling at a 20% annual rate, with no sign of deceleration.

If anything, the rate of price deflation has accelerated since 2008 from 17% to the current 20%. Even if new-home sales, existing-home sales, housing starts and building permits were to bottom out in the next few months (as they should, as they are close to 80% down from their bubble peak), their recovery would remain so sluggish--and the downward pressure on prices so large--that home prices will have to fall by another 15% to 20% before they bottom out in 2011.

So beware of the nonsense about green shoots in housing: The worst housing recession since the Great Depression is still in full swing, and the yellow weeds have taken over millions of empty housing lots--and are still going.
Tu Ne Cede Green Shoots.

Credit Suisse's Western Resort Loans Are Nuclear

I suspect the Stress Test doesn't account for this sort of underwriting. I'm sure it's an isolated incident.

Link to the story here

Thursday, May 21, 2009

BKUNA Matata

BKUNA Matata, What a wonderful phrase

BKUNA Matata! Ain't no passing craze

It means no worries for the rest of your days

It's our problem-free.... philosophy

BKUNA Matata....

Nothing to see here folks, nothing to see here. Move along now. No worries - Just a $12.8 billion asset bank failure. Well, actually, given the FDIC's press release says they expect to lose $4.9 billion, it's more like an $8 billion asset bank; 4.9 of the 12.8 is fictitious.

Doesn't that make you feel good about all the other bank balance sheets that get reported? "Oh, by 'thirteen" billion, we meant 'eight' billion. Is it wrong to overstate your assets by 60%?"

Don't worry though, Citigroup is solvent and its balance sheet, despite overflowing with toxicity, is money good.

BTW, kind of hysterical that BKUNA's stock rallied just three days ago to almost $1 per share. Wish I'd been paying attention for a short. Anyone who thought this wasn't going to have negative value with the FDIC eating explicit losses plus a loss sharing agreement on the balance hasn't been paying attention.

So, BKUNA is going to generate losses of at least 37% of their "assets". Long time followers of TILB realize that the FDIC have not really bothered with taking down banks on which they don't expect to lose at least 25% of assets and the pace of takeovers has accelerated (and generally ultimate losses have been worse than expected losses), which is a far cry from the +6% of assets as equity value that the Feds like to see in a well capitalized bank.

We at TILB can easily imagine that if, rather than waiting until the banks were worth negative twenty five percent, the FDIC was inclined to take over all banks at least 10% insolvent, we'd be closer to 1,000 failed institutions.

But who cares? No worries. BKUNA matata.