Tuesday, July 28, 2009

Sam Zell Interview On CNBC: Talks Residential, CRE, Brazil, Tribune, And More

Sam Zell was interviewed by the Money Honey, Maria Bartiromo, on CNBC after today's close. He touched on a number of topics.

As always, The Grave Dancer is worth listening to.

When asked (paraphrasing) "fact or fiction the residential single family home market is seeing signs of rebounding", Zell basically agreed. He caveated by saying that he is not forecasting a strong rebound, rather an equilibrium that allows for normalization. He further said his views exclude the worst markets, on which he takes no opinion other than likely continued pain.

On commercial real estate, Zell said the only thing holding this market together is low rates (CRE mortgages tend to be LIBOR+). Believes that a huge portion of the CRE market is underwater, but as long as they can continue servicing their debt load, the banks will probably allow commercial mortgage borrowers to keep trying. Zell said that he thinks borrowers really begin cracking in two or three years, given his central view on when rates begin to rise.

Brazil is his favorite market in the world to own real estate assets in. Six main reasons:
1) An elected government that we get along with;
2) 180 million person populous gives the nation scale;
3) Energy self sufficient;
4) Commodity self sufficient;
5) An educated business class; and
6) Ease of doing business (this and #1 are the big differentiators from China which he also likes long term).

When asked about Tribune, Sam Zell said that from a macro perspective the print business will continue to struggle but will not disappear entirely. He expects to have the Cubs situation resolved soon (sounds like he's selling them ASAP).

Zell believes a big advantage is that he is not emotionally attached to investment assets. This fits with Buffett's frequently stated quote that "You have to have the right temperament. I tell the students who come visit me that if you have more than 120 or 130 I.Q points, you can afford to give the rest away. You don't need extraordinary intelligence to succeed as an investor. You need a philosophy and the ability to think independently. It doesn't make any difference what other people think of a stock. What matters is whether you know enough to evaluate the business."

Finally, Zell said he believes that many of the governmental social programs being proposed today (e.g., cap and trade, health care) have the ability to undermine the fragile state of confidence we have in society and that confidence is the key to recovery.

Enjoy the interview:

Florida CRE Carnage In Photos

(HT ZeroHedge)

ZeroHedge circulated this link of the carnage in commercial real estate in Southern Florida.

Lots and lots of empty storefronts and even emptier parking lots. Here are a few indicative samples. Enjoy?

Monday, July 27, 2009

Liberty Quote Of The Day: John Adams

Second president of the United States and revolutionary heartbeat, John Adams, was a prolific writer and constant thinker. He understood the dangers of too much power and sought to limit it within our government, a lesson forgotten by most of today's public "servants".

"There is danger from all men. The only maxim of a free government ought to be to trust no man living with power to endanger the public liberty."
- John Adams

Sunday, July 26, 2009

WSJ Acknowledges California IOUs As A Currency; Schwarzies Take A Place On The Podium Next To Clamshells

As California announces a budget that gets them out of crisis...for nine months...it is likely that Schwarzie issuance will soon take a temporary respite (TILB already predicted that this budget will not hold for a variety of reasons).

It is at this juncture in history that the WSJ has decided to reflect on the implications of Schwarzies. The article even goes so far as to employ an uncited use of our phrase "Schwarzenegger Scrip" (we challenge you to find a similar reference older than ours to said currency). The Journal talks about where Schwarzies stand amongst the various scrips that were issued by state and local municipalities during the Great Depression, including certain places that issued clam shells with hand written denominations (if only TILB could have been there reporting...).

Ironically, clam shell currencies held their real value much better than our shitty fiat dollars (lovingly referred to by TILB as "Bernankes"). Per the WSJ:
Two towns in California -- Crescent City and Pismo beach -- circulated scrip printed on clamshells. [The] 10-cent note was issued by the Crescent City Chamber of Commerce. It's worth about $500 today.
And do you know why it held its value (obviously a 5000 bagger is better than "holding its value", even adjusted for dollar debasement/inflation)? Two related reasons explain the return: 1) novelty, which we do not hope for modern currencies to replicate; and 2) scarcity. Sadly, Comrades Obama, Bernanke and Geithner do not seem to fully appreciate the latter reason (or, perhaps more accurate and frightening, they do understand). Rather than talking about holding the volume of dollars somewhat stable, they speak of dropping freshly minted dollars on the populous from the cargo bed of helicopters.

Gold, a currency that has been accepted throughout time fairly universally, allows natural supply/demand forces to function as its central bank. In essence, gold has a built in scarcity function - finding, mining, refining, certifying, and establishing a reputable "brand" are expensive. As such, these functions (which increase gold supply) occur in modest, fairly stable amounts over time, leading to a dependably scarce, value protecting, and widely accepted currency.

The article goes on to inform us that California State Controller Chiang may continue to issue a few more Schwarzies as the implications of the budget are digested:
Since California ran out of cash early this month, it has issued more than 194,000 IOUs, with a total value of $1.03 billion. They are redeemable in U.S. dollars on Oct. 2, or sooner if the state comes up with the money. The legislature on Friday approved a plan to close a $24 billion budget gap, but officials say it could still take a few weeks to analyze the state's cash situation and resume giving creditors checks instead of promises.
Prediction: the state will not come up with the money sooner than Oct. 2nd. Paying them off early would be a negative arbitrage and thus they'd never do it.

If they had half a brain and a good sense of humor, they'd finance old Schwarzies with new Schwarzies and really establish them in circulation.

Friday, July 24, 2009

Seven More Failures; FDIC On A Bank Failure Treadmill

Seven banks were closed today.

The FDIC almost cannot shut banks down fast enough these days.

Earlier this week, TILB predicted that the FDIC would shutdown 250 or more banks over the next 15 months (equating to 4-5 failures per week). One week into our prediction, the FDIC has not let us down.

That said, as with the last time we had seven failures, this week comes with a big caveat: six of the failures were sister banks in Georgia: Security Bank of Gwinnett County, Security Bank of Bibb County, Security Bank of Houston County, Security Bank of Jones County, Security Bank of North Metro, and Security Bank of North Fulton. Collectively these six banks had a pretty good sized asset base at $2.8 billion.

The seventh bank was the tiny Waterford Village Bank in Williamsville, NY with $61.4 million of assets.

As has been true in the majority of cases, no depositors took losses as all deposits were absorbed by acquiring banks (including deposits over the FDIC minimum). Someday in the future, we will talk about how the FDIC is basically subsidizing non-insured depositors despite this clearly being outside their legal mandate. In our opinion, the FDIC's action on this front is dishonest, illegal and immoral. This undeserved gift to uninsured depositors, of course, comes at the expense of the tax payer and the dollar-based saver (the latter resulting from our suspicion that printing money is the Occam's Razor answer that will be pursued to handle the enormous debts our government is issuing, including the debt it will take on in order to replenish the FDIC deposit insurance fund, which is virtually empty).

Unlike most weeks, the FDIC did not break out its estimate of losses for each of the different bank failures. Instead, the Security Bank failures were aggregated together. As such, we've assumed that each bank is allocated a pro-rata share of losses based on its asset base (collectively, the Security Banks are estimated to cost the FDIC insurance fund 28.8% of their assets). Here's this week's analysis (spoiler alert: things still suck for the FDIC):

Waterford Village Bank, NY
Assets: $61.4mm, FDIC Losses: $5.6mm, Losses as a Percentage of Assets: 9.1%

Security Bank of Gwinnett County, GA
Assets: $322mm, FDIC Losses: $92.8mm, Losses as a Percentage of Assets: 28.8%

Security Bank of Bibb County, GA
Assets: $1,200mm, FDIC Losses: $346mm, Losses as a Percentage of Assets: 28.8%

Security Bank of Houston County, GA
Assets: $383mm, FDIC Losses: $110mm, Losses as a Percentage of Assets: 28.8%

Security Bank of Jones County, GA
Assets: $453mm, FDIC Losses: $131mm, Losses as a Percentage of Assets: 28.8%

Security Bank of North Metro, GA
Assets: $242mm, FDIC Losses: $64.6mm, Losses as a Percentage of Assets: 28.8%

Security Bank of North Fulton, GA
Assets: $209mm, FDIC Losses: $60mm, Losses as a Percentage of Assets: 28.8%

Straight Average Losses as a Percentage of Assets: 26.0%
Weighted Average Losses as a Percentage of Assets: 28.4%

For those keeping score at home, you may recall that last week we applauded California and Georgia for making a contest of the failure championship. Illinois, on the backs of the Campbell family, seemed to be running away with the 2009 Red Jersey of Shame (mistakenly referred to as black last week).

What a difference a week makes! Georgia now leads the competition and has posted sixteen bank failures in 2009. Third place California has eight bank failures and current runner-up Illinois has twelve. Those three states represent 36 of the 64 failures this year.

Noticeably absent from the list is meaningful failure volume from Nevada, Florida or Arizona based banks. We suspect California banks have a good chunk of Nevada and Arizona risk, but there is no way local banks in those states are not getting obliterated. As an email from a friend of TILB at BTIG said today:


--- so homes are starting to clear = good, but the clearing prices are still 45% lower than they are now = bad ....... i wonder if they have a break down of speculators vs real family buyers
This does not auger well for the FDIC's bank failure pipeline. When you're levered 12:1 or 15:1, collateral value declines of 50% (peak to today) have a particularly upsetting impact.

Thursday, July 23, 2009

Liberty Quote Of The Day: Ron Paul

Avowed protector of Liberty, Congressman Ron Paul tells us what freedom really means. Folks less familiar with Texas's great Dr. No should realize that when Ron Paul talks about robbing our neighbors, he means it both literally and figuratively. For those that follow our Liberty Quote of the Day series, you understand that in most modern forms, taxes, monetary inflation (money printing), and governmental borrowing are the primary forms of the figurative theft he (and we) refer to (see our recent Cliff Asness or Francisco D'Anconia quotes, for instance).

"The most basic principle to being a free American is the notion that we as individuals are responsible for our own lives and decisions. We do not have the right to rob our neighbors to make up for our mistakes, neither does our neighbor have any right to tell us how to live, so long as we aren’t infringing on their rights. Freedom to make bad decisions is inherent in the freedom to make good ones. If we are only free to make good decisions, we are not really free."
— Ron Paul

Tuesday, July 21, 2009

Failure Friday Killed Four More Banks, A Visit From Our Friend Vineyard Bank, And A Prediction As To How Many Banks Will Fail In The Next 15 Months

Friday July 17th, 2009 was a special day for TILB.

As we referenced in our post this past weekend on bank failures, two of this past weekend's four failures communicate a particularly fascinating message. Today we will address one of those messages.

Not only did four banks fail, one of them was Vineyard Bank. TILB first wrote about Vineyard Bank's walking dead status a year ago. In that blog posting, we walked through its deleterious state noting that it was virtually certain to fail.

Vineyard's collapse gives us a specific, useful metric: for all intents and purposes, this bank failed over a year ago in May 2008 when its regulators began sending angry and restricting letters. The FDIC finally admitted as much and took it over this past weekend. As such, that 14.5 month span provides a handy measuring stick for determining how far behind the curve the FDIC is. As of now, it appears the pipeline is 14-15 months deep.

Since May 5th, 2008, we have had 81 banks fail. Of course, the past year has seen much worse credit performance than the year prior. The pace of bank failures has been 4x in 2009 what it was in 2008 (and actually many times greater yet if you just compare 1H08 to 1H09).

Given that asset performance continues to worsen for most banks and we can easily define how far behind the curve the FDIC is by using the Vineyard measuring stick, TILB believes it is fair to extrapolate that the pipeline for failures in the next 15 months is approximately 3x-4x the past 15 months or 243-324 banks. That comes out to somewhere between 3.7 - 5.0 failures per week for that entire 15 month period.

We will state it again: TILB is forecasting over 250 failures in the next 15 months. If borrower performance deteriorates further (which it will), we believe the number could be much greater than 250.

Ignore our warning at your own risk.

Green shoots?

Nay. Brown vines.

Liberty Quote Of The Day: Andrew Jackson

The American Lion, President Andrew Jackson, provided us with a glimpse of what Congress was like in the early part of the 19th century. By way of preview, it already had reached a state of moral decrepitness from which it has never recovered. Arguably it today plumbs the depths of its all time lows.

I weep for the liberty of my country when I see at this early day of its successful experiment that corruption has been imputed to many members of the House of Representatives, and the rights of the people have been bartered for promises of office.
- Andrew Jackson
If reading that does not instantly bring to the front of mind thoughts of Pelosi and Frank, you have not been paying attention.

As a bonus on this Two-for Tuesday (we hate that radio-line), we provide you with an additional Jackson quote:
"I have always been afraid of banks."
- Andrew Jackson
Concisely stated, Mr. President. We agree.

Monday, July 20, 2009

Is The End Of California IOUs Nigh? Schwarzies, We Love You

The NY Times is reporting that California has reached a budget compromise, potentially imperilling new Schwarzie issuance. This is a sad day for America (not really) but an even sadder day for TILB (really).

Our friends at Directive 10-289 sent us this link which provides great detail on Schwarzie issuance, etc. We were going to cherish posting this graph:

But alas. The NY Times tells us that focus was all for not.

As an aside, all this budget does it get California to June 30th of next year...maybe their credit ratings and tax base will have stabilized by then allowing them to avoid further cuts (HAHAHAHAHA...not fucking likely). Further, it screws localities by forcing them to funnel money up to the mothership in Sacto, effectively passing the buck.

The NY Times reports the following (all emphasis added by TILB):
California lawmakers, their state broke and its credit rating shot, finally sealed the deal with the governor Monday night on a plan to close a $26 billion budget gap.

The plan, which is certain to be viewed with trepidation among legislatures across the country also facing huge budget gaps, distributes pain through nearly every aspect of government services. While the Legislature pushed back on Gov. Arnold Schwarzenegger’s proposal to eliminate health care programs for children and the state’s generous welfare program, both took large cuts. So did public education, universities and local governments.

All told, the deal contains $15.5 billion in cuts, about $2 billion in borrowing, $4 billion in new revenues and about $3 billion in accounting maneuvers like shifting a payday into the next fiscal year, which Mr. Schwarzenegger had claimed he would not brook.

Under the new budget, which runs through the 2010 fiscal year, localities will basically serve as unwilling lending agents to the state. It will raid their coffers and repay them over time as the state’s fiscal situation improves. [any day now!]
As a result, the state’s deficit continued to grow, and the controller has been forced to issue millions of dollars in i.o.u.’s [Schwarzies] to vendors and taxpayers in lieu of payment because the state is short on cash.
Local governments will lose millions of dollars that are used to build housing, among other purposes, and the state plans to borrow roughly $2 billion in property taxes from localities, which would have to be repaid within three years. Lawmakers believe that cities and counties could in turn borrow against that borrowing; localities bankrupt or nearly so would be exempt.

One of the biggest sticking points was over the $11 billion already cut from public schools. The budget deal calls for roughly $650 million more in cuts.
We suspect this is not the last we will hear of California's budget woes. When California budget does finally break, you can be sure we'll be there, laughing in their face.

What is truly sad about all this is that California has actually taken a big step in the right direction, but it still is not a big enough step. In the end, legislators basically decided it was too much pain to take all at once.

We understand even if we disagree.

Cali's pain will continue until they finish out the process of establishing actual fiscal discipline. Our suspicion is they may not even be able to make it to the fiscal year end as tax "revenue" will come in well below forecast blowing an even bigger hole in the budget than forecast.

As a final aside, California had better pray to high heaven that its credit rating does not take that last downgrade to junk. That would set loose all hell.

Bernanke OpEd In Tomorrow's WSJ: The Fed's Exit Strategy

This article just hitting the WSJ website. Good luck tightening, Ben.

We don't normally post articles in their entirety, but given the Fed's mission here is to communicate policy strategy to the public at large, we provide it uncut below.

The Fed's Exit Strategy
By Ben Bernanke

The depth and breadth of the global recession has required a highly accommodative monetary policy. Since the onset of the financial crisis nearly two years ago, the Federal Reserve has reduced the interest-rate target for overnight lending between banks (the federal-funds rate) nearly to zero. We have also greatly expanded the size of the Fed’s balance sheet through purchases of longer-term securities and through targeted lending programs aimed at restarting the flow of credit.

These actions have softened the economic impact of the financial crisis. They have also improved the functioning of key credit markets, including the markets for interbank lending, commercial paper, consumer and small-business credit, and residential mortgages.

My colleagues and I believe that accommodative policies will likely be warranted for an extended period. At some point, however, as economic recovery takes hold, we will need to tighten monetary policy to prevent the emergence of an inflation problem down the road. The Federal Open Market Committee, which is responsible for setting U.S. monetary policy, has devoted considerable time to issues relating to an exit strategy. We are confident we have the necessary tools to withdraw policy accommodation, when that becomes appropriate, in a smooth and timely manner.

The exit strategy is closely tied to the management of the Federal Reserve balance sheet. When the Fed makes loans or acquires securities, the funds enter the banking system and ultimately appear in the reserve accounts held at the Fed by banks and other depository institutions. These reserve balances now total about $800 billion, much more than normal. And given the current economic conditions, banks have generally held their reserves as balances at the Fed.

But as the economy recovers, banks should find more opportunities to lend out their reserves. That would produce faster growth in broad money (for example, M1 or M2) and easier credit conditions, which could ultimately result in inflationary pressures—unless we adopt countervailing policy measures. When the time comes to tighten monetary policy, we must either eliminate these large reserve balances or, if they remain, neutralize any potential undesired effects on the economy.

To some extent, reserves held by banks at the Fed will contract automatically, as improving financial conditions lead to reduced use of our short-term lending facilities, and ultimately to their wind down. Indeed, short-term credit extended by the Fed to financial institutions and other market participants has already fallen to less than $600 billion as of mid-July from about $1.5 trillion at the end of 2008. In addition, reserves could be reduced by about $100 billion to $200 billion each year over the next few years as securities held by the Fed mature or are prepaid. However, reserves likely would remain quite high for several years unless additional policies are undertaken.

Even if our balance sheet stays large for a while, we have two broad means of tightening monetary policy at the appropriate time: paying interest on reserve balances and taking various actions that reduce the stock of reserves. We could use either of these approaches alone; however, to ensure effectiveness, we likely would use both in combination.

Congress granted us authority last fall to pay interest on balances held by banks at the Fed. Currently, we pay banks an interest rate of 0.25%. When the time comes to tighten policy, we can raise the rate paid on reserve balances as we increase our target for the federal funds rate.

Banks generally will not lend funds in the money market at an interest rate lower than the rate they can earn risk-free at the Federal Reserve. Moreover, they should compete to borrow any funds that are offered in private markets at rates below the interest rate on reserve balances because, by so doing, they can earn a spread without risk.

Thus the interest rate that the Fed pays should tend to put a floor under short-term market rates, including our policy target, the federal-funds rate. Raising the rate paid on reserve balances also discourages excessive growth in money or credit, because banks will not want to lend out their reserves at rates below what they can earn at the Fed.

Considerable international experience suggests that paying interest on reserves effectively manages short-term market rates. For example, the European Central Bank allows banks to place excess reserves in an interest-paying deposit facility. Even as that central bank’s liquidity-operations substantially increased its balance sheet, the overnight interbank rate remained at or above its deposit rate. In addition, the Bank of Japan and the Bank of Canada have also used their ability to pay interest on reserves to maintain a floor under short-term market rates.

Despite this logic and experience, the federal-funds rate has dipped somewhat below the rate paid by the Fed, especially in October and November 2008, when the Fed first began to pay interest on reserves. This pattern partly reflected temporary factors, such as banks’ inexperience with the new system.

However, this pattern appears also to have resulted from the fact that some large lenders in the federal-funds market, notably government-sponsored enterprises such as Fannie Mae and Freddie Mac, are ineligible to receive interest on balances held at the Fed, and thus they have an incentive to lend in that market at rates below what the Fed pays banks.

Under more normal financial conditions, the willingness of banks to engage in the simple arbitrage noted above will tend to limit the gap between the federal-funds rate and the rate the Fed pays on reserves. If that gap persists, the problem can be addressed by supplementing payment of interest on reserves with steps to reduce reserves and drain excess liquidity from markets—the second means of tightening monetary policy. Here are four options for doing this.

First, the Federal Reserve could drain bank reserves and reduce the excess liquidity at other institutions by arranging large-scale reverse repurchase agreements with financial market participants, including banks, government-sponsored enterprises and other institutions. Reverse repurchase agreements involve the sale by the Fed of securities from its portfolio with an agreement to buy the securities back at a slightly higher price at a later date.

Second, the Treasury could sell bills and deposit the proceeds with the Federal Reserve. When purchasers pay for the securities, the Treasury’s account at the Federal Reserve rises and reserve balances decline.

The Treasury has been conducting such operations since last fall under its Supplementary Financing Program. Although the Treasury’s operations are helpful, to protect the independence of monetary policy, we must take care to ensure that we can achieve our policy objectives without reliance on the Treasury.

Third, using the authority Congress gave us to pay interest on banks’ balances at the Fed, we can offer term deposits to banks—analogous to the certificates of deposit that banks offer their customers. Bank funds held in term deposits at the Fed would not be available for the federal funds market.

Fourth, if necessary, the Fed could reduce reserves by selling a portion of its holdings of long-term securities into the open market.

Each of these policies would help to raise short-term interest rates and limit the growth of broad measures of money and credit, thereby tightening monetary policy.

Overall, the Federal Reserve has many effective tools to tighten monetary policy when the economic outlook requires us to do so. As my colleagues and I have stated, however, economic conditions are not likely to warrant tighter monetary policy for an extended period. We will calibrate the timing and pace of any future tightening, together with the mix of tools to best foster our dual objectives of maximum employment and price stability.

—Mr. Bernanke is chairman of the Federal Reserve.

Liberty Quote Of The Day: Cliff Asness

Cliff Asness is known for his role as the founder and intellectual leader of investment firm, AQR Capital. His below quote is directed at The Obama Administration's efforts to nationalize healthcare and establish the provision of health care services as a right.

From TILB's mouth to Asness's fingers:
"Listing rights generally involves enumerating things you may do without interference (the right to free speech) or may not be done to you without your permission (illegal search and seizure, loud boy-band music in public places). They are protections, not gifts of material goods. Material goods and services must be taken from others, or provided by their labor, so if you believe you have an absolute right to them, and others don't choose to provide it to you, you then have a 'right' to steal from them. But what about their far more fundamental right not to be robbed?"
- Cliff Asness


We add below this video clip which neatly summarizes our view of The Administration's efforts on so many fronts:

Don't fight it. Simply hand your (formerly) free will over to The Administration and their collection of czars. Why think for yourself when silver tongued aggressors are willing to think for you?

Ah, sweet sweet mindless freedom...

[HT: LB]

Third Failed Auction In China In Two Weeks

China again fails to sell the amount of bills it hoped to sell. This is getting relatively little press. This is the third failed auction for Chinese Treasuries of one term or another in two weeks. It is particularly worrisome given it is short-term paper. Imagine the buyer strike in long maturity offerings...

We believe this news spells danger for the US.

As we see demand for non-US auctions drying up (despite, arguably, a better currency in China) and the US Treasury continuing to ramp issuance volume, one cannot help but wonder where incremental demand for US Treasury absorption will come from (more than $2 trillion of incremental issuance in CY 2009). Simple math shows that even if all existing buyer cohorts increase their buying by enormous amounts, the funding gap in 2009 alone will be close to half a trillion dollars. Many people point to the growth in money market fund assets as the bridge. Of course, green shooters often claim those same money market dollars as there own when they talk about "all the excess cash sitting on the sidelines in money market funds". This alleged "excess" cash will apparently be able to fund both the US Treasury and serve as a catalyst for risk assets ("just wait until that money comes flooding back into small cap equities!"). Alas, both cannot happen without a substantial and unlikely increase in leverage.

Fed monetization is a virtual certainty.

As to the aforementioned failed auction in China, here are some highlights from Bloomberg. All emphasis added:

China’s government failed to sell as much debt as it planned for the third time in two weeks on speculation the central bank will push up money-market rates to prevent bubbles in stock and property prices.

The finance ministry sold 18.51 billion yuan ($2.7 billion) of the six-month bills, less than the 20 billion yuan on offer, Chinabond said in a statement on its Web site. The average winning yield was 1.6011 percent, higher than the 0.85 percent rate at the last sale of 182-day bills on June 19.[rates double in one month?!?!]

Yields on similar-maturity treasury bills have risen 45 basis points this month on concern the country’s 4 trillion yuan ($585 billion) fiscal stimulus package will stoke inflation. Loans rose almost fivefold in June from a year earlier to 1.5 trillion yuan and the government yesterday reported that economic growth accelerated to 7.9 percent in the second quarter.

The Shanghai Composite Index has jumped 75 percent this year, a performance second only to Peru among 88 global stock benchmarks tracked by Bloomberg. Home prices in China’s major cities rose in June for the first time in seven months, the government reported last week. [money printing driving prices for "investment" assets]
Demand for debt is cooling as investors favor assets that will benefit most from the economic recovery and this month’s resumption of new shares sales prompts investors to free up cash. China State Construction Engineering Corp. said on July 13 it got approval for what may be the nation’s biggest initial public offering in two years. [in order to participate in IPOs in China, you have to set aside the case, so apparently many are pointing to this giant IPO as a demand drain from the auction]

The government barely met its sale target in a 28 billion yuan three-year debt auction on July 15, drawing bids for 1.16 times the amount on offer, after attracting insufficient demand in two sales last week. The so-called bid-to-cover ratio at today’s sale was 0.925 times, compared with an average of about 1.5 at successful sales this year. [trouble]


Sunday, July 19, 2009

CIT Bondholders Leading Last Minute "Rescue"; Would Buy Breathing Room

This basically looks like CIT bondholders (led by PIMCO) are willing to gamble that this "injection" will make CIT more regulator friendly and perhaps get them better options from the FDIC. Structured as a high interest rate bridge that buys CIT some time to undertake a series of exchange offers. This alone wouldn't fix their liquidity problem, but would give them breathing room. If this deal were to happen, our view is that at best it most likely postpones the inevitable. In any case, CIT has no balance sheet flexibility to make new loans right now as all new capital is desperately needed to pay off existing creditors. In fact, it has every incentive to be incredibly aggessive with existing borrowers in order to recover as much cash now as possible. As such, from a systemic standpoint, CIT is as good as dead already...

Highlights from the WSJ follow:
CIT Group Inc. was close to securing $3 billion in last-minute rescue financing from its bondholders Sunday in a deal that should keep the struggling firm -- once the largest issuer of small-business loans in the U.S. -- out of bankruptcy court, people familiar with the matter say.

The deal, which was being considered by CIT's board Sunday night, charges CIT very high interest rates, and it doesn't permanently fix the company's long-term financing needs, say people involved in the transaction. But it buys time for the lender to restructure itself, and minimizes bondholders' losses. Bondholders calculated they would lose more if CIT filed for bankruptcy and sold assets at fire-sale prices than if they offered the rescue.
If the deal is completed, it could help reduce CIT's debt load, strengthen its capital position and alleviate pressure on CIT to pay down $1 billion in debt that comes due in August. It may also preserve the U.S. Treasury's $2.33 billion investment made as part of the Troubled Asset Relief Program.
Still, CIT and its bondholders hope that their effort to stabilize the company will cause bank regulators to look more favorably on a CIT plan to transfer more of its loans from the holding company to its bank in Utah. CIT has trouble borrowing money, but its bank can finance itself by taking in deposits. To transfer more assets to the bank, however, CIT needs an exemption from the Federal Reserve and a nod from the Federal Deposit Insurance Corp.
Under the proposal, CIT would likely pay interest rates 10 percentage points above the London interbank offered rate, said these people. (As of Friday, three-month Libor stood around 0.5%.) CIT has also agreed to pledge some of its highest-quality loans as collateral on the $3 billion package.

The new loan could act like a "bridge" to a series of debt-exchange offers that CIT would launch in order to get bondholders to swap some of their bonds for equity in the company or for new debt that matures later.
At least one analyst viewed the deal as a stopgap measure. "Even if they put together a deal today and postpone a bankruptcy filing, CIT may be back in the same place in the not-too-distant future because unemployment rates, business-loan delinquencies and corporate default rates are climbing," said Martin Weiss, president of Weiss Research, an investment consulting firm in Jupiter, Fla. "The outlook for the next six months looks pretty rough for many banks, including CIT," he said.

Late Thursday night, CIT officials believed they had secured a $2 billion rescue-financing plan from J.P. Morgan Chase & Co. But that fell through by Friday morning, said these people.

J.P. Morgan would have considered lending if CIT were first to seek bankruptcy protection, but the bank "couldn't get comfortable with a deal outside (bankruptcy) court," said one person familiar with the matter.

Four Banks Fail; FDIC Euthanization Pace Stays Brisk

The overs take it for the third week out of four...and each of those wins was by a wide margin, perhaps indicating a new stage in our ongoing bank failure cycle.

The real turn began four Fridays ago when we had what seemed like the dawning of a new era as five banks failed. That was trumped a week later by an epic Fourth of July fireworks celebration of seven failed banks. The seven failures were followed by a relative snoozer last week with only one failure. This past Friday was back on track with four failures: Temecula Valley Bank in CA, Vineyard Bank in CA, BankFirst in SD and First Piedmont Bank in GA.

As a personal aside, it's nice to see Cali and Georgia get back in the game. Illinois had broken off from the peloton and it seemed California and Georgia might simply compete for second as they let Chief Illiniwek run away and capture the black jersey of shame. But the chase pack has mobilized! In 2009, Georgia has posted ten bank failures, California eight bank failures, and Illinois leads with twelve. Those three states represent 30 of the 57 failures.

Anyway, back to the story at hand. With 17 failures in the past four weeks, it seems to indicate that the FDIC has finally ramped its staff to begin handling a sustainably higher level of failures. It has long been our suspicion that the FDIC was woefully undermanned for the crisis at hand. More than four failures per week for four weeks has us believing that the staffing issues are much closer to being ironed out.

As long time readers of TILB know, one of the metrics we are fond of tracking is what the FDIC assumes losses will be as a percentage of stated bank assets. In mid-2008, losses were averaging 20-25% of assets. More recently it has been in the 30%+ range, which is an enormous number.

Let's see how this week and last week went:

Bank of Wyoming, WY (last week's single failure)
Assets: $70mm, FDIC Losses: $27mm, Losses as a Percentage of Assets: 38.6%

First Piedmont Bank, GA
Assets: $115mm, FDIC Losses: $29mm, Losses as a Percentage of Assets: 25.2%

BankFirst, SD
Assets: $275mm, FDIC Losses: $91mm, Losses as a Percentage of Assets: 33.1%

Vineyard Bank, CA
Assets: $1900mm, FDIC Losses: $579mm, Losses as a Percentage of Assets: 30.5%

Temecula Valley Bank, CA
Assets: $1500mm, FDIC Losses: $391mm, Losses as a Percentage of Assets: 26.1%

Straight Average Losses as a Percentage of Assets: 30.7%
Weighted Average Losses as a Percentage of Assets: 28.9%

This is in line with the longer-term trend and indicates that the lower loss percentage that accompanied the six Illinois-based banks all controlled by one family (the Campbell's) that failed on July 2nd was the anomaly.

When those six and one other bank failed two weeks ago, the summary stats were as follows:

Straight Average Losses as a Percentage of Assets: 23.0%
Weighted Average Losses as a Percentage of Assets: 23.5%
We strongly suspected that because the banks were controlled by a single family, the FDIC took a few down that - if they'd been truly independent - it may have otherwise kept on life support for more time. In fact, we wrote:

We suppose this is "good" news as 23% average losses seems like a bit of an improvement (though still epically horrible). However, this week is a bit of a strange bird given that six of the banks are related to each other and all six were in pretty bad shape even if all six were not in the 30%+ camp. One of the six Illinois cousins was 30%+, one was 20%+, the largest bank was just under 20% and the other three were mid-teens. I suspect the reality is the FDIC knew if it closed one it would have to close all six.
The Texas bank, on the other hand, is just a total shit show at almost 40% losses to assets.
We will have more commentary on this week's failures in ensuing posts as two of the failed banks provide particular insight into the state of our current crisis.

Stay tuned...

Friday, July 17, 2009

Commerical Mortgage Defaults Continue To Skyrocket

The pile-up that is the CRE lending market is just beginning to reveal itself.

Unlike resi-mortgages, which hopefully are approaching Camp O'Donnell on the final legs of their death march toward consumer capitulation, commercial mortgages have just recently left Bataan. [sorry, insensitive reference - apologies in advance]

TILB recently came across a great graph that showed 60+ day delinquencies* for loans in CMBS by aggregate annual collateral vintage beginning in 2003 (this includes the vast majority of outstanding loans underlying CMBS). The X-axis shows the number of months since issuance and the Y-axis shows percentage of loans from that vintage that were 60+ days delinquent. See below for the graph.

Historically a graph like this would start out low and flat, trending up ever so slightly. Beginning in month 60 (year five), we'd see a spike up and then back down after the first set of maturities passed (forming a hump). The same would occur around month 84 (year seven) and so on. If well underwritten, each vintage should behave about the same. Certainly no vintage would show a meaningful spike beginning in month 16 (for 2007 vintage), 28 (for 2006) or 40 (2005). But that is precisely what the graph shows. And these upticks are not the beginning of humps; they are the beginning of rockets that have basically gone vertical.

As fascinating as those 2005-2007 vintages are (and they are indicating an astoundingly bad future), we find 2004 to be the most informative because that vintage has just hit its first round of maturities (5 year balloons). Perhaps it represents the proverbial canary?

Let us dig.

For 2004-vintage loans included in CMBS, 24% of those maturing in 2009 are 60+ days delinquent versus less than 2% for those maturing later. Read that again: 24% of all 2004 CRE mortgages packaged in CMBS that are maturing in 2009 are already 60+ delinquent. That's not 24% of all 2004 loans that already have matured in 2009, it's 24% of loans that already have or will mature in 2009 are 60+. 24% through May!?!?

By the end of 2009, this may very well be 40%+ as the five year loans underwritten in the second half of 2004 (and thus ballooning in 2H09) were written just as asset values seemed to take off and lending standards loosened. In fact, according to NCREIF's website, cap rates were still 7%+ for most of 2004, basically in the middle innings of the fateful cap rate plunge to nearly 5%.

In 2004, a few conservative folks thought CRE was getting a bit frothy, though for the most part underwriting standards were still reasonable (at least compared to the 2005 - 1H2008 period). Basically we are saying that the 2004 vintage is failing despite not being astoundingly "toxic". Underwriting standards and the valuations used to support them became progressively more "flexible" every year thereafter.

CMBS Delinquency Graph - May 2009

If the commercial mortgage delinquencies experienced so far in 2009 worry you, just wait until next year (2010) when the aggressively underwritten 2005 vintage has maturities, then 2011 when the 2004 seven year maturities and the egregious 2006 five year wave hits!

Every time you think the last car has hit the pile-up, just think about the ensuing year.

2012 is unfathomably bad: seven year maturities from 2005 originations and five year from 2007; two truly toxic vintages have big resets together.

TILB's personal view is that the way banks and insurance companies try to "solve" this nightmare is by extending maturities in exchange for some amount of new equity injection, tighter covenants and a new rate. This will not be practical in many situations, but it will occasionally be accomplished. This is not an act of charity; it will be their attempt at postponing the recognition of and provision for bad loans. Securitizations will probably be more aggressive in dealing with problem loans now which will keep pressure on CRE prices, preventing recovery.

In any case, as banks and insurers extend, it will have a suffocating effect on new lending as these loans will continue to eat balance sheet capacity for lending institutions (and new securitization will remain dormant). This lack of fresh lending capacity will obliterate CRE valuations for obvious reasons.

Watch what happens in two or three years when these postponed problem loans come due at the same time that two major maturity waves from problem vintages hit: a shitstorm of Texas sized proportions.

We look forward to watching Geithner and Bernanke somehow argue that Wells Fargo/Wachovia, Bank of America and the regional banks, which have just begun digesting these trends, are well capitalized. The ultimate losses lenders absorb will be astounding.

As a self aggrandizing aside, here's a brief reminder from TILB's annual Prediction and Surprises we wrote in late December and posted this past January (#3 and #6 in particular):
3) Housing prices cross the -30% peak to trough level (Case Shiller 20-city index). Commercial real estate becomes the watchword as housing price declines begin to slow toward the end of 2009.

6) The credit crisis is not arrested. After having rolled through housing, it begins its attack on commercial and corporate in force. The default rate for HY approaches double digits but bank debt only makes it to mid single digits (5-7%), so far. As I predicted a few years ago, the default wave continues to roll through credit sub-classes. While it was initially in subprime, which had the nearest resets and the lowest quality borrowers and collateral, we see it move into Option ARMs as people begin to reach 115% of their initial balance due to minimum payments and some 3/1 and 4/1 ARMs from the more toxic vintages of 06 and 05 hit resets. New CRE (commercial real estate) financing is unavailable at attractive interest rates and cap rates climb near double digits. That said, the CRE default wave only begins to pick up modest steam in 09 as the 5/25 balloons from 2004 and early 2005 approach or cross through their reset periods. Covenant-lite LBO debt performs horribly, but due to a lack of covenants, the defaults are really a 2010 and beyond phenomenon. Because each of these huge credit asset sub-classes really have staggered aggregate maturities, the credit crisis has trouble getting past us (subprime 2007-08, option ARM 2008-09, jumbo prime 2009-10, CRE 2009-14, full covenant bank debt 2009-10, HY 2009-11, muni 2010-11, cov-lite bank debt 2010-12). All flavors of credit are obviously correlated as the companies and institutions that provide the loans are the same for all kinds of credit and this continues to drive availability of credit down and the price of and standards for credit up. This adjustment hurts many people.
As the creator of the above graph noted, the only green shoot we are seeing is the vertical green line on the 2004 vintage mortgages.

* 60+ days delinquency generally indicates serious delinquency (whereas 30+ includes folks that may simply have foot faulted).

Thursday, July 16, 2009

Liberty Quote Of The Day: The First Amendment

Our ongoing series in quotes on liberty, freedom, and personal responsibility is going to occasionally remind us of the rights we are granted simply by waking up as citizens of these United States. The Bill of Rights (or the first ten amendments to the Constitution) were first authored by James Madison. Today, we begin with the First Amendment which guarantees no laws establishing a national religion, no restrictions on your exercise of religion, and no laws restricting your speech (including via a free press and the right to peaceably assemble):
“Congress shall make no law respecting an establishment of religion, or prohibiting the free exercise thereof; or abridging the freedom of speech, or of the press; or the right of the people peaceably to assemble, and to petition the Government for a redress of grievances."
-First Amendment of The U.S. Constitution

Wednesday, July 15, 2009

CIT Left For Dead; Geithner Discovers He Has At Least One Nut

Well, we apologize to "Mister" Geithner (for now...). WSJ reporting CIT is as good as done. All available lines will be drawn by customers. Losses won't be able to be replaced with new capital and the tens of billions of debt repayments due in the next 24 months tell the story.

CIT, we hardly knew you.

CIT Stock Halted: Too Medium To Fail

The subject line speaks for itself. The news will come shortly. As TILB has predicted, the government won't have the balls to let CIT go, further affirming the worries expressed by our friends over at Directive 10-289.

We know the announcement has not yet happened, but we all know where this is headed. Quoting friend of TILB, CR, "I threw up in my mouth". Hopefully, at a minimum, they nuke the equity holders. Maybe they'll even go in senior to psuedo equity (converts, preferreds). Ideally they'll let nature actually take its course and We The People Will stop playing God with the gladiator style thumbs up or down for survival.

Stand For California: Arnold Schwarzenegger The Road Stops Here

As LB said in an email to me earlier today, "The unintentional comedy of this is very high."


While Schwarzie issuance continues unabated and the likelihood of the federal government being forced to show its hand vis a vie letting state finances collapse, Arnold has this inspiring and soul affirming video to share with his citizenry.

Good news Californians, "the road stops here." Lord willing, Arnold.

Size Of The Derivatives Market? A Cool Half A Quadrillion Dollars

Actually, it is much bigger than half a quadrillion. The OTC market alone is 0.6 quadrillion dollars. The listed derivatives is additive by another $50-60 trillion and makes the aggregate bigger yet.

The below report by the Bank for International Settlements (BIS) is published twice a year on the size, scope and evolution of the derivatives market. Here are a few great takeaways (sometimes direct quotes, sometimes TILB's words, growth rates are all from the mid-year 2008 report):

  • "The financial crisis in the second half of 2008 resulted in the first ever decline in the total notional amounts outstanding of over-the-counter (OTC) derivatives since data collection began in 1998. Notional amounts of all types of OTC contracts stood at $592.0 trillion at the end of December 2008, 13.4% lower than their total of $683.7 trillion six months before." These numbers have been reduced to avoid double counting amongst reporting institutions (each contract has two exposures). While that elimination is true from a systemic perspective, you can decide for yourself whether that is appropriate from a micro-perspective.
  • "Gross market values, which measure the cost of replacing all existing contracts, represent a better measure of market risk than notional amounts. Despite the drop in amounts outstanding, significant price movements resulted in notably higher gross market values, which increased by 66.5% to $33.9 trillion at the end of December 2008. The higher market values were also reflected in gross credit exposures, which grew 29.7% to $5.0 trillion." Note that US GDP is about $14 trillion.
  • As we all know, interest rate derivatives (specifically rate swaps) are by far the largest area of the derivative market. Good news though, notional doesn't matter in rate swaps because, you know, rates never move that much. "In the second half of 2008 the market for OTC interest rate derivatives declined for the first time, after recording an above average rate of growth in the first half of the year. Notional amounts of these instruments fell to $418.7 trillion at the end of December 2008, 8.6% lower than six months before. Despite the decrease in notional amounts outstanding, declining interest rates resulted in a notable 98.9% increase in the gross market value of interest rate derivatives, to $18.4 trillion."
  • By the way, imagine what happens if monetarist worries prove out. As TILB talked about in the second half of this post, if the Fed and Treasury truly lose their grip on the value of the dollar, watch out. We're sure this won't cause a trainwreck in derivatives world. Rate derivatives only equal 0.4 quadrillion dollars so the multiplier effect of a huge move in rates would not be against a base of any significant size. Certainly the 0.4 quadrillion dollar market has hedged out its risk elegantly...
  • TILB suspects rate derivatives were one of the largest growth areas during the first half of 2009. If our interaction with hedge fund managers is any indication, even equity guys have started hedging rate risk in size. Dealers tell us pensions and insurers, broadly speaking, are on the other side of this macro bet in order to manager their A/L structure.
  • Multilateral netting brought down the notional amount of CDS, but gross exposure actually grew by nearly 80%.
  • These numbers of course exclude the impact of listed derivatives, which is a much smaller market.

TILB's conclusion: the real "black swan" (we're starting to hate that term for its overuse) lurking out there is the impact of a rate shock on the system. Our suspicion is that the rate derivatives market is not built to handle that shock and that it's size makes the occurance of a shock at some point a virtually certainty.

"I love the smell of napalm in the morning."

BIS Report on Derivatives - Year End 2008

Liberty Quote Of The Day Friederich Hayek

Brilliant economist of the Austrian school, Friedrich Hayek, gave us the below quote which is very much along the lines of an earlier TILB posting about Equality of Outcomes vs. Equality of Choice.

“From the fact that people are very different it follows that, if we treat them equally, the result must be inequality in their actual position, and that the only way to place them in an equal position would be to treat them differently. Equality before the law and material equality are therefore not only different but are in conflict with each other; and we can achieve either one or the other, but not both at the same time.”
- Friedrich August Hayek

Tuesday, July 14, 2009

Liberty Quote Of The Day: Marcus Tullius Cicero

Cicero was a great Roman philosopher and statesman. His simple quote below on the value of freedom rings as true today as when he put pen to paper over two thousand years ago.

Cicero's views on freedom were forged from a remarkable and unlikely life lived in the crosshairs of history. After a variety of hurdles including an exile that caused Cicero to reflect on freedom lost, Cicero stood bravely behind his conviction in opposition to Julius Caesar's dictatorship and in favor of a true republic. While not part of the conspiracy that led to Caesar's assassination at the hands of Brutus, allegedly Brutus called out for Cicero to restore the Republic even as he withdrew the bloodied knife from Caesar's body.

The power vacuum created by Caesar's murder was filled by the competing efforts of Cicero and Caesar's loyal servant Mark Antony. Cicero fought Antony with a barrage of words in his attempt to re-establish the Republic. After losing a power struggle, Cicero sought to escape the Empire before being captured, decapitated and de-handed (if that's a word). Antony nailed his head and hands to the speaker's podium of the Roman Forum (yes, you read that correctly). Wikipedia states that Antony's wife removed Cicero's tongue and "jabbed it repeatedly with her hairpin in final revenge against Cicero's power of speech."

Having processed the above, TILB dares not take its own freedom for granted. As Cicero noted:

"Freedom is a possession of inestimable value."
- Cicero

Monday, July 13, 2009

Liberty Quote Of The Day: Dr. Adrian Rogers

Dr. Rogers' most famous quote (at least that we are aware of) is that which follows. He spent much of his life in ministry and understood closely the nature of poverty and the nature of charity vs. confiscation. His statement below resonates with TILB:
"You cannot legislate the poor into freedom by legislating the wealthy out of freedom. What one person receives without working for, another must work for without receiving. The government cannot give to anybody anything that the government does not first take from somebody else. When half of the people get the idea that they do not have to work because the other half is going to take care of them, and when the other half gets the idea that it does no good to work because somebody else is going to get what they work for, that my dear friend, is about the end of any nation. You cannot multiple wealth by dividing it."
- Dr. Adrian Rogers

[Hat tip: LB]

Sunday, July 12, 2009

Michael Lewis In Vanity Fair On AIG

Michael Lewis writes the most extensive article yet on AIG in the new issue of Vanity Fair.

Believe it or not, he - gasp - actually talked to people that work at AIG FP. Amazingly, Ed Liddy had never visited FP prior to his infamous March testimony. Bernanke, Paulson and Geithner have never visited. Congressmen have never visited. The article is a must read. Below is Michael Lewis's recounting of the AIG bonus witch hunt:

The perception was that the very same people who had made these insane, greed-driven decisions that might cost the U.S. taxpayer $182.5 billion were still paying themselves big bucks! An exchange between C.E.O. Liddy and Florida congressman Alan Grayson captured the spirit of that moment:

grayson: Mr. Liddy, you said before that there’s 20 or 25 people who were involved in the credit default business. What are their names, please?

liddy: I don’t have their names at my disposal, sir. grayson: Well, I’m sure you remember a few of the names. I mean, they did cause your company to crash.

liddy: You know, I’ve been at the company, as you know, for six months. I don’t know all the people that were in AIG F.P., and many of them are gone.

grayson: Well, there or gone, it doesn’t really matter. I want to know who they are. Names, please.…

liddy: If it’s possible to provide you the names, we will. We will cooperate with you.

grayson: That’s good, but I want to know the names that you know right now.

liddy: I don’t know them, sir.

grayson: Not a single one. You’re talking about a group, a small group of people who caused your company to lose $100 billion, as you sit here today, you can’t give me one single name.

liddy: The single name I would give you is Joseph Cassano, who ran …

grayson: That’s a good start. You already gave that name. Give me another name.

liddy: I just don’t know them. I do not know those names. I don’t have them all at my command.

grayson: Well, how can you propose to solve the problems of the company that you’re now running if you don’t know the names of the people who caused that problem? … I would expect you’d at least know more than one name. How about two names? Give us one more name.

liddy: I’m just not going to do that, sir, because that will provide—that’ll be the—that could be a list of people that we could do—individuals who want to do damage to them could do that. It’s just not …

grayson: Well, listen, these same people could now be working right now today at Citibank. Is it more important to protect them, the ones who caused the $100 billion loss, or protect us? Which is more important to you right now?

For a brief moment you had a glimpse of how harshly financial people might be treated if Wall Street ever lost its political influence. Just days before, Larry Summers had gone on the morning talk shows to explain that a contract is a contract and the government couldn’t just go in and void it and take back A.I.G.’s paychecks, but that “every legal step possible to limit those bonuses is being taken by Secretary Geithner and by the Federal Reserve System.” Then Obama himself went out of his way to denounce the greed at A.I.G. F.P. and say he was looking for a way to get the bonus money back—and even that failed to slake the public anger. “On A.I.G.,” a journalist asked Obama at a press conference, “why did you wait—why did you wait days to come out and express that outrage? It seems like the action is coming out of New York and the attorney general’s office. It took you days to come public with Secretary Geithner and say, Look, we’re outraged. Why did it take so long?”

“It took us a couple of days because I like to know what I’m talking about before I speak,” Obama said testily. “All right?”

It’s unlikely that he actually did know what he was talking about, except in the broadest outlines. Nor, for that matter, did the people who had engineered the bailout. How could they? At no point did anyone from the U.S. Treasury or the U.S. Congress, or any of the various New York State authorities that had gotten involved, call them up, much less visit A.I.G. F.P.—as, say, someone might who was genuinely curious to know what, exactly, had happened there. Not even A.I.G. C.E.O. Ed Liddy had bothered to make the drive from Manhattan to Wilton, Connecticut, where many of the offending trades had been done, and most of the offending bonuses were being paid, to ask questions of the people still on the scene—people who could have told him a great deal about what had happened and why. Everyone seemed to be operating on whatever they read in the newspapers—and the people inside A.I.G. F.P., who had the best view of the action, did not appear to be talking to reporters.

Friday, July 10, 2009

Liberty Quote Of The Day: C.S. Lewis

While most famous for his The Chronicles of Narnia series, C.S. Lewis was a brilliant Oxford professor, writer and philosopher as well as a prominent Christian. The following quote which presages the concept of the Nanny State and the Obama Doctrine comes from Lewis's work God in the Dock.
"Of all tyrannies, a tyranny exercised for the good of its victims may be the most oppressive. It may be better to live under robber barons than under omnipotent moral busybodies. The robber baron’s cruelty may sometimes sleep, his cupidity may at some point be satiated; but those who torment us for our own good will torment us without end for they do so with the approval of their own conscience. They may be more likely to go to Heaven yet at the same time likelier to make a Hell of earth. Their very kindness stings with intolerable insult. To be ‘cured’ against one’s will and cured of states which we may not regard as disease is to be put on a level of those who have not yet reached the age of reason or those who never will; to be classed with infants, imbeciles, and domestic animals."
- C.S. Lewis

Thursday, July 09, 2009

Inflation Vs. Deflation And The Race To Debase The Dollar

Wall Street boutique dealer, BTIG, circulated the following story from China yesterday a.m.:
Neptune Orient Lines Ltd., China Cosco Holdings Co. and 12 other container lines agreed to raise rates on Asia-U.S. routes, seeking to end a price war caused by slumping demand, overcapacity and "panic." The lines decided on a $500 increase for carrying a 40-foot box from Aug. 10 as a "voluntary guideline," the Transpacific Stabilization Agreement said in an e-mailed statement yesterday. The companies will also raise fuel levies and may add peak season surcharges, the group said. Container lines will try to raise rates again after an April increase collapsed amid rising competition and a 20 percent drop in demand, the TSA said. Spot market Hong Kong-Los Angeles rates have slumped to as low as $900, according to Lloyd's List, as U.S. retailers pare orders for Asian-made furniture and toys on weak consumer -spending. - Bberg
Today, the same dealer friend at BTIG circulated the following:
TOKYO (Nikkei)--Amid still-faltering exports, rates on container ships from Asia to North America have been dropped for the first time in three years, reaching six-year lows.

In just-ended negotiations with businesses, shippers -- including Japanese firms Nippon Yusen KK (9101), Mitsui O.S.K. Lines Ltd. (9104) and Kawasaki Kisen Kaisha Ltd. (9107) -- agreed to reduce rates by 20-40% for the fiscal year ending May 2010. The major reason is sluggish exports of automobiles and housing-related products from Asia to the U.S. in the wake of the economic recession.

The new rate on service to the U.S. west coast, such as Los Angeles, is 1,000 dollars to 1,500 dollars per 40 feet container. It is 2,300 dollars to 2,800 dollars for the Midwest region, such as Chicago, and 2,000 dollars to 3,000 dollars for the east coast, including New York.

Marine transport from Asia to North America started plunging around November last year and continued its double-digit year-on-year losing streak until April. Even though shippers have revamped routes and reduced services, there are still more vessels available than needed.

Major Japanese and overseas shippers bled huge red ink in the January-March quarter because of the harsh business environment for container ship operations. They intend to seek a rate hike if demand recovers for shipments to North America. A clause included in many contracts allows renegotiation for higher rates in the second half of fiscal 2009.
(The Nikkei July 10 morning edition)
These stories are directly in conflict with each other (or, perhaps, they are perfectly in sync with each other since there is little chance the cartel manages to keep all the participants in line). TILB forwarded those BTIG emails and posed the following question to a handful of friends: "Deflation or Inflation?"

TILB friend and Fed watcher extraordinaire, J-Thrill, responded as follows [bracketed statements are from TILB]:
The main thing holding back inflation now is low velocity/Money multiplier [i.e., banks are not lending/demand by quality borrowers is low]. If V/MM comes back with low interest rates = we’ll get 70’s inflation or worse. The Fed has expanded their balance sheet at an unprecedented rate and to the extent the debt they guarantee goes bad, it’s pure inflation. I think that money creation number is probably going to be 2 Trillion from loan losses.

In the early 80's, there was a similar capacity utilization deficit, but inflation persisted until Volcker stamped out inflation with higher rates and restrained M3. I think the low inflation during the 90’s was due to China’s massive low cost import increase to the U.S. and was a free gift to Greenspan (he concedes this). If (when) China’s [currency] strengthens and they continue to make better stuff over time, it will cause inflation for us, but a weak dollar should help our exports. The question is, do we really want to regain the position of the lowest cost tube sock manufacturer to “gain” jobs by killing our currency? I do not. When we start exporting cars to China, you should go long the dollar.
Please pardon a brief digression. As TILB has been known to say in real life (as opposed to the blogosphere), Americans worried about having lost jobs to China need not worry. What we have "lost" are the lowest returning, worst parts of the worst businesses to China, et al. We agree with J-Thrill: we do not want those "jobs" back; government edicts be damned. TILB much prefers our scarce resources be directed at higher value industries by the collective actions of the many rather than commanded toward lower value industries by the whims of a ruling elite.

Our government does not get it (nor do most governments). They think jobs can be saved by "protecting" our manufacturing base. Long run, this will kill jobs from a macro standpoint and lead to malinvestment of scarce resources (directed away from a natural, likely to be more productive use and toward an unnatural, likely to be less productive use). The jobs "saved" will be an illusion since it will cost other better jobs elsewhere (That Which Is Not Seen) leading to a less dynamic economy.

In any case, back to "Inflation or Deflation?" J-Thrill included the following fun graphs that layout the inflation/deflation back and forth quite well.

First, we have measured and reported Urban CPI actually hitting a negative number. - (deflation):

Here, we have capacity utilization at historic lows. - (deflation):

Here, we show the St. Louis Fed's report on the monetary base, which after growing slowly and steadily for decades has more than doubled in the past year (or, as we are wont to say, "it took 100 years to print the first trillion dollars and then it took a few months to print the next trillion; don't worry though, things are fine"). - (inflation)

This final graph shows that net exports have been very negative since the end of the early 90s recession but has corrected a huge amount in the last year (though still very negative). The graph does not clearly lead to a conclusion on inflation vs. deflation. However, it hints. You can extrapolate quickly that we have been sending hundreds of billions of dollars annually to foreign countries for years and years. Those foreign nations have been kind enough to provide epic amounts of low interest seller financing. Perhaps we'll pay them back with newly debased dollars? - (inflation) Further, it indicates that domestic demand for imported goods has fallen off a cliff (that's the reason for the recent inflexion rather than a burst of exports). - (deflation)

GE Creeps Back Toward Ten Dollars Per Share

General Electric has ever-so-quietly been creeping back down toward the $10/share a threshold that it fell below in mid-February. As with so many financial institutions, after breaching $10 the "wrong" way, it found a free fall that ended with the commencement of the early March Geithner rally. Eerily, the closing low of GE was $6.66 (coincidentally? the intraday low of the S&P 500 was 666). Intraday GE stock actually reached as low as $5.87 before proceeding to nearly triple, peaking out around $15/share in early May. The last two months have seen it fall back to $10.71 at yesterday's close.

As long time TILB readers know, $10/share has been a major price threshold for financial businesses during this crisis. $10/share shouldn't have any particular fundamental meaning, but the psychology of fear has been the motive force during this crisis (and in highly levered businesses that depend on regular access to market-based funding, psychology actually has a huge impact on business value because it impacts the availability and cost of that funding).

While we at TILB do not currently have a position in GE either way*, we did short it from about about $9 to $6.80 last time around (in an unusually well timed series of actions, we implemented the short February 25th and covered March 4th). We rarely "trade" here at TILB (in general virtually everything we do has a multi-year horizon to it), but the $10 threshold has been one of the most consistent trends we have ever seen. Perhaps a second bite at the apple is coming...

It is something that we are keeping an eye on.

* TILB's positions are subject to change and we feel no obligation to inform the world if or when that happens. Investing is inherently risky. Listening to people that write blogs about investing is potentially riskier yet. Caveat emptor.

Liberty Quote Of The Day: Frederic Bastiat

For those readers that are not familiar with Bastiat, we are pleased to introduce you. Bastiat's concept from 1850 of that which is seen and that which is not seen permeates an enormous portion of TILB's thinking. He will be a frequent contributor to Liberty Quote of the Day.

Today, we bring you Bastiat's concise and trenchant views of taxation and wealth redistribution as legalized theft:

"Sometimes the law defends plunder and participates in it. Thus the beneficiaries are spared the shame and danger that their acts would otherwise involve... But how is this legal plunder to be identified? Quite simply. See if the law takes from some persons what belongs to them and gives it to the other persons to whom it doesn't belong. See if the law benefits one citizen at the expense of another by doing what the citizen himself cannot do without committing a crime. Then abolish that law without delay ... No legal plunder; this is the principle of justice, peace, order, stability, harmony and logic."
- Frederic Bastiat

Wednesday, July 08, 2009

Follow Up To Yesterday's Patrick Henry Liberty Quote Of The Day

Long-time friend of TILB, CK, emailed a request for historical context on today's Patrick Henry Liberty Quote of the Day. Herein follows the complete text of his famous Give Me Liberty or Give Me Death speech from whence we plucked today's quote [red font added]:

Give Me Liberty Or Give Me Death
Patrick Henry, March 23, 1775.

No man thinks more highly than I do of the patriotism, as well as abilities, of the very worthy gentlemen who have just addressed the House. But different men often see the same subject in different lights; and, therefore, I hope it will not be thought disrespectful to those gentlemen if, entertaining as I do opinions of a character very opposite to theirs, I shall speak forth my sentiments freely and without reserve. This is no time for ceremony. The questing before the House is one of awful moment to this country. For my own part, I consider it as nothing less than a question of freedom or slavery; and in proportion to the magnitude of the subject ought to be the freedom of the debate. It is only in this way that we can hope to arrive at truth, and fulfill the great responsibility which we hold to God and our country. Should I keep back my opinions at such a time, through fear of giving offense, I should consider myself as guilty of treason towards my country, and of an act of disloyalty toward the Majesty of Heaven, which I revere above all earthly kings.

Mr. President, it is natural to man to indulge in the illusions of hope. We are apt to shut our eyes against a painful truth, and listen to the song of that siren till she transforms us into beasts. Is this the part of wise men, engaged in a great and arduous struggle for liberty? Are we disposed to be of the number of those who, having eyes, see not, and, having ears, hear not, the things which so nearly concern their temporal salvation? For my part, whatever anguish of spirit it may cost, I am willing to know the whole truth; to know the worst, and to provide for it.

I have but one lamp by which my feet are guided, and that is the lamp of experience. I know of no way of judging of the future but by the past. And judging by the past, I wish to know what there has been in the conduct of the British ministry for the last ten years to justify those hopes with which gentlemen have been pleased to solace themselves and the House. Is it that insidious smile with which our petition has been lately received? Trust it not, sir; it will prove a snare to your feet. Suffer not yourselves to be betrayed with a kiss. Ask yourselves how this gracious reception of our petition comports with those warlike preparations which cover our waters and darken our land. Are fleets and armies necessary to a work of love and reconciliation? Have we shown ourselves so unwilling to be reconciled that force must be called in to win back our love? Let us not deceive ourselves, sir. These are the implements of war and subjugation; the last arguments to which kings resort. I ask gentlemen, sir, what means this martial array, if its purpose be not to force us to submission? Can gentlemen assign any other possible motive for it? Has Great Britain any enemy, in this quarter of the world, to call for all this accumulation of navies and armies? No, sir, she has none. They are meant for us: they can be meant for no other. They are sent over to bind and rivet upon us those chains which the British ministry have been so long forging. And what have we to oppose to them? Shall we try argument? Sir, we have been trying that for the last ten years. Have we anything new to offer upon the subject? Nothing. We have held the subject up in every light of which it is capable; but it has been all in vain. Shall we resort to entreaty and humble supplication? What terms shall we find which have not been already exhausted? Let us not, I beseech you, sir, deceive ourselves. Sir, we have done everything that could be done to avert the storm which is now coming on. We have petitioned; we have remonstrated; we have supplicated; we have prostrated ourselves before the throne, and have implored its interposition to arrest the tyrannical hands of the ministry and Parliament. Our petitions have been slighted; our remonstrances have produced additional violence and insult; our supplications have been disregarded; and we have been spurned, with contempt, from the foot of the throne! In vain, after these things, may we indulge the fond hope of peace and reconciliation. There is no longer any room for hope. If we wish to be free-- if we mean to preserve inviolate those inestimable privileges for which we have been so long contending--if we mean not basely to abandon the noble struggle in which we have been so long engaged, and which we have pledged ourselves never to abandon until the glorious object of our contest shall be obtained--we must fight! I repeat it, sir, we must fight! An appeal to arms and to the God of hosts is all that is left us!

They tell us, sir, that we are weak; unable to cope with so formidable an adversary. But when shall we be stronger? Will it be the next week, or the next year? Will it be when we are totally disarmed, and when a British guard shall be stationed in every house? Shall we gather strength by irresolution and inaction? Shall we acquire the means of effectual resistance by lying supinely on our backs and hugging the delusive phantom of hope, until our enemies shall have bound us hand and foot? Sir, we are not weak if we make a proper use of those means which the God of nature hath placed in our power. The millions of people, armed in the holy cause of liberty, and in such a country as that which we possess, are invincible by any force which our enemy can send against us. Besides, sir, we shall not fight our battles alone. There is a just God who presides over the destinies of nations, and who will raise up friends to fight our battles for us. The battle, sir, is not to the strong alone; it is to the vigilant, the active, the brave. Besides, sir, we have no election. If we were base enough to desire it, it is now too late to retire from the contest. There is no retreat but in submission and slavery! Our chains are forged! Their clanking may be heard on the plains of Boston! The war is inevitable--and let it come! I repeat it, sir, let it come.

It is in vain, sir, to extenuate the matter. Gentlemen may cry, Peace, Peace-- but there is no peace. The war is actually begun! The next gale that sweeps from the north will bring to our ears the clash of resounding arms! Our brethren are already in the field! Why stand we here idle? What is it that gentlemen wish? What would they have? Is life so dear, or peace so sweet, as to be purchased at the price of chains and slavery? Forbid it, Almighty God! I know not what course others may take; but as for me, give me liberty or give me death!
Having read Patrick Henry's great words, another long time reader of TILB said in an email to investmentlb@gmail.com, "A different breed TILB, a different breed."


We find it quite remarkable how many of our founding fathers feared government. Statement after statement of the evils of government permeate their public words and actions. They took that healthy fear and built a system designed explicitly to limit government, but 230 years of bastardization later and even a seemingly foolproof system is struggling under the weight of power hungry bureaucrats.

While today the revolutionary fire in America burns dimmer on the whole, it sits on a tinderbox shielded by misplaced patience. As patience with stolen liberties and a future of debt-burdened national servitude awaits us, the need for action grows greater by the day. We are treated by our government in much the same way Henry complains of the British Ministry treating Americans. Our war, of course, is not a war of flesh, but a war of principle, a war of oppression, a war to recover the ideals on which our nation was built and in which its greatness took root. Hope in and patience with government are our greatest obstacles in the struggle to break free from the oppression of the ruling elite whom daily seem to take our liberties and labors and use them for their own power hungry purposes.

May we live to see the day when we revert back to a high regard for true personal freedom and liberty. Government, at its best, provides protection of personal freedom. Alas, government's ever increasing size is inherently the enemy of that freedom it is designed to cherish. We observe that our government does not seem to be shrinking. Liberty lovers should readily understand that what they cherish is under a powerful attack and persistent oppression.

Stand by quietly and watch your freedom evaporate. "Hope" will not solve the ills we suffer from. Patrick Henry understood that clearly 230 years ago and TILB believes the lesson rings true today.

Liberty Quote Of The Day: Francisco D'Anconia

To call the following a "quote" is a bit aggressive as it is clearly more of a passage or essay.

What follows is an outburst by Ayn Rand's copper and mining barron in Atlas Shrugged, Francisco D'Anconia. D'Anconia talks about the meaning of money as a representative and exchangeable unit of man's labor. As such, Rand - via A'Anconia - concludes that money is not an evil but a virtue. This is a passage that many readers find profane, but that interpretation tends to be the result of either a fundamental misunderstanding of Rand's point or because they are the looters and moochers she refers to. Note that when Rand talks of "money", she really talks about "the productive capacity of man" with money as the storage and exchange mechanism for that productive capacity. This is how humanity survives and advances. It is human virtue.

On to the passage [all emphasis added]:

"When you accept money in payment for your effort, you do so only on the conviction that you will exchange it for the product of the effort of others. It is not the moochers or the looters who give value to money. Not an ocean of tears not all the guns in the world can transform those pieces of paper in your wallet into the bread you will need to survive tomorrow. Those pieces of paper, which should have been gold, are a token of honor--your claim upon the energy of the men who produce. Your wallet is your statement of hope that somewhere in the world around you there are men who will not default on that moral principle which is the root of money, Is this what you consider evil?

"Have you ever looked for the root of production? Take a look at an electric generator and dare tell yourself that it was created by the muscular effort of unthinking brutes. Try to grow a seed of wheat without the knowledge left to you by men who had to discover it for the first time. Try to obtain your food by means of nothing but physical motions--and you'll learn that man's mind is the root of all the goods produced and of all the wealth that has ever existed on earth.

"But you say that money is made by the strong at the expense of the weak? What strength do you mean? It is not the strength of guns or muscles. Wealth is the product of man's capacity to think. Then is money made by the man who invents a motor at the expense of those who did not invent it? Is money made by the intelligent at the expense of the fools? By the able at the expense of the incompetent? By the ambitious at the expense of the lazy? Money is made--before it can be looted or mooched--made by the effort of every honest man, each to the extent of his ability. An honest man is one who knows that he can't consume more than he has produced.'

"To trade by means of money is the code of the men of good will. Money rests on the axiom that every man is the owner of his mind and his effort. Money allows no power to prescribe the value of your effort except the voluntary choice of the man who is willing to trade you his effort in return. Money permits you to obtain for your goods and your labor that which they are worth to the men who buy them, but no more. Money permits no deals except those to mutual benefit by the unforced judgment of the traders. Money demands of you the recognition that men must work for their own benefit, not for their own injury, for their gain, not their loss--the recognition that they are not beasts of burden, born to carry the weight of your misery--that you must offer them values, not wounds--that the common bond among men is not the exchange of suffering, but the exchange of goods. Money demands that you sell, not your weakness to men's stupidity, but your talent to their reason; it demands that you buy, not the shoddiest they offer, but the best that your money can find. And when men live by trade--with reason, not force, as their final arbiter--it is the best product that wins, the best performance, the man of best judgment and highest ability--and the degree of a man's productiveness is the degree of his reward. This is the code of existence whose tool and symbol is money. Is this what you consider evil?

"But money is only a tool. It will take you wherever you wish, but it will not replace you as the driver. It will give you the means for the satisfaction of your desires, but it will not provide you with desires. Money is the scourge of the men who attempt to reverse the law of causality--the men who seek to replace the mind by seizing the products of the mind.

"Money will not purchase happiness for the man who has no concept of what he wants: money will not give him a code of values, if he's evaded the knowledge of what to value, and it will not provide him with a purpose, if he's evaded the choice of what to seek. Money will not buy intelligence for the fool, or admiration for the coward, or respect for the incompetent. The man who attempts to purchase the brains of his superiors to serve him, with his money replacing his judgment, ends up by becoming the victim of his inferiors. The men of intelligence desert him, but the cheats and the frauds come flocking to him, drawn by a law which he has not discovered: that no man may be smaller than his money. Is this the reason why you call it evil?

"Only the man who does not need it, is fit to inherit wealth--the man who would make his own fortune no matter where he started. If an heir is equal to his money, it serves him; if not, it destroys him. But you look on and you cry that money corrupted him. Did it? Or did he corrupt his money? Do not envy a worthless heir; his wealth is not yours and you would have done no better with it. Do not think that it should have been distributed among you; loading the world with fifty parasites instead of one, would not bring back the dead virtue which was the fortune. Money is a living power that dies without its root. Money will not serve the mind that cannot match it. Is this the reason why you call it evil?

"Money is your means of survival. The verdict you pronounce upon the source of your livelihood is the verdict you pronounce upon your life. If the source is corrupt, you have damned your own existence. Did you get your money by fraud? By pandering to men's vices or men's stupidity? By catering to fools, in the hope of getting more than your ability deserves? By lowering your standards? By doing work you despise for purchasers you scorn? If so, then your money will not give you a moment's or a penny's worth of joy. Then all the things you buy will become, not a tribute to you, but a reproach; not an achievement, but a reminder of shame. Then you'll scream that money is evil. Evil, because it would not pinch-hit for your self-respect? Evil, because it would not let you enjoy your depravity? Is this the root of your hatred of money?

"Money will always remain an effect and refuse to replace you as the cause. Money is the product of virtue, but it will not give you virtue and it will not redeem your vices. Money will not give you the unearned, neither in matter nor in spirit. Is this the root of your hatred of money?

"Or did you say it's the love of money that's the root of all evil? To love a thing is to know and love its nature. To love money is to know and love the fact that money is the creation of the best power within you, and your passkey to trade your effort for the effort of the best among men. It's the person who would sell his soul for a nickel, who is loudest in proclaiming his hatred of money--and he has good reason to hate it. The lovers of money are willing to work for it. They know they are able to deserve it.

"Let me give you a tip on a clue to men's characters: the man who damns money has obtained it dishonorably; the man who respects it has earned it.

"Run for your life from any man who tells you that money is evil. That sentence is the leper's bell of an approaching looter. So long as men live together on earth and need means to deal with one another--their only substitute, if they abandon money, is the muzzle of a gun.

"But money demands of you the highest virtues, if you wish to make it or to keep it. Men who have no courage, pride or self-esteem, men who have no moral sense of their right to their money and are not willing to defend it as they defend their life, men who apologize for being rich--will not remain rich for long. They are the natural bait for the swarms of looters that stay under rocks for centuries, but come crawling out at the first smell of a man who begs to be forgiven for the guilt of owning wealth. They will hasten to relieve him of the guilt--and of his life, as he deserves.

"Then you will see the rise of the men of the double standard--the men who live by force, yet count on those who live by trade to create the value of their looted money--the men who are the hitchhikers of virtue. In a moral society, these are the criminals, and the statutes are written to protect you against them. But when a society establishes criminals-by-right and looters-by-law--men who use force to seize the wealth of disarmed victims--then money becomes its creators' avenger. Such looters believe it safe to rob defenseless men, once they've passed a law to disarm them. But their loot becomes the magnet for other looters, who get it from them as they got it. Then the race goes, not to the ablest at production, but to those most ruthless at brutality. When force is the standard, the murderer wins over the pickpocket. And then that society vanishes, in a spread of ruins and slaughter.


"To the glory of mankind, there was, for the first and only time in history, a country of money--and I have no higher, more reverent tribute to pay to America, for this means: a country of reason, justice, freedom, production, achievement. For the first time, man's mind and money were set free, and there were no fortunes-by-conquest, but only fortunes-by-work, and instead of swordsmen and slaves, there appeared the real maker of wealth, the greatest worker, the highest type of human being--the self-made man--the American industrialist.

"If you ask me to name the proudest distinction of Americans, I would choose--because it contains all the others--the fact that they were the people who created the phrase 'to make money.' No other language or nation had ever used these words before; men had always thought of wealth as a static quantity--to be seized, begged, inherited, shared, looted or obtained as a favor. Americans were the first to understand that wealth has to be created. The words 'to make money' hold the essence of human morality.

"Yet these were the words for which Americans were denounced by the rotted cultures of the looters' continents. Now the looters' credo has brought you to regard your proudest achievements as a hallmark of shame, your prosperity as guilt, your greatest men, the industrialists, as blackguards, and your magnificent factories as the product and property of muscular labor, the labor of whip-driven slaves, like the pyramids of Egypt. The rotter who simpers that he sees no difference between the power of the dollar and the power of the whip, ought to learn the difference on his own hide-- as, I think, he will.

"Until and unless you discover that money is the root of all good, you ask for your own destruction. When money ceases to be the tool by which men deal with one another, then men become the tools of men. Blood, whips and guns--or dollars. Take your choice--there is no other--and your time is running out."
- Francisco D'Anconia (Ayn Rand)