The Investment Linebacker

World's Largest Pension And Owner Of JGBs Announces It's A Net Seller

2011-02-25T07:41:00.002-05:00

Butterfly wings for Japan...
Linky Linky

Hayman Capital's Kyle Bass Provides CNBC Interview On Japan, Europe And Munis

2011-02-16T23:09:00.004-05:00

Watch, listen, learn. Also, here's a link to Bass's/Hayman's most recent annual letter.

Intro and Japan:

Europe:

Munis and Meredith Whitney:

Hayman Capital's Kyle Bass Writes About The Cognitive Dissonance Of It All

2011-02-15T13:41:00.003-05:00

Hayman Capital's Kyle Bass writes about "The Cognitive Dissonance of it All" - the fact that an increase in the unsustainable policies and economic structure of the past forty years that led to the recent financial crisis is being offered as the cure to the ills the very same policies caused. Sovereign defaults, debt accumulation, the Keynesian endpoint, Japan's coming X-Day, the future of the euro/EMU, fiat money, gold and other topics are all discussed.

Enjoy.

48881153 Kyle Bass Hayman Investor Letter February 2011[1]

When Teppers Speak, Investment Linebackers Listen

2011-01-21T10:52:00.003-05:00

In this extended CNBC interview, Appaloosa's David Tepper is still somewhat optimistic, albeit toned down a bit from last September. Watch and see for yourself what Trader Tepper (as opposed to Investor Tepper) has to say about the opportunity set today. As always, he's entertaining as hell. [click here for his fantastic market call last September - many people credit this interview with setting the market psychology for the balance of 2010]

Part I - Tepper's New "Bank" Investment (NJ Food Bank charity) and a Look Back at His Fall Call:

Part II - Tepper Tones Down His Bullishness From Last Fall:

Part III - Tepper Gives His Somewhat More Micro Outlook (Semis, Semicap Equipment, Banking to a Certain Extent, potentially some of the PIIGS if they "do the right things"), Currencies and Gold are Tough, etc.:

Appaloosa's David Tepper Returns To CNBC This Friday January 21st

2011-01-19T15:02:00.004-05:00

Long time readers know that we are David Tepper fans, if for no other reason than his fantastic communication skills. We directed you to watch the interview he gave on CNBC last September (which you still can do here). In that interview, he told you in no uncertain terms to buy because the Fed was intent on making everything go up, inflationary consequences be damned.

Mission Accomplished.

This Friday, he's back to drop more knowledge.

[HT: LB}

Jim Rogers, Ron Paul & Tom Woods Interviewed By Judge Napolitano

2010-12-27T14:08:00.003-05:00

In a veritable quad-fecta of freedom loving interviews, Judge Napolitano interviews Congressman Ron Paul, Mises academic Tom Woods (and friend of TILB), and legendary investor Jim Rogers in this assembled video

Fourth in the quad-fecta is the combination of John Papola and Russ Roberts interviewed about their famous rap video concerning the debate between Hayek and Keynes.

Russia Is A Seven: Sergei Magnitsky's Murder Officially Swept Under The Rug

2010-12-23T20:11:00.004-05:00

HT: Big E

As long time tilb readers know, we've been following the murder of Russian lawyer Sergei Magnitsky in Russian prison. He basically helped uncover a massive tax fraud/embezzlement by Russian officials only to have the tables turned on him. The officials turned around and charged him with theft, jailed and tortured him then had him murdered in prison. Bill Browder of Hermitage Capital (who was Magnitsky's relevant client in uncovering the original fraud) has spoken out loudly only to have his complaints drowned out by silence.

The NY Times gave the story a few last breaths of life today.

Human Freedom Relies On Gold Redeemable Money

2010-12-09T16:33:00.005-05:00

I think the title of this post is pretty close to a piece Congressman Howard Buffett wrote in the first half of the 20th century (yes, Warren Buffett's father - they have slightly different political leanings).

In any case, I felt it was an apt title to the below video from Charlie Rose where he discusses gold, inflation, "quantitative easing", and dollar debasement with a few folks including Greenlight Capital's David Einhorn (whom we are a big fan of), Jim Grant (again, we're huge fans), the Chairman of Barrick Gold and John Hathaway of Toqueville Asset Management. Enjoy.

Jim Grant - "gold is money."

HT: TB

Munis, Munis, Munis

2010-11-18T11:22:00.004-05:00

Long-time TILB readers know that we are very concerned about the muni-market (click here for our coverage of the bankruptcy filing for Harrisburg, Pennsylvania - that fine state's capital city).

Certain states, like Texas and Virginia, appear to be in fine shape and are resonable credits (though you aren't getting paid enough to care, in our opinion). We'll call citizens of these states Future Subsidizors. Other municipalities - like California, New Jersey and Illinois (aka Future Subsidizor Supplicants) - will go through stress or outright distress.

Many of these Future Subsidizor Supplicants may at some point be great investments, if you know what you're doing. But the vast majority of the muni-market lender base (which is largely doctors and lawyers retail investors) have no idea what they are doing - nor do their advisors (e.g., muni mutual funds or private wealth advisors).

In the last few days the muni-market has become spooky. Examples - a small town outside Detroit, Michigan called Hamtramck has begun the process of seeking state permission to file for bankruptcy (link here). Additionally, some much bigger munis (like the state of California - which would be one of the largest sovereign issuers in the world if it were a standalone country) have pulled some offerings due to "tepid demand". At some point these municipalities are going to have to start issuing again in order to fund their deficits and - TILB supposes - many will have to fund at rates that far exceed their budgeted cost. This of course will lead to further strain on those government budgets, leading to higher interest rates, further budget cuts, more local economic straing, yet further strain on those government budgets, leading to higher still interest rates, etc., etc. ad nauseum...default (or restructure).

Beware. Skillful investors willing to take an active role in helping these munis "solve" their debt problems will be able to make money (Jenny Hedge Fund Manager will buy California's debt at 40c and selling back to Cali at 60c, thus making itself a quick 50% while helping Cali reduce that issuance by 40%), but Johnny Retail is about to get rolled.

Caveat Emptor - get ready for more Schwarzies.

Below are some excerpts from today's Wall Street Journal A1 page (all emphasis added):

America's strapped states and cities took another hit Wednesday, with California seeing tepid demand for its latest bond sale and other governments pulling about $700 million worth of borrowing deals this week as investors continued stepping away from the municipal bond market.

The normally staid market has grown volatile the past week, posting its sharpest selloff in nearly two years, as investors demand higher interest rates to buy paper issued by states, cities and counties to finance their operations. Localities have been hammered by a drop in tax revenue amid the downturn—and unlike the federal government, most are barred constitutionally from running deficits.

"The tax-exempt municipal bond market is a cold, cold world right now for issuers and taxpayers," Tom Dresslar, a spokesman for the California State Treasurer, said late Wednesday. He added that the state decided to cancel another $267.3 million bond sale it planned to price next week "in light of market conditions."
California's $10 billion bond sale this week was seen as a test of access for governments to the bond markets, and the middling interest signaled that municipalities could have to pay more to attract investors. The state further jolted the market by delaying the close of the bond sale, citing a lawsuit filed Tuesday that challenges a separate tactic the state is using to raise funds.

"California's timing unfortunately couldn't be worse," said Gary Pollack, head of fixed-income trading and research at Deutsche Bank Private Wealth Management. "This creates a fear among individual investors and probably could hurt the state in terms of paying a higher borrowing cost than if they'd done a deal at a different time."

After pouring billions into municipal bond funds most of the year, investors pulled $115 million out of the funds last week, the Investment Company Institute said Wednesday. That was the first weekly outflow in seven months, ICI said.

The fragility of government finances was also evident in a move by Moody's Investors Service to downgrade the city and county of San Francisco, as well as the city of Philadelphia, and by a request by Hamtramck, a small Michigan city, for permission to file for bankruptcy.

California, facing a projected $25 billion shortfall through June 2012, aimed this week to sell $10 billion in so-called "revenue anticipation" notes. Over three days, it reported total orders of about 60% of that amount, or $6.06 billion, for the securities, according to the Treasurer's office. In September 2009, California sold 75% of a similar offering to retail investors. The remainder of an offering is typically bought by big institutional investors.

...

The short-term notes mature next May and June and yield 1.25% and 1.5%, roughly what California paid a year ago, though higher than other states. "It's still an incredibly low rate, and it's an awful lot of bonds," said Matt Fabian, senior analyst at Municipal Market Advisors. [TILB note: Basically commercial paper for California - keep not extending maturities and rolling it short Cali, it will work out just fine...]

...

At the same time, concerns have been mounting over whether, after the double whammy of 2008 market losses and the economic downturn, municipalities will be able to maintain their reputation for always paying their bondholders.

Average yields on 30-year municipal bonds rose 0.13 percentage point Wednesday to 4.77% and are up roughly 0.5 percentage point in recent weeks. Yields on 5-year bonds rose 0.06 percentage point to 1.58% on Wednesday.

About $700 million worth of bond sales were pulled this week, according to Thomson Reuters. That is roughly 3% of the week's planned sales, according to data from Ipreo. Many of the bond sales were to refinance outstanding debt at lower rates, meaning the governments didn't need the money.

But postponed deals are atypical, market watchers say, and they attribute them to investor demand for higher interest rates amid a glut of bonds as well as the impact of the move in 30-year Treasurys.

...

Moody's cited "continued weakness of the city's finances" in its downgrade of Philadelphia, affecting $3.85 billion in outstanding debt. Rob Dubow, the city's finance director, said, "We understand we face fiscal challenges, and we have, but for us the timing is odd, because we feel like we have stabilized." As for San Francisco, the bond rater said the "city ended fiscal 2009 with a balance sheet that was weaker than at any time in the prior ten years."

A spokesman for San Francisco's mayor said the ratings downgrade was "not unexpected" given the challenging economy, and that the city still had a better rating than many other local governments.

As a brief aside, this whole thing is very sad. Most municipalities could handle their debt if they were willing to make hard choices. However, in a culture where homeowners now making "strategic defaults" on their mortgages, it does not surprise us that rather than cut back on trash service or government size, our municipalities are choosing to renig on their contractual and moral obligations to their lenders.

We think lenders - broadly - are not requiring enough compensation for this sea-change in risk.

"This Is True, The Plumber Is Clearly Smarter Than The Ben Bernanke"

2010-11-12T16:24:00.003-05:00

I can't think of one thing that I disagree with in this. As an aside, I love when people use extraneous "the"s. Such as, "The Ben Bernank"[sic].

HT: O

Liberty Quote Of The Day: Rand Paul

2010-11-03T10:44:00.006-04:00

We've Come To Take Our Government Back.

"Do we believe in the individual or believe in The State? Thomas Jefferson wrote the government is best that governs least. Likewise, freedom is best when enjoyed by the most. America can rise up and surmount these problems if we just get government out of our way."
-Rand Paul - 11/2/2010 U.S. Senate Acceptance Speech from Kentucky

Amen.

Vote or DIIIIIIIIIIEEEEEEEEEEEEEE!!!!!!!!!!!!!

2010-11-02T10:45:00.003-04:00

Vote donkey today and don't ever complain again

OR

choose a different path: one that supports liberty, encourages a government that protects and serves its people rather than controls and harbors power over them, and that provides for its citizens to operate relatively unfettered by centralized influences.

Obama Tells Businessman To Hire More People

2010-10-27T11:10:00.002-04:00

Hilarious.

Appaloosa's David Tepper On CNBC

2010-09-24T10:38:00.004-04:00

Always great to listen to. He's a guy that was literally given a statue of a pair of brass balls by his hedge fund buddies. Enjoy.

First half of the interview:

Second half of the interview:

He doesn't give a shitszu.

Phil Davison Is Seeking The Candidacy For Stark County (Ohio) Treasurer

2010-09-10T10:52:00.004-04:00

Democrats, you best come with your boots on, because Phil Davison is coming with guns blazing. He recognizes politics is not touch football, politics is winner takes all. It always has been and always will be. He does not apologize for his tone. THIS IS THE OPPORTUNITY WE HAVE BEEN WAITING FOR!!! NOW IS THE TIME TO SEIZE THIS OPPORTUNITY!!! (tear) HE WILL COME OUT SWINGING AND WILL END UP WINNING!!! ...AND HE LIVES IN A VAN DOWN BY THE RIVER!!!!!!!!!!!!!!!!

[HT: TT]

The Khan Academy - Brilliant

2010-08-25T07:04:00.000-04:00

I'm embarassed to have not been aware of this before. This guy, Salman Khan - who's an ex-SF-based hedgie, has basically created a high quality, free online library of teachings on basically any subject you can think of related to math or science and is below String Theory. I suspect String Theory is coming. He also has extensive playlists that address finance, economics, and government policy (e.g., an entire set of objectively presented lectures on the "Paulson Bailout" and "Collateralized Debt Obligation (CDO)"). I haven't vetted those, but I can tell you the more traditional lectures are excellent - understandable, effective and consumable. This sort of thing has the potential to revolutionize education.

Click here to check out the Khan Academy and spread the good word. Here's his intro video that shows the schematic overview of basically everything that is available on his website.

Welcome to the future, the weather is great.

[HT: TD]

Yen:Dollar In Freefall

2010-08-24T11:40:00.005-04:00

Wow - the yen's strength is remarkable (or is it the dollar's weakness - pick your poison). Say Sayonara to the Japanese government's budget. Say Ohaiyo Gozaimasu to QE52 in Japan and the ultimate destruction of their currency. As we've discussed several times in the past, this is a "when, not if" scenario.

St. Louis Fed President James Bullard On Deflation Risk

2010-07-30T10:50:00.004-04:00

James Bullard, one of the Fed's few "inflation hawks" (which is a relative term when we're talking about people who's job it is to debase our currency, so being a hawk on the Fed really just means he's not as overwhelming an inflationist as some of his colleagues) is - out of left field - warning about deflation. Strangely, his argument is that the easy money language of the Fed "extended period of time", etc. is what is driving this. However, really what he's saying is that the interest rate isn't what matters at this point in a deflation cycle, that the Fed needs to be more forceful and adopt further quantitative easing. Interest rate movements simply incent borrowing and money creation whereas QE causes it explicitly.

Folks, QE2 is nearly upon us.

If you think Bernanke, an avowed currency debasor, isn't the puppetmaster coordinating this - even to the point of using one of his biggest inflation hawks to lead the debasement charge - then you are fooling yourself. By the way, Bullard is not just saying the fed needs further quantitative easing, he's saying they need to make an open-ended commitment to QE, they need to explicitly state their QE as part of ongoing policy, and that it should probably be a lot. Not QE2, but QEForever.

The first time around, the Fed simply did "a lot" but didn't make it open ended and explicit enough. Bullard says the Fed won't make the same mistake twice.

Folks, get your AU and AG now. We are entering crazy-land - these guys literally have no idea about the implications of what they are talking about.

BTW, they would not do this unless they were really, really worried about the state of the economy. I watch this and am legitimately frightened.

[HT: TD]

The SEC Is No Longer Subject To FOIA

2010-07-28T10:23:00.003-04:00

Unf'ingbelievable. Or, as some crazy ranting guy I saw on Youtube said, "is it possible to be astonished but not surprised?" The hope and change that The Borg - I mean Administration - promised to bring forth continues to be oppression of freedom and strengthening of government control of your lives.

This article highlights how the new FinReg legislation has a brief, well hidden section that basically attempts to put the SEC above the law (fortunately, I don't think it is constitutional). It's ironic for our cheif enforcer of corporate governance to have used backroom agreements to institute horrible governance itself. Link to article.

Margaret Thatcher On The Income Gap

2010-07-23T09:25:00.005-04:00

Since the Canadian Broadcast Corp has blocked our prior video clip of Maggie Thatcher, herein we enclose another great Maggie video:

Southeastern Asset Management's Mason Hawkins Levels High Frequency Trading

2010-07-16T10:28:00.004-04:00

Southeastern Asset Management, the manager of the legendary Longleaf family of mutual funds, put together a scathing analysis of high frequency trading (HFT), debunking the myth of its "benefits" to market participants. This was assembled and presented by Southeastern founder O. Mason Hawkins and his team for and to Luis Angular of the SEC.

Must read.

2010-06 Southeastern to SEC Re HFT
[HT: Black Ball]

Li Lu's Forward To Chinese Edition Of Poor Charlie's Almanack

2010-06-23T11:12:00.004-04:00

We are huge fans of Munger, as long-time readers know. With the work of Shai Dardashti and Enoch Ko, we have Li Lu's (of LL Capital/Himalaya Capital/Tiananmen Square student leader fame) forward to Poor Charlie's Almanack Chinese edition translated below. TILB has had the good fortune of meeting Li Lu, and expect he is one of Buffett's replacements on the public investing side.

Included below is Ko's translation. Many thanks to the source.

My Teacher: Charlie Munger

Author：Li Lu
May 21, 2010
Source: “Chinese Entrepreneurs”

【"China Entrepreneur" Magazine】Twenty years ago, as a young student coming to the United States, I couldn’t have imagined having a career in investments and would never have thought that I’d be fortunate enough to meet with the contemporary investment guru, Mr. Charlie Munger. In 2004, Mr. Munger became my investment partner and has since become my lifelong mentor and friend -- an opportunity I would have never dared to dream about.

I graduated from Columbia University in 1996 and founded my investment company in 1997, thus starting my professional investment career. Till this day, the vast majority of individual investors and institutional investors still follow investment philosophies that are based on "bad theories." For example, they believe in the efficient market hypothesis, and therefore believe that the volatility of stock prices is equivalent to real risk, and they place a strong emphasis on volatility when they judge your performance. In my view, the biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. Not only is the mere drop in stock prices not risk, but it is an opportunity. Where else do you look for cheap stocks? But I found that while, on the surface, famous fund managers appear to accept the theories of Buffett and Munger and show great respect for their performance, they are in actual practice the exact opposite because their clients are also the exact opposite to Buffett and Munger. They still accept the theories that say "volatility is risk" and "the market is always right."

A serendipitous opportunity led me to meet my lifelong mentor and friend, Mr. Charlie Munger.

Charlie and I first met at a mutual friend’s house while I was working on investments in LA after graduating from college. The first impression he gave me was “distant” -- he often appeared to be absent-minded to the presence of his conversation partners and was, instead, very focused on his own topics. But this old man spoke succinctly; his words full of wisdom for you to mull over.

Seven years after we’ve known each other, at a Thanksgiving gathering in 2003, we had a long heart-to-heart conversation. I introduced every single company I have invested in, or researched, or am interested in to Charlie and he commented on each one of them. I also asked for his advice on the problems I’ve encountered. Towards the end, he told me that the problems I’ve encountered were practically all the problems of Wall Street. The problem is with the way the Wall Street thinks. Even though Berkshire Hathaway has been such a success, there isn’t any company on Wall Street that truly imitates it. If I continue on this path, my worries will never be eliminated. But if I was willing to give up this path right then, to take a path different from Wall Street, he was willing to invest. This really flattered me.

With Charlie’s help, I completely reorganized the company I founded. The structure was changed into that of the early investment partnerships of Buffett and Munger (note: Buffett and Munger each had partnerships to manage their own investment portfolios) and all the shortcomings of the typical hedge funds were eliminated. Investors who stayed made long-term investment guarantees and we no longer accepted new investors.

Thus I entered another golden period in my investment career. I was no longer restricted by the various limitations of Wall Street. The numbers still fluctuate as before, but eventual result is substantial growth. From the fourth quarter of 2004 to the end of 2009, the new fund returned an annual compound growth rate of 36% after deducting operating costs. From the inception of the fund in January 1998, the fund returned an annual compound growth rate in excess of 29%. In 12 years, the capital grew more than 20 folds.

Buffett said that, despite the countless people he has met in his life, he has never encountered anyone else like Charlie. And in the years that I’ve known Charlie, and was fortunate to be able to intimately understand him, I am also deeply convinced that. Even from all the biographies of people from all ages, I have yet to see anyone similar to him. Charlie is such a unique man -- his uniqueness is in his thinking and, also, in his personality.

When Charlie thinks about things, he starts by inverting. To understand how to be happy in life, Charlie will study how to make life miserable; to examine how business become big and strong, Charlie first studies how businesses decline and die; most people care more about how to succeed in the stock market, Charlie is most concerned about why most have failed in the stock market. His way of thinking comes from the saying in the farmer’s philosophy: I want to know is where I’m going to die, so I will never go there.

Charlie constantly collects and researches the notable failures in each and every type of people, business, government, and academia, and arranges the causes of failures into a decision-making checklist for making the right decisions. Because of this, he has avoided major mistakes in his decision making in his life and in his career. The importance of this on the performance of Buffett and Berkshire Hathaway over the past 50 years cannot be emphasized enough.

Charlie's mind is original and creative, never subject to any restrictions, shackles, or dogmas. He has the curiosity of children and possesses the qualities of a top-notch scientists and their scientific research methods. He has a strong thirst for knowledge throughout his life and is interested in practically all areas. To him, with the right approach, any problem can be understood through self-study, building innovations on the foundation laid by those who came earlier. His thinking radiates out to every corner of business, life, and [areas of] knowledge. In his view, everything in the universe is an interactive whole, and all of human knowledge are just pieces to the study of the comprehensive whole. Only by combining of these knowledge through a latticework of mental models can they become useful in decision-making and in developing the proper understanding of things. So he advocates studying all the truly important theories in all disciplines, and building on this foundation the so-called “worldly wisdom” as a tool for studying the important issues in business and investments.

Charlie’s way of thinking is based on being honest about knowledge. He believes that in this complex and changing world, there will always be limitations to human cognition and understanding, so you must use all the tools at your disposal. And, at the same time, you must constantly collect new verifiable evidences, correcting and updating your knowledge, and knowing what you know and what you don’t know.

But even so, the true insights a person can get in life is still very limited, so correct decision-making must necessarily be confined to your "circle of competence". A “competence” that has no defined borders cannot be called a true competence. How do you define your own circle of competence? Charlie said, if I want to hold a view, if I cannot refute or disprove this view better than the smartest, most capable, most qualified person on Earth, then I’m not worthy of holding that view. So when Charlie truly holds a certain point of view, his thinking is not only original and unique, but also almost never wrong.

A beautiful lady once insisted that Charlie use one word to sum up the source of his success, Charlie said it was being “rational.” However, he has a more stringent definition of rationality. It is this kind of “rationality” that grants him the sensitive and unique vision and insight. Even in a completely unfamiliar territory, with just one look he could see through to the essence of things. Buffett calls this characteristic of Charlie the “two-minute effect” -- he said Charlie can, in the shortest time possible, unravel the nature of a complex business and understand it better than anyone else can. The process of Berkshire’s investment in BYD Auto is an example. I remember in 2003, when I first discussed about BYD with Charlie, despite having never met Wang Chuanfu (Chairman of BYD Auto), visited BYD’s factory, and being relatively unfamiliar with the Chinese market and culture, his questions and comments about BYD remains, till this day, the most pertinent questions a BYD investor need to ask.

Everyone has blind spots, and even the brightest people are no exceptions. Buffett said: “Benjamin Graham taught me to only buy cheap stocks, Charlie allowed me to change my thinking. That’s the real impact Charlie had on me. I needed a powerful force to walk out of the limitations imposed by Graham’s theories. Charlie’s ideas were that source of power -- he expanded my horizons.” I’ve also had this profound experience. Charlie pointed out the blind spots in my thinking; if it weren’t for his help, I’ll still be still in process of evolution, slowly crawling along.

Charlie spent a lifetime studying disastrous human mistakes and is particularly fond of catastrophic errors caused by human psychological tendencies. The most valuable contribution is that he predicted the disastrous consequence of the spread of financial derivatives and the loopholes in the accounting and auditing system. Back in the late 1990s, he and Mr. Buffett already raised the disastrous potentials of financial derivative products. They escalated their warnings with the proliferation of financial derivative products, calling financial derivative products finance-based weapons of mass destruction; if they were not stopped in a timely and effective manner, they would have a devastating impact on the modern society. The financial tsunami and global economic recession in 2008 and 2009 unfortunately validated Charlie’s far reaching vision and insights.

Compared with Buffett, Charlie has a far wider range of interests. For instance, he has strong interests and has done extensive studies in almost all fields of sciences and social sciences, integrating them to form the original and unique Munger ideology. Compared to anything coming from within the ivory towers’ system of thinking, Munger’s doctrines are built to solve practical problems. For example, as far as I know, Charlie was the first to propose and systematically study human psychological tendencies and its huge impact on decision-making processes in investments and business. Now, tens of years later, behavioral finance has become a popular area of research in economics, with behavioral economics winning the recognition of the Nobel Prize. The theoretical framework Charlie describes in the final chapter of this book, “the Psychology of Human Misjudgment," may become more widely understood and applied by people in the future.

Charlie is naturally full of energy. Charlie was 72 years old when I first met him in 1996. He is 86 years old this year. In the tens of years I’ve known Charlie, his level of energy has never changed. He is always energetic and is an early riser. Breakfast meetings always begin at 7:30 am. At the same time, because of dinner events, his spends less time sleeping than the average people, but that does not affect his exuberant energy. His memory is also amazing. He still remembers BYD's operating figures I discussed with him many years ago while my memories have already blurred.

The 86-year-old man has a better memory than this young man. These are his innate advantages, but he acquired through hard work the unusual qualities that contributed to his success. Once Charlie found one thing he wants to do, he can do it for a lifetime.

To me, Charlie is not just a partner, he is also an elder, a teacher, a friend, a role model for success and a role model in life. Not only did I learn from him the principles of value investing, I also learned from him how to live life. He made me understand that a person's success is not accidental. Timing and opportunities are, of course, important, but the inherent qualities of people are even more important.

Charlie likes to meet people for breakfasts, usually starting at 7:30 am. I remember the first time I had breakfast with Charlie, I arrived on time, only to find Charlie sitting there, finished with the day’s newspapers. While it was only a few short minutes away from the 7:30, but I felt bad letting an elderly man I respected wait for me. For our second date, I arrived about fifteen minutes earlier and still found Charlie sitting there, reading the newspaper. For our third meeting, I arrived half an hour earlier and Charlie was still reading the newspaper, as if he had been waiting there all year round and had never left the seat. For the fourth meeting, when I arrived an hour early at sat there to begin waiting at 6:30 am, and at 6:45 am, Charlie leisurely walked in with a pile of newspapers and sat down, not even looking up, completely unaware of my existence. Afterwards, I came to understand that Charlie will always be arrive early for meetings. But he doesn’t waste time either, he will take out the newspaper he prepared to read.

In my interactions with Charlie, there was another thing that made a big impact on me. One year, Charlie and I were attending an out-of-state meeting. After the event, I was hurrying to get back to New York and unexpectedly met Charlie at the airport terminal. When his huge body passed through the security detector, for some unknown reason the detector kept being set off. Charlie returned to again and again for the security check. He finally passed through the security checkpoint after a long and laborious effort, but, by then, his plane had already departed.

But Charlie was not in a hurry. He took out a book he carried with him and sat down to read while he waited for the next plane. Incidentally, my flight was also delayed so we waited for our flights together.

I asked Charlie: “You have your own private jet and so does Berkshire, why do you bother going through the trouble of flying commercial?”

Charlie replied:”Firstly, it is a waste of fuel for me to fly in my private jet. Secondly, I feel safer flying in a commercial aircraft.” However, the real reason is Charlie’s third reason, “I want to live an engaged life. I don’t want to be isolated.”

What Charlie can’t tolerate is to lose contact with the world because of money and wealth. To isolate yourself in a single room behind a labyrinth of offices, to require layers after layers of approvals to setup meetings, and to hide behind a complicated bureaucracy so you become hard to reach for anyone - that is how you lose touch with the realities of life.

"As long as I have a book in my hand, I don’t feel like I’m wasting time." Charlie always carries a book on him. Even if he’s sitting in the middle seat in economy class, as long as he has a book, he’ll have no complaint. Once he went to Seattle to attend a board meeting, taking the economy class as usual, he sat beside a Chinese girl who was doing her calculus homework throughout the flight. He was impressed with this Chinese girl because he has difficulty imagining American girls of the same age having such power of concentration to ignore noise on the aircraft and concentrate on studying. If he was aboard a private jet, he would have never had the opportunity to come into close contact with these stories of ordinary people.

Though Charlie has very strict self-discipline, he is very generous with others and treat people he cares and love really well. He is not stingy with money, always hoping others will benefit more. For his own travels, whether for business trips or for personal trips, he always flies economy class, but when traveling with his wife and family, he would take his own private jet. He explained: my wife brought up so many children in her lifetime and has given me so much. Now that her health isn’t as good as it used to be, I must take good care of her.

Charlie spent his lifetime studying the causes of human failures, so he has a profound understanding of the weaknesses of human nature. Because of this, he believes people must be strict and demanding on themselves, continuously improving their discipline in life in order to overcome the innate weaknesses of human nature. This way of life is, to Charlie, a moral requirement. To an outsider, Charlie might seem like a monk; but to Charlie, this process is both rational and pleasant and it allows people to having a successful and happy life.

Charlie is such a unique person. But if you think about it, if Munger and Buffett weren’t so so unique, how could they have built Berkshire’s performance over 50 years into one that is unprecedented in the history of investments and one that has yet to be replicated.

Over the years I’ve known Charlie, I often forget that he is an American. He is closer to being the traditional Literati (scholar-officials) of Imperial China that I knew.

After the Imperial examination system ended, over the past hundreds of years, the spirit of the Literati has been lost to reality. Especially in the highly developed commercial society of this time and age, the Chinese scholars who bear the spirit of the Chinese Literati are often confused about the value and ideals of their own existence. In a commercial society where tradition has been lost, is the spirit of Literati still applicable or useful? In the late Ming Dynasty, capitalism began to sprout in China, the merchants at that time raised the ideals of "a business person with a Literati’s soul.” Today, the forces of the commercial market has become the dominant power, and I think there are more possibilities for this ideal to become a reality.

Charlie can be said to be the best example of "a businessman with a Literati’s soul". First of all, Charlie is extremely successful in business. However, in the deep intimate interactions I’ve had with Charlie, I found Charlie to be essentially a moral philosopher and a scholar. He reads widely, is knowledgeable over a broad range of topics, is truly concerned about his own moral cultivation, and is ultimately concerned about the society. Charlie's value system, from the inside out, promotes self-cultivation and self-development to become the “saints” who help others.

After achieving business success and wealth, Charlie is still committed to charity and to benefiting the people of the world. He was complete dependent on his wisdom in achieving his success, and this is undoubtedly an exciting role model for Chinese scholars. He made full use of his own wisdom and achieved great success in business with the utmost integrity. Today, in the market economy, can the Chinese scholars be filled with the spirit of the Literati and, by improving themselves through learning and self-cultivation, achieve the successes of the secular society while realizing the value of their own ideals?

Charlie very much appreciates Confucius. I sometimes think that if Confucius was reborn in America today, Charlie will probably be the best incarnation. If Confucius returned 2000 years later to the commercialized China, his teaching will probably be: have your heart in the right place, cultivate your moral character, fortify your family, acquire wealth, and help the world!

(This article was written for the foreword to "Poor Charlie's Almanack - The Wit and Wisdom of Charles T. Munger” - published in May 2010, some paragraphs were cut, the title was added by the editor.)

J.P. Morgan Chase's Jamie Dimon Gives Syracuse University Commencement Address On Accountability

2010-06-16T10:03:00.003-04:00

J.P. Morgan Chase's Jamie Dimon gave a terrific commencement address to Syracuse University's graduating class of 2010 on May 16, 2010. The speech was on accountability - both individual and external.

Some highlights include [full text below]:

Acquiring knowledge must be a life-long pursuit—it should never end. You learn by reading—read everything, all the time—and by talking to and watching other people. And you especially learn by listening to the arguments on the other side.

It's your job to constantly learn and develop informed opinions as you move forward in your lives. There are some very thoughtful people out there, and reading their views and analysis will help educate you.

...

Also, make sure you have friends and colleagues who will always bring you back to earth when you—like we all do at times -- are deceiving yourself.

In business and in life, it is very important to both be a truth-teller for others and to surround yourself with those who will be truth-tellers for you.

...

It takes knowing how to deal with failure to be accountable.

...

this wonderful country whose bounties we benefit from, was built by so many people who made endless and often the ultimate sacrifices… before we were even born.

It is important to respect what they have done and to be grateful for it…

[TILB adds that this also means we have to defend what we have, what those before us have given us, and not allow it to be taken away by the Wormwoods and thieves that purport to be something else]

Finally, we fully agree with this statement:

If you continue to be successful and go on to become a leader of people, that is the time when it becomes about them and not you. Leadership is an honor, and a privilege and a deep obligation.

Throughout your lives you will meet people who may not be as smart, talented and skilled as you. They may not have had all of the benefits that you have had. But many are doing the best they can possibly do… and they take great pride in doing their part well.

Being accountable to them requires a grace and generosity of spirit… it requires compassion and treating all with respect… from CEO to clerks… and it requires giving back.

Jamie Dimon - Syracuse - May 16 2010

SCHWARZIES!!!!

2010-06-15T17:36:00.004-04:00

Ah, it feels so good. Long time TILB readers know that last year we had something of an obsession with California's 2009 vintage scrip, which we named Schwarzies.

Well, today we read an article (linked here) from Bloomberg which says California is not close to passing a budget and it will run out of cash by end of August. The article goes on to discuss how state legislators will (yet again) violate the state constitution and not provide a proposed budget to the Governator by midnight tonight (June 15th). This is perhaps our favorite quote of the year:

“We’re working on it,” said Alicia Trost, a spokeswoman for Senate President Darrell Steinberg, a Democrat from Sacramento. “The most important thing is that we have a fair and balanced budget instead of getting it done by a constitutional deadline.”

I know, right? I mean, like, who needs, like, to follow the constitution thingy?

In any case, in honor of hints of renewed Schwarzie issuance, the author of Directive 10-289 and friend of TILB sent along this song to celebrate the moment. Enjoy.

You are now about to witness the strength of Wall Street knowledge

Verse One: Arnie

Straight outta Sactown, crazy governator with his lats blown
From the gang called IOU
When I'm called out I get politically put out
Flex the pecs and raise the Tax no doubt
You too boy if don’t pay me
The police are gonna hafta come and get ya out of Cali
Off yo ass that's how I'm goin out
For the punk Kalifornians that's showin out
SoCal start to mumble, NoCal wanna rumble
Mix em and cook em in a pot like gumbo
Goin off on a governator like that
with a gat that's pointed at yo cash
So give it up smooth
Ain't no tellin when I'm down for a jack move
Here's a financial rap to keep you dancin'
with a debt record like Greece Athens
Schwarzie is the tool
Don't make me act the no payin' fool
Me you can go toe to toe, no maybe
I'm knockin' playas out tha box, daily
yo weekly, monthly and yearly
until them dumb democrats see clearly
that I'm down with the capital I.R.S.
Boy you can't play with me
So when I'm in your neighborhood, you better duck
Coz Arnie is pumped up like a buck
As I leave, believe I'm issuin, something missin'
but when I come back, boy, I'm comin straight outta Sactown.

Genius.

In case anyone wants the original, it's Ice Cube's opening verse to Straight Outta Compton.

Pershing Square's Bill Ackman On GGP - May 2010 Update

2010-06-07T14:28:00.003-04:00

Bill Ackman of Pershing Square presented at the May 26, 2010 Ira Sohn Conference. In addition to opining on the ratings industry (see here), he spent 90 slides briefing the audience on why GGP is an attractive long investment. Long time TILB readers know that we have extensively covered Ackman, Hovde and Tilson's views on GGP and the resulting back and forth (and back and forth...and back...and forth...). Ackman lays out here why he thinks GGP still has a lot of value for shareholders.

Enjoy.
GGP - Ackman Presentation at Ira Sohn Monference - May 2010

Pershing Square's Bill Ackman's Ira Sohn Presentation On The Ratings Agencies

2010-06-03T13:58:00.004-04:00

Bill Ackman of Pershing Square Capital Management gave this presentation at the May 2010 Ira Sohn conference. He also gave an excellent presentation on General Growth Properties (GGP), though that presentation is not included here. This ratings agency pitch provides his assessment of how to "save" the ratings agencies (Moody's, S&P, Fitch) by modifying their incentive structure and limiting their ability to consolidate power. Having read Christine Richard's book on Ackman's justified holy jihad against the monolines (MBIA in particular), I understand why the man hates him some ratings agencies. Over and over, he gave the NRSROs detailed warnings that the monolines (which were misrated AAA) were ticking timebombs, and over and over the agencies listened and then promptly ignored him (largely due to their own perverse incentives).

Go get 'em, Bill.

Wait to Rate - Bill Ackman Presentation on Ratings Agencies - Ira Sohn - May 2010

Vaclav Klaus On The Failure Of The Euro Experiment

2010-06-01T16:04:00.005-04:00

TILB Political Hall of Famer Vaclav Klaus, president of the Czech Republic, makes the point that "the Euro Zone has failed" in today's WSJ OpEd section. I could not agree more. Oh, to have Klaus as our president here stateside...

Below is the OpEd in its entirety and here is a link to the WSJ online site itself. The OpEd is basically a reprinting of an essay that he recently published via the Cato Institute (link here).

ESSAY - The Wall Street Journal
JUNE 1, 2010
'The Euro Zone Has Failed'
By VáCLAV KLAUS

After the fall of communism in 1989, the Czech Republic wanted to be a normal European country again as soon as possible, after being excluded from participating in the post-World War II European integration process for 41 years. The only way to achieve this was to become a member country of the European Union. We had no other choice, but the communist experience was still too "fresh." We wanted to be free and didn't want to lose our freedom and our finally regained sovereignty. Many of us were therefore in favor of a looser form of European integration, against the so-called deepening of the EU and against the creation of political union in Europe. People like me understood very early that the idea of a European single currency is a dangerous project which will either bring big problems or lead to the undemocratic centralization of Europe. My position was clear: With all my reservations, we had to apply for EU membership, but at the same time we had to fight against projects such as the euro.

As a long-standing critic of the idea of a European single currency, I have not rejoiced at the current problems in the euro zone because their consequences could be serious for all of us in Europe—for members and non-members of the euro zone, for its supporters and opponents. Even the enthusiastic propagandists of the euro suddenly speak about the potential collapse of the whole project now, and it is us critics who say we have to look at it in a more structured way.

The term "collapse" has at least two meanings. The first is that the euro-zone project has not succeeded in delivering the positive effects that had been rightly or wrongly expected from it. It was mistakenly and irresponsibly presented as an indisputable economic benefit to all the countries willing to give up their own long-treasured currencies. Extensive studies published prior to the launch of the European single currency promised that the euro would help to accelerate economic growth and reduce inflation and stressed, in particular, that the member states of the euro zone would be protected against all kinds of external economic disruptions (the so-called exogenous shocks).

This has not happened. After the establishment of the euro zone, the economic growth of its member states has slowed down compared to previous decades, increasing the gap between the rate of growth in the euro-zone countries and that in other major economies—such as the United States and China, smaller economies in Southeast Asia and other parts of the developing world, as well as Central and Eastern European countries that are not members of the euro zone.

Economic growth in Europe has been slowing down since the 1960s, thanks to the increasingly damaging economic and social system which started dominating Europe at that time. The European "soziale Marktwirtschaft" is an unproductive variant of a welfare state, of state paternalism, of "leisure" society, of high taxes and low motivation to work. The existence of the euro has not reversed that trend. According to the European Central Bank, the average annual rate of growth in the euro-zone countries was 3.4% in the 1970s, 2.4% in the 1980s, 2.2% in the 1990s and only 1.1% from 2001 to 2009 (the decade of the euro). A similar slowdown has not occurred anywhere else in the world (speaking about "normal" countries, e.g. countries without wars or revolutions).

Not even the expected convergence of inflation rates has taken place. Two distinct groups have formed within the euro zone—one (including most of the countries of western and northern Europe) with a low inflation rate and one (including Greece, Spain, Portugal and Ireland) with a higher inflation rate. We have also seen an increase in long-term trade imbalances. There are countries where exports exceed imports and countries that lastingly import more than they export. It is no coincidence that the latter countries also have higher inflation. It has no connection with the world-wide crisis. This crisis "only" escalated and exposed longtime hidden economic problems; it did not cause them.

During its first 10 years, the euro zone has not led to any measurable homogenization of its member states' economies. The euro zone, which comprises 16 European countries, is not an "optimum currency area" as defined by the economic theory. Even Otmar Issing, the former member of the Executive Board and chief economist of the European Central Bank, has repeatedly pointed out (most recently in a speech in Prague in December 2009) that the establishment of the euro zone was primarily a political, not an economic, decision. In such a situation, it is inevitable that the costs of establishing and maintaining it exceed its benefits.

My choice of the words "establishing" and "maintaining" is not accidental. Most economic commentators were satisfied by the ease and apparent inexpensiveness of the first step (the establishment of the common monetary area). This helped to form the impression that everything was fine with this project.

The exchange rates of the countries joining the euro zone probably more or less reflected the economic reality at the time when the euro was born. However, over the last decade, the economic performance of euro-zone countries diverged and the negative effects of the "straight-jacket" of a single currency have become more and more visible. When "good weather" (in the economic sense of the word) prevailed, no visible problems arose. Once the crisis (or "bad weather") arrived, the lack of homogeneity manifested itself very clearly. In that sense, I dare say that—as a project that promised to be of considerable economic benefit to its members—the euro zone has failed.

The second meaning of the term collapse is the possible collapse of the euro zone as an institution, the demise of the euro. To that question, my answer is no, it will not collapse. So much political capital had been invested in its existence and in its role as a "cement" that binds the EU on its way to supra-nationality that in the foreseeable future the euro will surely not be abandoned.

It will continue, but at a very high price—low economic growth. It will bring economic losses even to non-members of the euro zone, like the Czech Republic.

The huge amount of money that Greece will receive can be divided by the number of the euro-zone inhabitants, and each person can calculate his or her own "contribution." However, the "opportunity" costs arising from the loss of a potentially higher growth rate, which is much more difficult for a non-economist to imagine, will be far more painful. I do not doubt that for political reasons this price will be paid and that the euro-zone inhabitants will never find out just how much the euro truly cost them.

The mechanism that will save the European monetary union is the increasing volume of financial transfers that will have to be sent to euro-zone countries suffering from the biggest economic and financial problems. Yet everyone knows that sending massive financial transfers is possible only in a state, and the EU, or the euro zone, is not a state. Only in a state there is a sufficient feeling of solidarity among its citizens. Only in a state—and unified Germany in the 1990s is an excellent example—can massive financial transfers be justified and made politically viable. (By the way, the inter-German financial transfers in that era annually equaled the whole sum potentially needed for Greece to survive). Twenty years ago, I happened to be the minister of finance in a dissolving political—and monetary—union called Czechoslovakia. I have to confess that the country broke up because of the lack of mutual solidarity.

That is why Europe will have to decide whether to centralize itself politically as well. Europeans don't want that because they know (or at least feel) that it would be to the detriment of liberty and prosperity. There is, however, a real danger that the politicians will do it anyway—behind the backs of those who elected them. And this is what bothers me most. The recent dealings in EU headquarters in Brussels—literally behind closed doors—about the aid package for Greece demonstrated that there is no democracy there. The German-French tandem made the decision on behalf of the rest of the euro-zone countries, and I am afraid this will continue.

It is evident that the euro—the European single currency—and the currently proposed measures to save the euro do not represent any "salvation" for the European economy. In the long run, it can be saved only by a radical restructuring of the European economic and social system. My country had a velvet revolution and made a radical transformation of its political, economic and social structures. Fifteen years ago, I sometimes joked that after entering the EU we should start a velvet revolution there as well. Unfortunately, this ceases to be a joke now.

The Czech Republic has not made a mistake by avoiding the membership in the euro zone. I am glad we are not the only country taking that view. In April, the Financial Times published an article by the late governor of the Polish central bank, Slawomir Skrzypek. He wrote it shortly before his tragic death in an airplane crash near Smolensk, Russia. In that article, Mr. Skrzypek wrote, "As a non-member of the euro, Poland has been able to profit from flexibility of the zloty exchange rate in a way that has helped growth and lowered the current account deficit without importing inflation." He added that "the decade-long story of peripheral euro members drastically losing competitiveness has been a salutary lesson." There is no need to add anything to that.

Václav Klaus has served as president of the Czech Republic since 2003

[click here for video of an excellent interview with Klaus by Peter Robinson from 2009]

FrontPoint's Steve Eisman's Speech And Presentation From Ira Sohn Conference

2010-05-27T13:25:00.005-04:00

This is Steve Eisman's excellent presentation and speech from the May 2010 Ira Sohn Conference on why much of the for profit education space is a short. He specifically talks about ITT Education, APOL, WPO and COCO. He makes the analogy between these business models and the subprime debacle. The first 40 or so pages are the actual presentation and the last several pages are the text of his speech. We recommend reading the speech first, then digging through the presentation. Our notes on Eisman's talk are here.

You may know Eisman from his fame calling the financial collapse and shorting subprime securities as well as many of the links into subprime (e.g., originators, banks, etc.). Michael Lewis profiled Eisman (and Burry and others) in his new book The Big Short.

This whole industry is so dirty, it's easy to see how government regulation is the only way that it is sustained. Munger and others often talk about buying businesses that are good for their whole ecosystem (suppliers, employees, customers, and owners). Much of the for profit education system is actually a shitshow for huge portions of its ecosystem, most importantly its customers. Typically those sorts of businesses can only exist and thrive with the help of government's Visible Fist.

Anyway, read the speech first (near the end of the slide deck) then review the slides. Eisman's speech is titled, "Subprime Goes to College."
Steve Eisman - Ira Sohn Conference - May 2010

David Einhorn Complete Ira Sohn Conference Speech

2010-05-27T13:01:00.005-04:00

As we discussed here and here, at yesterday's Ira Sohn Conference, David Einhorn gave a speech entitled "Good News for the Grandchildren" about why sovereign debts, huge structural budget deficits, and debt monetization/QE/quantitative easing will matter for our generation and will have to be dealt with well before our grandkids' time.

It was an excellent speech. Below is the unabridged version. Enjoy. Think gold.

David Einhorn - Greenlight Capital - Ira Sohn Conference Speech 2010 - Good News For The Grandchildren

David Einhorn OpEd: NY Times - Easy Money, Hard Truths

2010-05-27T09:12:00.003-04:00

TILB friends know that we have followed Greenlight Capital's David Einhorn for years. A year and a half ago, when he first began to publicly disclose his position in gold, we took note.

As we reported from yesterday's Ira Sohn Conference, Einhorn gave a presentation called "Good News for the Grandchildren" (implying that the debt crisis will manifest itself in our generation, not theirs). In today's NY Times, he basically provided them with a slightly modified version of the speech as an OpEd.

Here is the OpEd from the NY Times. Because it's basically the transcript of a speech he gave yesterday, we provide it below in its entirety. Please support the NY Times, one of TILB's favorite newspaper.

Op-Ed Contributor
NY times
Easy Money, Hard Truths
By DAVID EINHORN
Published: May 26, 2010

Before this recession it appeared that absent action, the government’s long-term commitments would become a problem in a few decades. I believe the government response to the recession has created budgetary stress sufficient to bring about the crisis much sooner. Our generation — not our grandchildren’s — will have to deal with the consequences.

According to the Bank for International Settlements, the United States’ structural deficit — the amount of our deficit adjusted for the economic cycle — has increased from 3.1 percent of gross domestic product in 2007 to 9.2 percent in 2010. This does not take into account the very large liabilities the government has taken on by socializing losses in the housing market. We have not seen the bills for bailing out Fannie Mae and Freddie Mac and even more so the Federal Housing Administration, which is issuing government-guaranteed loans to non-creditworthy borrowers on terms easier than anything offered during the housing bubble. Government accounting is done on a cash basis, so promises to pay in the future — whether Social Security benefits or loan guarantees — do not count in the budget until the money goes out the door.

A good percentage of the structural increase in the deficit is because last year’s “stimulus” was not stimulus in the traditional sense. Rather than a one-time injection of spending to replace a cyclical reduction in private demand, the vast majority of the stimulus has been a permanent increase in the base level of government spending — including spending on federal jobs. How different is the government today from what General Motors was a decade ago? Government employees are expensive and difficult to fire. Bloomberg News reported that from the last peak businesses have let go 8.5 million people, or 7.4 percent of the work force, while local governments have cut only 141,000 workers, or less than 1 percent.

Public sector jobs used to offer greater job security but lower pay. Not anymore. In 2008, according to the Cato Institute, the average federal civilian salary with benefits was $119,982, compared with $59,909 for the average private sector worker; the disparity has grown enormously over the last decade.

The question we need to ask is this: If we don’t change direction, how long can we travel down this path without having a crisis? The answer lies in two critical issues. First, how long will the capital markets continue to finance government borrowings that may be refinanced but never repaid on reasonable terms? And second, to what extent can obligations that are not financed through traditional fiscal means be satisfied through central bank monetization of debts — that is, by the printing of money?

The recent United States credit crisis was attributable in large measure to capital requirements and risk models that incorrectly assumed AAA-rated securities were exempt from default risk. We learned the hard way that when the market ignores credit risk, the behavior of borrowers and lenders becomes distorted.

It was once unthinkable that “risk-free” institutions could fail — so unthinkable that the chief executives of the companies that recently did fail probably didn’t realize when they crossed the line from highly creditworthy to eventually insolvent. Surely, had they seen the line, they would, to a man, have stopped on the solvent side.

Our government leaders are faced with the same risk today. At what level of government debt and future commitments does government default go from being unthinkable to inevitable, and how does our government think about that risk?

I recently posed this question to one of the president’s senior economic advisers. He answered that the government is different from financial institutions because it can print money, and statistically the United States is not as bad off as some other countries. For an investor, these responses do not inspire confidence.

He went on to say that the government needs to focus on jobs now, because without an economic recovery, the rest does not matter. It’s a valid point, but an insufficient excuse for holding off on addressing the long-term structural deficit. If we are going to spend more now, it is imperative that we lay out a credible plan to avoid falling into a debt trap. Even using the administration’s optimistic 10-year forecast, it is clear that we will have problematic deficits for the next decade, which ends just as our commitments to baby boomers accelerate.

Modern Keynesianism works great until it doesn’t. No one really knows where the line is. One obvious lesson from the economic crisis is that we should get rid of the official credit ratings that inspire false confidence and, worse, are pro-cyclical, aggravating slowdowns and inflating booms. Congress has a rare opportunity in the current regulatory reform effort to eliminate the rating system. For now, it does not appear interested in taking sufficiently aggressive action. The big banks and bond buyers have told Congress they want to continue the current system.

As William Gross, the managing director of the bond management company Pimco, put it in his last newsletter, “Firms such as Pimco with large credit staffs of their own can bypass, anticipate and front run all three [rating agencies], benefiting from their timidity and lack of common sense.”

Given how sophisticated bond buyers use the credit rating system to take advantage of more passive market participants, it is no wonder they stress the continued need to preserve the status quo.

It would be better to have each investor individually assess credit-seeking entities. Certainly, the creditworthiness of governments should not be determined by a couple of rating agency committees.

Consider this: When Treasury Secretary Timothy Geithner promises that the United States will never lose its AAA rating, he chooses to become dependent on the whims of the Standard & Poor’s ratings committee rather than the diverse views of the many participants in the capital markets. It is not hard to imagine a crisis where just as the Treasury secretary seeks buyers of government debt in the face of deteriorating market confidence, a rating agency issues an untimely downgrade, setting off a rush of sales by existing bondholders. This has been the experience of many troubled corporations, where downgrades served as the coup de grâce.

The current upset in the European sovereign debt market is a prequel to what might happen here. Banks can hold government debt with a so-called zero-risk weighting, which means zero capital requirements. As a result, European banks stocked up on Greek debt, and sold sovereign credit default swaps, and now need to be bailed out to avoid another banking crisis.

As we saw first in Dubai and now in Greece, it appears that governments’ response to the failure of Lehman Brothers is to use any means necessary to avoid another Lehman-like event. This policy transfers risk from the weak to the strong — or at least the less weak — setting up the possibility of the crisis ultimately spreading from the “too small to fails,” like Greece, to “too big to bails,” like members of the Group of 7 industrialized nations.

We should have learned by now that each credit — no matter how unthinkable its failure would be — has risk and requires capital. Just as trivial capital charges encouraged lenders and borrowers to overdo it with AAA-rated collateral debt obligations, the same flawed structure in the government debt market encourages and therefore practically ensures a repeat of this behavior — leading to an even larger crisis.

I don’t believe a United States debt default is inevitable. On the other hand, I don’t see the political will to steer the country away from crisis. If we wait until the markets force action, as they have in Greece, we might find ourselves negotiating austerity programs with foreign creditors.

Some believe this could be avoided by printing money. Despite the promises by the Federal Reserve chairman, Ben Bernanke, not to print money or “monetize” the debt, when push comes to shove, there is a good chance the Fed will do so, at least to the point where significant inflation shows up even in government statistics.

That the recent round of money printing has not led to headline inflation may give central bankers the confidence that they can pursue this course without inflationary consequences. However, printing money can go only so far without creating inflation.

Government statistics are about the last place one should look to find inflation, as they are designed to not show much. Over the last 35 years the government has changed the way it calculates inflation several times. According to the Web site Shadow Government Statistics, using the pre-1980 method, the Consumer Price Index would be over 9 percent, compared with about 2 percent in the official statistics today.

While the truth probably lies somewhere in the middle, this doesn’t even take into account inflation we ignore by using a basket of goods that don’t match the real-world cost of living. (For example, health care costs are one-sixth of G.D.P. but only one-sixteenth of the price index, and rising income and payroll taxes do not count as inflation at all.)

Why does the government understate rising costs? Low official inflation benefits the government by reducing inflation-indexed payments, including Social Security. Lower official inflation means higher reported real G.D.P., higher reported real income and higher reported productivity.

Subdued reported inflation also enables the Fed to rationalize easy money. The Fed wants to have low interest rates to fight unemployment, which, in a new version of the trickle-down theory, it believes can be addressed through higher stock prices. The Fed hopes that by denying savers an adequate return in risk-free assets like savings deposits, it will force them to speculate in stocks and other “risky assets.” This speculation drives stock prices higher, which creates a “wealth effect” when the lucky speculators spend some of their gains on goods and services. The purchases increase aggregate demand and lead to job creation.

Easy money also aids the banks, helping them earn back their still unacknowledged losses. This has the perverse effect of discouraging banks from making new loans. If banks can lend to the government, with no capital charge and no perceived risk and earn an adequate spread, then they have little incentive to lend to small businesses or consumers. (For this reason, higher short-term rates could very well stimulate additional lending to the private sector.)

Easy money also helps the fiscal position of the government. Lower borrowing costs mean lower deficits. In effect, negative real interest rates are indirect debt monetization. Allowing borrowers, including the government, to get addicted to unsustainably low rates creates enormous solvency risks when rates eventually rise.

While one can debate where we are in the recovery, one thing is clear — the worst of the last crisis has passed. Nominal G.D.P. growth is running in the mid-single digits. The emergency has passed and yet the Fed continues with an emergency zero-interest rate policy. Perhaps easy money is still appropriate — but a zero-rate policy creates enormous distortions in incentives and increases the likelihood of a significant crisis later. It was not lost on the market that during this month’s sell-off, with rates around zero, there is no room for further cuts should the economy roll over.

EASY money has negative consequences in addition to the risk of inflation and devaluing the dollar. It can also feed asset bubbles. In recent years, we have gone from one bubble and bailout to the next. Each bailout has rewarded those who acted imprudently. This has encouraged additional risky behavior, feeding the creation of new, larger bubbles.

The Fed bailed out the equity markets after the crash of 1987, which fed a boom ending with the Mexican crisis and bailout. That Treasury-financed bailout started a bubble in emerging market debt, which ended with the Asian currency crisis and Russian default. The resulting organized rescue of Long-Term Capital Management’s counterparties spurred the Internet bubble. After that popped, the rescue led to the housing and credit bubble. The deflationary aspects of that bubble popping created a bubble in sovereign debt, despite the fiscal strains created by the bailouts. The Greek crisis may be the first sign of the sovereign debt bubble bursting.

Though we don’t know what’s going to happen next, the good news for our grandchildren is that we will have to face our own debts. If we realize that our own future is at risk, we might be more serious about changing course. If we don’t, Mr. Geithner and others might regret having never said never about America’s rating.

David Einhorn is the president of Greenlight Capital, a hedge fund, and the author of “Fooling Some of the People All of the Time.” Investment accounts managed by Greenlight may have a position (long or short) in the securities discussed in this article.

A version of this op-ed appeared in print on May 27, 2010, on page A35 of the New York edition

Ira Sohn Recap

2010-05-27T08:40:00.005-04:00

We attended the Ira Sohn conference yesterday for the Tomorrow's Children's Fund. Klarman, Tepper, Arbess, Einhorn, Ackman, Dinan, Robbins, Zell, Eisman, Jacobson, S-Ratt, Grantham, and Niall Ferguson. In summary, this was by far the most macro oriented conference we've ever seen from a bunch of largely "bottoms up" investors.

Below are two sets of notes. One from your intrepid TILB author and the other from BTIG's Mike O'Rourke. O'Rourke writes BTIG's must read "Bedtime with BTIG" every night. While we are not much for technical trading, he provides technical insights and recaps that give a concise, useful review of the day past and preview of the day ahead. In any case, here are the notes. In both cases, these are not exact transcriptions. Also, sadly TILB had to leave in the middle of S-Ratt's brutal pack of lies, causing us to miss Larry Robbins, Bill Ackman, and Seth Klarman. Fortunately for you, O'rourke didn't leave and has complete notes. O'Rourke's notes are first, our's follow.

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BTIG Notes - Ira Sohn
Posted on Thu, May 27th, 2010 at 7:17 am
by Mike O'Rourke

This is a summary of ideas expressed at the 15th Annual Ira W. Sohn Investment Research Conference.
The Ira Sohn Research Conference Foundation is dedicated to the treatment and cure of pediatric cancer and other childhood diseases.
NOTE: The notes below were taken in real time, but we apologize in advance for any transcription errors. THESE ARE THE OPINIONS OF THE SPEAKERS, BTIG DOES NOT AGREE OR DISAGREE WITH ANY OF THE STATEMENTS.

Jonathon Jacobson, Highfields Capital Management
Highfields is a long term value investor. Jacobson is worried about the current investment environment. Despite all of the looming macro headwinds the biggest threat is the “Clowns & Climate in Washington D.C.” Several states are hovering on the edge of bankruptcy and we the taxpayers will wind up paying for those losses. The administration has embarked upon a process of rolling vilification of industry after industry, Health Care, financial Services, Energy, Cable, Soft Drink, etc. The perception in Washington is that if someone has done well in this country, it was done at someone else’s expense. Rather than address the issues politicians will continue to “kick the can down the road.” Fundamentals are hard to handicap when the rules are constantly changing.

Jacobson is bullish on Sallie Mae (SLM). The company is currently misunderstood by the market because it is in transition from being a lending based company to a fee based company. The key point is if Sallie Mae were strictly in a run off mode as the government ends cuts back the FFELP program (which they are not) it would be worth $15, even with a conservative 12% discount rate. It currently has a $5 Billion market capitalization and is trading 2x pre-tax, pre-provision earnings and is trading 4x pre-tax earnings. Most competitors have gone out of business or in the process of exiting the business. Jacobson believes Sallie Mae is worth somewhere between $15-$25 per share. In 2011 he is forecasting $0.80 -$1.00 in earnings power. Additionally the company is well positioned to acquire additional servicing rights as competitors exit the business. Sallie Mae is larger than the 3 other government approved student loan servicers combined. Management is acquiring stock and aligning their interests with shareholders. 87% of the balance sheet is funded to term. Credit losses peaked in Q3 2009. Main risk is regulatory, but if management believes the best move for shareholders is to liquidate the company, they will.

Sam Zell
The theme of the election was change. A major change has occurred within the American economy. One party political dominance is changing how investors will act in the future. It is an environment of survival of the fittest. Zell presented a music video that was an ode to Charles Darwin. Extinction is for those who do not adapt and evolve. The winner is the one who builds the better boat, not the one who rearranges the deck chairs. He who adapts succeeds.

Dan Arbess, Perella Weinberg Partners
The foundations of the global economy are shifting. Fiscal imbalance and sovereign risk are only symptoms of the problems that will fuels this change. The trend of deficit spending over-consumption in the west and the export driven production of the east needs to reverse. Consumption in the east must rise and the west must exercise restraint to bring a semblance of balance back. Macro squalls can wreak havoc on a portfolio, so effective hedging strategies are important. The key them Arbess proposed was “Shaking hands with China.” The way to play the theme is to be long those companies who sell China what it needs and short those who make products that the Emerging Markets can make better. Consumption is only 35% of GDP in China, half of what it is here and the Chinese save half of what they make. China alone will increase its urbanization rate from 46% to 58%, adding 210 million urban residents in 70 million households. They need a lot of stuff to urbanize 20 million people a year, and Arbess wants to be long the guys who will be selling it to them.
Arbess believes weaker currencies and weaker sovereign credits should be sold. He is bearish on the Euro and on EU sovereign debt. This is the endgame of the debt supercycle and confidence in fiat currencies will erode, as such he likes Gold. The deflationary economic environment will lead to monetary debasement. The irony today is post-Maoist China has no entitlements and needs to create some to boost domestic consumptions and the U.S. more entitlements than ever.

He likes commodities and the commodity nations in the G-20 and even Africa, both fundamentally and as a currency debasement hedge. He says own junior mining companies that own big assets close to their customers. These will often start out trading at discounts as much as 90% to their cash flow potential, and often show less downside beta than large caps.

Arbess likes Ivanhoe mines (IVN). Its vast copper and other mineral deposits in Mongolia are close to the same size as Manhattan. Noncore assets are worth half of the current market capitalization of the company. Rio Tinto is a key partner of Ivanhoe, and its presence reduces the risk for the investor. Rio recently purchased shares above the current price levels Backing out the coal business and other peripheral assets, the stock at its current price around $13 creates the copper mine at less than $2.5 billion, which is less than half of what it’s worth on an NPV basis, and a tiny fraction of inground metal value, assuming $2.50 long term copper and $1000 gold. At recent commodity prices, Arbess thinks the stock could be worth up to $30 to Rio.

Arbess also noted Solution (SOA) and Celanese (CE) as other ways to play his theme and believes both have 50% upside from current levels. Another name he likes is YUM Brands (YUM) who had 37% growth in China last year. China’s successes of the last 30 years are real and the country is fiscally strong with $2.5 Trillion in reserves and fiscal responsibility. Another play on his theme is shorting the Japanese Yen versus the Canadian Dollar. Japan is shrinking while its debt is growing, exactly the opposite of the urbanizing emerging markets. Canada, by contrast, has arguably the soundest economy in the G-7. No coincidence, they really don’t like leverage up there. And the country is rich in Shake Hands With China resources. This is the end of the buy now and pay later mentality. The global rebalancing process will be messy, but it will also be rife with opportunity.

David Tepper, Appaloosa ManagementTepper started with an anecdote about the horse “output” problem in 19th century New York City and forecast that city would be buried under horse excrement . The moral of his story was “don’t listen to the crap.” Tepper was highlighting that the world changes and evolves and people and societies adapt. Tepper noted that everyone of the “PIIGS” has instituted austerity programs, something many would not have believed would happen. He mentioned the ECB buying debt despite its conservative Bundesbank roots and the Spanish Government shutting down the largest Caja run by the Roman Catholic church. All of these things at one point seemed unthinkable, but this is society adapting to the situation.

Tepper likes the AIG-8.175% Junior Subordinated Debt. It is trading at $0.72 on the dollar giving it a current yield of 11%. Right now there is $73 Billion of capital structure below it $49 Billion in Preferred and $24 Billion in equity. He thinks those two combined are really only worth $40 Billion. He warned that this did not mean the equity is worth zero, there is some option value and a conversion of government preferred into common could distort a capital structure arbitrage if set up. Tepper says AIG has $9 Billion of EBIT and other assets worth $45 Billion.
Tepper noted there are opportunities in the CMBS market. He said what you should really care about in the CMBS market is “Can they make the coupon?” These are 10 year securities and if they can make the coupon you should ask what will the environment be in 2016? You should not be looking at today, you should be looking at the future.

Tepper still likes Bank of America (BAC). He believes normalized earnings are $2.65-$2.70 per share and has a $27 price target. He also likes Banco Santander (STD). it is one of a handful AA rated banks in the world (no major U.S. bank is as high as AA). Only 30% of the banks exposures are to Spain, it is really an Emerging Market/Global play. They will earn $1.50 and that has the potential to double. Tepper concluded noting that 2000 was the beginning of the end and that today we are at the end of the beginning.

Niall Ferguson, Harvard University
Ferguson proposed being “Long virtue.” Focusing on nations with good fiscal situations as opposed to the overly indebted Western governments. Citing Bank of International Settlements long term forecasts Ferguson highlighted Pigs “R” Us. Which means that the U.S. and the U.K. are in equally precarious fiscal situations as the “PIIGS.” Ferguson noted that 40% of U.S. Debt is short term and that type of duration leaves one open to roll risk. “U.S. Debt is a safe haven similar to the way Pearl Harbor was.” Ferguson highlighted the “good boys, ” nations with better fiscal situations. Topping the list was Norway with net debt of -140% of GDP due to the nations effective management of its oil reserves. Other good boys were Sweden, Denmark and Switzerland. The U.S. leaves itself at risk by being highly reliant upon foreign capital.

Steve Eisman, Frontpoint
Eisman’s theme was “Subprime goes to College.” After what transpired in the subprime mortgage market a few years ago, Eisman though he would never see a business with the capability to prey upon the underprivileged to those extremes again. Then he came across the For Profit Education industry. Despite only having 10% of the students these schools get 25% of the government aid. The industry is in bed with Washington due to serious lobbying efforts and the back and forth of executives from the companies to Government positions and back. Title IV loans offered by government programs comprise 90% of for profit education revenues.

ITT Educational (ESI) has higher margins than Apple (AAPL), and margins in the for profit education industry are 3-4 times those in other industries that deal with the government. For profit schools target poorer people, often leading them towards degrees that won’t get them jobs. The companies also maneuver to acquire small failing schools in order to get their accreditation. The loans the students take out for profit education have high default rates. ESI and Corinthian (COCO) often provision 50%-60% for the loans they privately offer, so the default rates overall are likely 50%. The companies in the industry are Education Management (EDMC), COCO, Apollo Group (APOL) and Washington Post (WPO). WPO, more than 100% of its EBITDA comes from for profit education. Eisman calculates there could be $300 Billion in defaults over the next 10 years. The key catalyst going forward is that the government will publish a rule for gainful employment , that threatens the companies. The government is also seeking to fix the accreditation process.

Jeremy Grantham, GMO
IN GMO’s 7 year forecast U.S. High quality names are aberrantly cheap and should provide 7.6% real return per year. In constructing a portfolio Grantham said it should be 40% U.S. Blue Chips, 20% Emerging Markets and 30% EAFE Blue chips. Grantham notes that bonds are “grotesquely” overpriced predicted to post a real return 1.7% per year. Grantham’s 3 choices or recommendations are Timber which has 7.5% forecasted real annual return. Then Grantham likes Emerging Markets which he believes will go to a premium P/E to the rest of the world. Finally he likes high quality U.S. blue chaps. They are trading at a 17% discount to fair value and 55% of earnings come from around the world.

The bedrock of Grantham’s thinking is that “Things regress to the mean.” Of the 34 bubbles GMO has identified it takes about 3.5 years for the bubble to run up and it comes back down to the trendline nearly as quickly. All bubbles reverse. Grantham believes both the U.K. and Australia are in housing bubbles. The risks to betting against bubbles are career risk and business risk. Grantham believes debt has nothing to do with growth, and debt has less influence than most think. Grantham concluded by noting the importance of the upward bias in the third year of the presidential cycle.

David Einhorn, Greenlight Capital
Einhorn’s theme was “Good news for the Grandchildren.” In essence the fiscal challenges of the United States are so severe that they will need to be dealt with before our grandchildren inherit them. Our own future is at risk. Average public sector pay is nearly double that of private sector pay. Public sector workers “Retire to rehire,” and fuel a system that is heading in the same direction as Greece. Einhorn wonders how long will the capital markets continue to let the U.S. keep borrowing. Nobody knows where the line is, not the Government nor the ratings agencies. A credible plan to avoid the debt trap is necessary. Europe is a prequel to what will happen here.

Einhorn is short the ratings agencies Moody’s (MCO) and McGraw-Hill (MHP). Credit rating agencies provide a false sense of security and are pro-cyclical. Einhorn also questioned the validity of the Government CPI data . Citing Shadowstats, Einhorn noted inflation calculated under the 1980 methodology would be 9%, as opposed to the less the 2% it is today. The lower real rates will fuel inflation and bad behavior and create bubbles. This easy policy of bubble bailouts is an unhealthy cycle.
He believe the lower real rates tempts the central bank to monetize debt. As a hedge against this Einhorn is long Gold as well as African Barrick (ABG LN) . ABG LN trades at ½ the value of its peers, 6x Ebitda and with a 10% free cash flow yield.

James Dinan, York CapitalDinan commenced by noting people adapt, markets adapt and animal spirits prevail. Dinan believes large companies are in good shape. Dinan likes Coca Cola Enterprises (CCE). The company is going through restructuring in which Coca Cola (KO) is giving CCE $10 per share and some European bottling assets in exchange for U.S. bottling assets. Dinan stated Europe is a better place than the U.S. for the bottling business, due to less competition. The deal also gives CCE the option to expand its European footprint. After the deal and receiving the $10 per share new CCE will be $15 and trade 10x earnings and 6x EBITDA. New CCE will have 20% gross upside.

Dinan’s next long idea was ING Groep (ING). ING has a global presence as a bank and insurance company. As part of the bailout the company received during the crisis the company must split its banking and insurance businesses by 2013. The company is currently trading at €6.25 which is .6x book value. Dinan believes it can go to 1x book which would make it worth €8.50-€9.20 per share. The life insurance divestiture could be used to pay back the Government bailout, or it could spin out the insurance business. An 8x-10x P/E multiple on the combined bank and insurance company would make it worth €14-€18.

Dinan also sees opportunity in post bankruptcy equities. Currently one he is investing in is Lyondell (LALLF). Currently the stock is trading below its reorganization plan value. Q1 earnings tracked well ahead of expectations especially in the companies commodity business. A sum of the parts valuation gives Dinan a $22-$28 price target.

Steve Rattner
The former advisor to Treasury on the Auto industry restructuring provided a defense for the Obama Administration’s handling of TARP, the Stimulus (EESA), the Stress Test (SCAP) and the Auto rescue. Rattner said the Administration sought the middle ground on most issues and gave examples of the extreme views in each case.
Regarding the Auto industry restructuring Rattner addressed the question of whether the UAW received more than it deserved. Rattner said that Labor was a critical creditor and all stakeholders received more than they would have in an outright liquidation. Rattner noted that in the Chrysler plan the UAW’s VEBA received 40%-50% of what they were owed. In the GM plan VEBA received 84%-92% of what it was owed. In both cases warranty holders, dealers and trade/suppliers all received 100 cents on the dollar. Rattner used this as an example that the plans sought to protect as much franchise value as possible.

Rattner offered what to expect from the Administration going forward. He said the government will remain involved in the Financial sector. He noted taxes are going up. The Administration has avoided protectionism and is leaving business in the industrial and manufacturing sector alone.

Larry Robbins, Glenview Capital Management
Robbins started asking the question of why is the market’s P/E so low. The 3 potential explanations he offered were the “E” is wrong and estimates could be too high, or “the bigger the D.C. the smaller the P/E.”The last reason and one he highlighted was that it is not a math problem, but it is a psychology problem. He note market participants are suffering from Post Traumatic Stress Disorder.
Robbins noted that individual stocks were one of the best ways to tackle an uncertain environment. He looks for stable earnings growth, potential for multiple expansion and positive optionality. Robbins likes McKesson (MCK). He notes earnings are growing at 18% and it is trading under 11x forward earnings. The company proved it is acyclical by posting growth in Q1 2009. Robbins highlighted he expects MCK to have $5.2 Billion of “Dry Powder.” This is a combination of cash and Free Cash Flow expected to be thrown off over the next 18 months. Robbins also likes Express Scripts (ESRX). Earnings are growing 35% and although that won’t be sustainable it will still continue fast growth. Management has been superior over the past decade in retiring stock. The company is trading 14x 2011 earnings and under 13x Free Cash Flow. Robbins next pick was Life Technologies (LIFE) which is in a consolidating and over capitalized industry. The company has a 80% consumable product mix and is trading 11.5x 2011 earnings. Robbins last pick was Fidelity National Information. The company rebuffed private equity takeover attempt because the price was not high enough and figured they could do the same thing Private Equity planned by doing a leveraged recapitalization. The company is tendering to buy $2.5 Billion of shares , or 22% of the outstanding. Robbins thinks they could have done $3.5 Billion but were being conservative. Earnings grow this 15%-23% and the company is trading under 12x 2011 and 10x Free Cash Flow.

Bill Ackman, Pershing Square
Ackman started by outlining how he believed the credit ratings business should be reformed. The short version is NRSRO’s should not be allowed to rate an issue until 60 days after it comes. That would create a buyside environment that would attempt to handicap what the rating should be using market forces. The underwriter would also need the instrument to hold up in the secondary market and therefore is incentivized to make sure it is a quality product. All relevant information should be disclosed to the market and the ratings agency should disclose its model.
From there Ackman went into GGP part two. GGP will be split into two companies GGP and GGO. GGP will have 200 regional malls. It will have a competitive advantage because 80% of the properties will be single property non-recourse financing . Company owns 31% of Aliansce (ALSC3 BZ) in Brazil. GGP is benefitting from the economic recovery. GGO is where GGP’s noncore assets will go. They include housing development land, land in Hawaii, land on the Las Vegas strip and South Street Seaport. Ackman referred to GGO, that he hopes it to be a mini Berkshire Hathaway. Ackman thinks new GGP will be worth $15 and new GGO will be worth $5. He finished by saying he bought 150 million Citigroup shares but did not give his thesis.

Seth Klarman, Baupost Group
Klarman delivered what would be his opening statement if ever called before Congress. Klarman noted that most people on Wall Street operate honestly, ethically and provide good service. It is the land of caveat emptor and transactions should be entered skeptically. When it comes to the complexity of derivatives, the purchaser should know they will wind up overpaying. There is a culture of compliance. He guides his firm with two rules. The Wall Street Journal Rule, don’t do anything you would not be willing to read about in the WSJ the next day. The second is the football field rule, if run to close to the sideline you increase the risk of running out of bounds, instead cut to the middle. Financial Transactions among consenting adults are an important part of the capitalist system. He has a fiduciary obligation to his clients, not his counterparties. Short sellers are the policemen of the financial markets.

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TILB Notes - Ira Sohn - these are in reverse order because we were emailing them one by one and I'm too lazy to cut and paste to reorder them.

Steve Rattner - ex Quadrangle, Treasury Car Czar, Lazard.

Reflections on crisis. Necessary and appropriate response to crisis. TARP was critically important. Stimulus package - not perfect but good. Stress Test for banks - restored confidence. Auto rescues (detail to come).

Believes Administration deserves credit for finding the middle ground.

Autos: no private capital available. Would have been chpt 9, not chpt 11. Labor was a critical creditor to these companies. Nothing abnormal about different stakeholders getting different recoveries. Believes every creditor received more than they would have in a liquidation. Doesn't believe they abrogated or changed law.

Put $50B into GM and believe it's investment worth $40B today on paper. Deems that 20% loss a success. [TILB: Conveniently left Chrysler out of that analysis]

I can't stand listening to him any further. No more notes on S-Ratt.

Jamie Dinon - York Capital
Don't think end is near. People adapt, societies adapt, etc. Equities are a good place to be if you're worried about that. Flexible, long duration, inflation resistant (albeit perhaps lagged).

Event driven:
CCE (Coke Bottling) - KO buying domestic bottling assets for $10/share. Left with European assets plus KO's Swedish and Norwegian bottlers. European macro for KO better than US - faster growing due to low penetration, better comptttv position vis a vie Pepsi and other bottling competitio, option to buy KO's Germany business as well as potential for other European assets. 6x EBITDA and <10x earnings for the stub. Comps trade at 8x ebitda and 13-15x. Stub at $15 vs comps implied $20-25. Dual listing catalyst. Safe business.

ING - Netherlands global bank. (All numbers in euro). Had Alt-A problems in crisis. Received Dutch bailout. Forced by EU to split insurance from banking. Sum of Parts: insurance - 30% in developed Europe (assume 0.7x bk in developed markets and 1-2x bk in EM, so overall 1x bk assume). Backing out insurance, €9.30 tangible book for bank. Trades today at €6. Deserves better than book, decent bank. Decent banks should trade > book.

Like post-bk equities. "Resurgence" phase.
Lyondell-Basel - ticker: LALLF came out of bk in April. $9.5B mrkt cap. Below plant value and below rejected bid from Reliance. Bk plan calls for 1.8B ebitda in 2010. Did $0.6B in Q1. Specialities business is rock solid and does 1B ebitda like clockwork and was on track in Q1. So the non-specialty business is crushing it if you back into the projections for that business. Apollo is biggest owner. Sum of Parts is $18-22B. Normalized ebitda $3.5B. Put 5-6x multiple on that and big upside.

Liquidation Play: Icelandic bank Keupthenk (spelling sorry). Claims trade at 23c. 25% Yield to Recovery. Base case 39c. Downside 22c. Upside mid 50s. 7th largest bk in history. 27% market price in cash. Most of the balance is performing loans.

David Einhorn: Greenlight
Title "Good News for the Grandchildren" [referring to passing budget debts to grandkids]

Obama knows what he wants to do on every issue in advance, but he wants to start a blue ribbon commission for dealing with debt w/o promising to actually do anything about it.

This won't be our grandchildrens' problem - it will be our generation's problem. The mount of debt is mind-numbing. Gov't acctng is done on a cash basis, so future promises (unfunded mandates/entitlements) aren't even counted yet.

Rails on average public sector worker situation vs private sector. Ridiculous skew of compensation and job security. Amount of gov't workers has now made them a critical voting block.

Questions: 1) how long will capital markets accept this? 2) how much liability can we pay via central bank monetization?

AAA financial instttns collapsed and nobody saw it coming, even as it became inevitable in retrospect. Think of the implication to gov't.

Using The Administration's 10 year forecast which assumes low rates and robust economic growth shows structural deficits through the whole period (just in time for unfunded mandate costs to kick in).

Should get rid of ratings agencies entirely or at least rid of their govt legislated position. Made fun of ratings agencies using their own quotes (especially the sovereign analysts).

Procyclical ratings agencies will cause problems at the worst moment. Ill-timed (from borrower's perspective) downgrade can serve as a coup de gras.

Zero risk weighting for banks to buy gov't debt will massively exacerbate the problem. Practically ensures the problem will spread fast.

Greenlight still short Moody's and McGraw Hill (S+P).

Monetization likely. May even show up in gov't statistics (sarcastically delivered). Recent bout of of QE not showing CPI ramp may have provided central bankers false confidence.

Shadow Stats says pre-1980 methodology would show 9% CPI today vs 2% govt reported. Lots of other stats on bad govt CPI stats.

[Summary from TILB so far - buy gold]

Low rates drives "wealth effect" by driving up capital market asset prices. This is fake.

Failed banks balance sheets most recent financial statements show solvency despite the huge losses fdic takes upon failure. This is almost certainly also true in "solvent" banks. Easy money policy used to bail them out.

Low rates creating an addiction. Japan can't even accept normalization.

If the emergency has passed, why still have 0% rate emergency policy? Negative consequences in addition to debasement/inflation: bubble inflation [malinvestment risk]. Rips Bernanke, etc.

Fed seems to want to create a new bubble. [Goes through history of Greenspan's bubble machine and into Bernanke's sov debt bubble...]

Gold, African Barrick Gold (ABG). ABG trades at half value on nearly every metric (6x ebitda). Believe catalysts include major index inclusion.

Patrick Wolfe (the guy that plays five people blindfolded simultaneously in chess at Berkshire). Announced the new Ira Sohn San Francisco Excellence in Investing in the Fall. Will be an annual event.

Next up, Einhorn

Jeremy Grantham - GMO
Got out of intense company analysis 20 years ago and into the bullshitting business. So here I am.

7 year forecast updated through May 21. S+P 1.5% pa real, high quality is "aborrently" cheap. Small cap expected return negative. [Long quality/short small crap anyone?]

Bonds grotesquely overpriced. EM 6.1% pa.

Timber is his top pick at 6% real. Didn't lose money through great depression. EM is his second place pick. US quality third. Combination "would make quite an interesting portfolio, I think".

US large high quality at cheapest value ever. "And right when we need them!"

Bubbles always make it back to trend. When you see one, it's time to cash in on some of your Career Risk chips. Avg bubble take 3.5 years to form and slightly faster to return to trends.

Took some time to taunt French and Fama. Made fun of Bernanke.

When you find a bubble, fighting it is incredible pain.

Today's bubble? UK Housing bubble is incredibly massive being supported by variable rate financing (Aussie too). UK housing needs to fall nationwide in price by 33%. Aussie needs to fall 42% to trend.

[TILB - Overall, one of most entertaining speakers]

Steve Eisman - Frontpoint
Subprime Goes to College (for profit education shorting)

Basic short thesis on for profit education. Bad companies, gov't in bed with for profit education, nasty selling habits, etc.

Often gov't grants/loans are 90% of revenue. ITT - 40% op mrgn vs 7-12% for typical gov't contractors. Title 4 has accntd for more than 100% of rev growth. Same for Apollo (growth more than 100% from gov't).
Historically, lower means families seek lower cost instttns. Title 4 inverts this needed relationship - hence the subprime analogy.

Further, the industry doesn't successfully educate their students (on average). Calls out CoCo, Apollo and ESI (ITT). Drop out rates 50-100% per year. Quite alarming, particulalry given student debt that accompanies this. Defaults of gov't guaranteed loans skyrocketing, despite industry obfuscation. When industry makes private loans, they provision 50-60% up front.

None of this matters until gov't cuts them off. Unregulated (loosely regulated) sales practices. Also, schools battle being cut-off by controlling accreditation process (akin to ratings agencies) to stay eligible for govt guarantee loans. BPI example shows how for-profits acquire distressed not for profit schools to get their accreditation.

Gov't looking at instituting new requirements. In particular, a Gainful Employment measurement for grads. Will crush APOL even if cut costs by 15% (40% hit to profit in two years), ESI 50%, COCO 40%, EDMC lose massive money due to debt, Washington Post would go from very profitable to overall loss making.

Believes if nothing is done, on the cusp of social disaster.

Niall Ferguson (Harvard).
No investment experience. Pure academic. Kept accidentally referring to David Tepper (prior speaker) as "Steve." Was an KC yesterday at a Kauffman Conference about Expeditionary Economics. Was hopeful it meant sending Paul Krugman to Somalia.

Believe we should be long "virtue". Even if PIGS cut to austere levels, still will be >100% debt to gdp. Guess what: same analysis shows worse for US and UK. PIGS R US.

Metrics of Doom. Shows cyclically adjusted primary balance: US, UK, Greece and Japan are absymal. Lots of other analysis that keeps showing US is "Out-pigging the PIGS" on all sorts of metrics. All his charts basically show is what won't happen. Problems will explode before them.

40% of US federal debt rolls in next 12 months. Treasuries are a safe haven in the same way Pearl Harbor was. Don't expect to hold a 10 year to maturity.

Shows a list of the Good Boys. Switzerland, Australia, NZ, Denmark, Czech, Australia, Canada, Sweden, Norway, etc.

Good way to diversify away from EM. Some of the same concepts but perhaps less China risk.

Don't argue with nasty fiscal arithmitic. Predicts US has Greece problem by 2012-13.

David Tepper: Appaloosa - 30%+ annualized since 1992.

Spoke at conf in 1998 to 75 people.

Was $13B of AUM last month. Now $12B. Oh well.

Wrote a song but not going to sing it.
Story from 1800s: tells story of horseshit problem that Hance also occasionally shares. Crisis from urban horse "output." Crisis happens, markets adapt, people adapt. Most likely won't be hyperinflation or deflation. The ECB bought govt bonds - the Bundesbank - "holy Christ. it's like the chastity belt is off and the girl is starting to play." The world adapts.

Investment ideas:
AIG - small insurance company (har, har). 8.175 jr sub debt. $4B issue. $24B of common equity. $12B of preferred. $9B of EBIT. Has another $40B of jr debt to his bonds which trade at 72c on dollar. So $70+B of jr securities. Maybe not worth $70B, but probably positive value. Govt owns 80% equity. Do your own work.
CMBS: started investing in late-08. Typical: 30% equity in a property (or 10 eq and 20 mezz). In the mortgage AAA 70%, jr AAAs 10% and then another 8% jr AAAs. Cap rate's not the thing. It's "can they make the payment"? No building going on. Bought an AJ the other day near 20% YTM likely to retire at par. Not looking at today, looking at future.

Equity Market: in 98, talked about Kospi and Samsung and Posco. Not bad ideas at that time period. If you want to make a lot of $ today, financials. BAC will make normalized $2.70. We say worth $27. Santandar (we know people hate it). One of 5-6 banks in world still AA. 30% Spain, majority EM, rest US. Double from here.

Thoughts on the world: thinking back to 97-98 period. History rhymes. Initial sov debt crisis. Lagged by Russia default. Then LTCM. Then Fed eased like crazy and market +50% (begining of end of bull mrkt). Maybe today is the end of the beginning. We know what our troubles are and we can attack them. Won't be that bad either way. Somewhere in the middle.

Sings a quick ditty then says, "I'm done."

Dan Arbess - Perella Weinberg Xerion (restructuring expert - (youngest partner ever at White and Case - led their restructuring group)).
Introduced his son who is a Leukemia survivor (6yrs ago). Loud applause.

Unsustainable global growth model of East lending to West for consumption of its production. World must rebalance. No quick fix. East must consume and West must save. This is bigger than 2008. Fear we and our politicians might not be up to the task. Placid macro backdrop may be gone for balance of our careers (he's probably 45). Success demands we be on the right side of global themes and hedged against dark side of those themes.

Themes we like: shake hands with China (buy what China needs). Short overleveraged Western producers. Hedge debasement (precious metals). Used an example of the West as a boiling frog.

Our nation alone owes China a trillion and a half dollars. Gov't taking over private debts through balance sheet contamination process. Every scenario bad for Euro. Bearish on Euro and Euro sov debt. US Treasuries perhaps short term safe haven, but beware. Confidence in fiat paper will erode. Gold and other precious metals. Prepare for stag-asset inflation.

We need to buy less, eat less and study more. Post Mao'ist China has no social entitlements and we have more than we can afford - it's ironic. Prepare for East to rise up and West to shrink down.

Gov't intervention growing and growing (took an explicit swipe at Rattner who is a speaker later in the day - referncing S-Ratt's pressure when Xerion led the Chrysler Holdouts [as a personal aside, hard to brlieve that was only a year ago]).

Like commodity rich nations (including Africa and jr miners).

Ivanhoe Mines ($13/sh). Owns largest undeveloped copper mine and huge met coal assets. Met coal and other non-core assets worth half market cap. Rio Tinto strategic partner that will own 47% of company. Has bought from $10-16. Down 30% this month. Believe copper mine is implied at half NPV value.

Look for good downstream businesses with big mrkt shares and EM presence. Solutia. Like it a lot.

Even further downstream - EM consumer businesses. YUM Brands. Explosive growth in China.

70% of all products sold in WMT made in China [TILB - wow]. Short high cost leveraged balance sheet G-7 producers.

Doesn't believe in China bubble. Formidable competitive advantage and resource base. True that latest stimulus is inefficient but believe urbanization trend and fiscal situation will drive them through that.

Short Yen vs CAD. Summary: Japan is totally f'd. Canada best G-7 economy.

2008 learned banks aren't safe. 2010 even sovereigns may not be. What's next? American innovation and EM globalization will drive the rest of our careers. Rebalancing will be messy and restorative. Loaded with invstmnt opps.

Sam Zell
No particular stock pitch. Here to tell you thoughts on the environment.
Post election theme of change. We have real change. No doubt. We are going to extremes that will impact investors in the future.
Every year since 1976, I've sent/issued an annual gift that has my thoughts on the next year. Here's what I sent this year:
The Survival of the Fittest (played
Extinction from inabikity to adapt. Shakes out weaker and benefits stronger. Ability to look around the corner and see what's coming. "Charlie...Charlie Darwin...sumpin' smells like fear" [autos, tbtf, swaps, etc. all addressed] "the pie got smaller, who will eat, who will be eaten". "The DNA that will endure is the DNA of the entrepreneur."

"So I guess the message, in less than subtle terms is 'he who adapts will succeed, he who doesn't adapt may not be here next year.'"

Short and to the point. Basically a video of his last music box and the song.

Jon Jacobson (Highfields) Went first because Sam Zell wasn't there yet.
20-30 core positions.
Very worried today. Primarily about the "clowns and the climate" in Washington. 50% of those filing tax returns in 2010 will not pay tax. We will be on the hook for state's liabilities. Administration that is fundamentally anti-business with a rolling antagonism and villification of business. There seems to be something wrong with earning acceptable returns and being successful. Worried about class warfare and social unrest down the road.

As excited about the discounts available today in good businesses as ever. But how do you trust the environment when the rules constantly change.

That said, talking about Sallie Mae. Good underlying biz fundamentals and we understand why it's disliked.

2x pre tax, pre provision earnings. 4x pre tax earnings.
6x net income.

Dealt with refinance concerns. Congress eliminated FFELP in the health care reform bill. Despite that loss, still #1 by far.

Worth $15-25/share. Liquidation/runoff vale $15. By 2011, $0.8 - $1 per share earnings. Potential to acquire servicing rights and improve balance sheet $0-$2+/share ($1/share of earnings power is possible). Biggest, most efficient student loan servicer. Dept of Education has SLM as one of four servicers for Fed direct student loans. Bigger than next 3 combined.

Dominates private student loans. Parents co-sign more than 80% of priv student loans.

Most effective collector of defaulted loans. Biggest mngr of 529 plans.

As FFELP goes away, many smaller student lenders will need to shed servicing as they lose scale. SLM well positioned to buy them.

Mgmt totally aligned. Love mgmt. Co. has retired $6B of unsecured debt at attractive prices in last 12 months. CEO buying with his own money, etc.
87% of balance sheet is term funded. Can easily retire maturities as needed. Appropriately capitalized.

SLM legislation risk. Hard to assess. Every company under attack.
Bank Tax risk. Bankruptcy reform. CFPA could become a regulator. Believe mgmt would literally liquidate if that's the best value per share opportunity.

Inflation Nation - Prepare For The Coming Hyperinflationary Dollar Collapse

2010-05-24T15:49:00.005-04:00

Dammit.

TILB has been trying to post less frequently and to have those infrequent posts avoid frustrating topics such as the destruction of our economic and social future. You can understand that.

I've established many times over that nobody cares, so why even keep banging the gong...particularly when it seems I'm banging it with my forehead instead of a mallet?

As an aside, friend of TILB and thief (before I invented it) of the phrase Tooth Fairy Economics Tom Woods makes several appearances in this video as do several other TILB mancrushes like Ron Paul, Peter Schiff, Mark Faber, and Uncle Jimmy Rogers.

This is the best video I've seen since Chris Martenson's Crash Course collection (someday I'll post about that video collection - if you haven't watched it yet, you must stop everything you're doing and spend a few hours watching immediately - link here).

I've been meaning to sit down and write more about the value of money, why price deflation is the natural course of the world (a good thing, btw!), and why not all GDP is created equal, but honestly, it's an emotional drain to reflect on and write about these ideas and it requires more of my head banging the gong. But I'll get to it, because while I'm sure nobody reads this, much less cares, I find the anguish and process of putting myself through it strangely beneficial.

In any case, watch this video and watch the Crash Course. As the great Cypress Hill has warned us so many times, "when the shit goes down, you better be ready...YOU BETTER BE READY!!" Indeed

PS: Please do me a favor and buy some actual, physical gold. It's for your own good.

Hayman Advisor's Kyle Bass: The Pattern Is Set

2010-05-11T23:47:00.006-04:00

As we've said many times, we hate us some dollar and we hate us some yen even more than the dollar. The euro is an enigma. Other fiat currencies are subject - long-term - to the same issues. That leaves us with gold. Apparently Hayman's Kyle Bass agrees with us. This should come as no surprise to long-time TILB readers as we've highlighted Kyle's work/talks several times.

Below is the text of Hayman's most recent letter to its clients following the European debacle this weekend. TILB's immediate reaction was "holy shit, I don't want to own the euro", in spite of most Wall Street participants claiming this was a great showing of support for the euro. Our view was this "show of support" was more akin to a roadmap for self destruction. The euro's rally than recent retrenchment seems to support our initial take.

We lifted the below text it from First Adaptor's blog (click here for First Adaptor). Make sure to follow First Adaptor on Twitter.

The Pattern is Set - Betting the Bank on a Keynesian Free Lunch by Kyle Bass

--------------------------------------------------------------------------------

Dear Investors:

With the avalanche of announcements over the weekend out of Europe and the IMF (and even the US Federal Reserve), I think it is important to communicate our views. The Lisbon Treaty explicitly prohibits direct monetization of fiscal deficits (i.e. printing money out of thin air in order to perpetuate deficit spending) because central bankers are (or I guess at least "were") aware it is the path to severe inflation or even hyperinflation. Just as the Romans did time and time again, the EU has now decided to change from the rule of law to the rule of man when it suits them. With none of the sixteen members of the currency union forecasted to be in compliance with the Maastricht Treaty (the foundation on which the EMU is built) in 2010, today's actions further attempt to eliminate the natural policing role that markets play with respect to egregious economic behavior. It looks like there will be no consequences for fiscal profligacy... no negative implications for continuing to spend far beyond one’s means... there will be nothing but moral hazard for running massive deficits as member countries can now hold hostage the entire EU (as Greece has done).

The ECB’s monetary policy action simply adds to the moral hazard that was originally created on the fiscal side of the problem. The pattern is now set. This is exactly how very smart people meeting together in order to "solve" a debt crisis frequently (and now permanently, it appears) mistake a solvency crisis for a liquidity crisis. From now on, it seems everything will be deemed to be a liquidity crisis that will be met with more "bail-outs" and debt financed spending. This will eventually break traction in a violent way and facilitate severe inflation or even hyperinflation. The one thing the EU taught us this weekend is that paper money will be worth less (maybe much less) in the future.

Germany weakened itself as it has now abandoned the core bargain of the Euro (which was that they would never be responsible for another country’s debt) by opting to be the largest guarantor of a new loan program that essentially makes European countries joint and severally liable for emergency funds for the worst fiscal offenders in the EU. It has begun a process of ceding its fiscal sovereignty to the over-indulgent countries. I still cannot believe Germany has done this. No wonder Merkel’s government is so unpopular. Meanwhile, I guess that Trichet must have decided on the lesser of two disastrous outcomes for fear that the very existence of their European Union was being called into question. He must have believed this to be the case as it would be the only rational reason to agree to such drastic measures – despite his blanket opposition to such policies just days ago and against the explicit wishes of the Bundesbank, Germany’s central bank.

We believe that there is a “Keynesian End” to the policy du jour that governments can solve all their fiscal and economic problems with more debt and more cross guarantees (aided and abetted by desperate central bankers). We at Hayman believe this theoretical endpoint is reached when debt service exceeds government revenues. Of course, any particular country has certain fixed expenses beyond debt service; therefore, the real endpoint occurs significantly in front of our definition. Outside of Greece and “Club Med” countries, Japan will begin to grace the front pages of newspapers very shortly. Japan has already reached a point where its central government tax revenues are eclipsed by debt service and social security payments alone. Coupled with its debt and demography problems, the world's second largest economy is about to enter a real bond crisis.

Attached is a Bank of International Settlements working paper that I highly suggest you read [TILB - link to referenced working paper here]. Please pay particular attention to the chart on the top of page 11 and remember the numbers you are seeing are as a percentage of GDP and NOT government revenue. This paper takes a very conservative view of interest rates (it essentially assumes they stay flat from the low levels of a few months ago – regardless of changes to debt levels or savings rates) and extrapolates current fiscal projections and even assumes pretty robust global growth. Even in this somewhat utopian scenario, the Keynesian End arrives in many of the world's countries much sooner than is popularly believed.

The competitive devaluation will begin in full force with Japan needing a weaker Yen to grow exports, the US needing a weaker dollar in order to double our exports (under the current Obama plan), and the EU really needing a weaker euro in order to grow their own exports. It is no wonder that Bretton Woods failed so miserably in prohibiting “cheating” via currency weakening. It is also no wonder that the IMF and World Bank were created at that very same meeting in 1944.

We have also attached a chart showing total IMF commitments to member countries as a percentage of each respective country’s IMF quota. The magnitude of the initial EUR 30 billion commitment to Greece trumps all other commitments made throughout this crisis by multiples. This does not even include the EUR 250 billion announced for the broader Eurozone this weekend. By granting Greece more than 30x their quota, they are making a mockery of their own rulebook.

This weekend, the EU and the IMF effectively went all-in with a bad hand in the highest stakes game of financial poker ever played with the world. We believe the agreement released was nothing more than a Potemkin agreement in order to placate bond investors. In the end (and there will be a reckoning for many countries) nations, including the United States, need to dramatically cut spending and get their fiscal balances in order. Unfortunately, our elected officials are on the hamster wheel of electoral cycles and are not able to make tough decisions like this as they would likely not be re-elected without a “sea change” in public opinion towards government spending and deficits. We are therefore on the path to significant currency devaluation around the world that will likely result in significant inflation. We increased our holdings of gold on Monday morning as well as taking other steps to position ourselves for the most likely outcome over the next few years. Interestingly enough, based upon the market reaction in the last 36 hours, it seems the law of diminishing returns applies to bailouts as well.

Sincerely,

J. Kyle Bass
Managing Partner

Kyle is clearly cut from the Austrian cloth.

Visualizing President Obama's Budget Cuts

2010-05-11T23:08:00.001-04:00

An oldie but a goodie. Lord, I hate our government.

Obama: "I Do Think At A Certain Point You've Made Enough Money"

2010-04-29T14:43:00.005-04:00

When Mr. President leaves the teleprompter, his alter ego The Redistributor often comes out. Here he tells people he doesn't begrudge making an honest buck, but that at a certain point you've made enough money.

We look forward to discovering what our overlords believes that limit is. His campaign promise was $250,000 and below would be safe. So we're guessing "enough" is somewhere in the neighborhood of just north of twofity.

We eagerly await learning about our next social engineering experiment, oh Great Obamanation, ruler of The Borg.

To those of us without Obamanation's all seeing, all knowing vision, prepare to be assimilated.

HT: RG

Keynesianism Is So Nuanced

2010-04-20T19:04:00.000-04:00

[This will be a multi-part series that discusses inflation, what money is and why it has value. We begin with some basics through the lens of Keynesianism's "attractiveness".]

I was on an email string recently about The Carnegie Endowment for International Peace's Uri Dadush. I made the statement that Dadush is simply a Keynesian, albeit one that is well connected and understands there are many difficult challenges that need to be addressed. In response to my email, a long-time friend of TILB and fellow liberty loving free marketer - though he is still finding his legs with regards to understanding the implications of his beliefs - responded to me that he has spoken at length with Dadush and that he's more nuanced and "complex" than being simply called a Keynsian. Here's a quote from Dadush's recent FT OpEd:

There are ways to mitigate the pain. For example, Germany and other countries could adopt more expansionary fiscal policies for a while. Or, more powerfully, the wider euro area could adopt more expansionary monetary policies for several years. Today, this second option is anathema as the “inflation fundamentalists” will have none of it.

Nuanced? I guess.

Here's what my friend said (mind you, he's an avowed libertarian - though he's still figuring himself out so to speak) - light editing for privacy reasons or clarification:

I met with the guy for 2 hours, and I would not classify him as such [a "strong Keynesian with fairly mainstream opinions"]. If anything, he is complex – and clearly what he says on CNBC and in NY Times oped is not what he can say behind closed doors. While Keynesian, he is not a classically academic Keynesian, sitting in a library dealing with only theory. He counsels governments facing massive social unrest and high unemployment, and he approaches his work with a much deeper appreciation for the human situation than we can. So while espousing money creation below, he was also very pragmatic with me about the moral hazard of this choice, the continued low interest rates, our over-reliance on debt, etc.

I am sympathetic with his situation. We often throw around our ideas without considering the reality of what will inevitably happen – at least in the short term – if our ideas were implemented. I know you will vehemently disagree with me on this, but the fact is that – again, in the short term – what you and I want ideally is economically wishful thinking and politically impossible. Yes, the opposite will bankrupt the world, and we are largely already insolvent. There’s no argument there. Should we suddenly balance our budget, shrink government dramatically, stop stimulus, war, and over-regulation, the result could be 50-60-70% unemployment rates – in the short run. I do believe the LT benefits of Austrian economics are obviously far superior to the Keynsian ponzi scheme.

However, no one talks about the transition, and what it would really mean for us. If you take a heroin addict, and suddenly “reform” him with complete withdrawal and going cold turkey, he will often die from this. His body cannot handle the shock.

Uri had just met with the Italian Finance Minister prior to seeing me – I can imagine that conversation. How do you convince someone like that that what he really needs is to leave the EU, get on the gold standard, balance his budget, cut taxes – and face assassination b/c 100 million are thrown into convulsions?

My point is that Uri deals with the reality of our current situation, while we do not. We read letters and books, then pontificate and rant without a good understanding of what it really means. It will kills us eventually, yes. But it will be a long, slow death probably instead of a quick one.

Lastly, I’ve read Ron Paul, Murry [sic] Rothbard, etc. They all talk about how wrong things are – and I agree with them. I have yet to see a transition plan, so if you know of anything they have written on how to get off the system we are currently addicted to, I’d love to read it.

I decided not to send him a reply by email. Instead, I decided to bring the discussion to TILB, as it's a more productive forum for this sort of thing. To be direct, I disagree with a number of his assertions.

In my opinion, what you described is in fact classic Keynesianism. No self respecting Keynesian would claim that running large deficits and printing money is a long-term viable solution or economically healthy approach. That is simply the tag line non-Keynsians use to belittle the Keynsian approach. It's the politicization the word "Keynesian" but not the reality. Dadush is a classic, behind-the-desk academic Keynesian. He provides advice based in theory as does every other economist, Austrian or otherwise.

The Keynesian argument is always more nuanced or "complex". The argument is generally that goverment needs to implement aggressive and targeted public spending policies during difficult economic periods because taking the hard medicine in the middle of a recession would (they believe) be too painful and counterproductive. By putting it into human terms it becomes very powerful (for obvious reasons) even if - in my opinion - the Keynsian trade is to attempt to avoid some human pain today in exchange for accepting much more human pain in the future.

What's here is tangible and it matters more to voters than tomorrow's pain.

So if we can just take a few easy money bong hits and confuse our body into thinking it's healthy, we can take the hard medicine then. We'll do what needs to be done, but just not yet. Tomorrow. Always some day in the future.

As you know, the issue is that the recession is not the problem, the recession is the cure. It's the cure to profligacy; a recession is simply a period of excess savings that offsets periods of excess spending and consumption.

Switching from a societal bias toward spending to one of savings is painful because society was confused by the profligacy into setting up a structure that serves society's apparent "needs" as if the profligate period is normal. The profligacy is full of false/unsustainable demand signals that trick people into creating/investing in the wrong kinds of businesses or in the wrong amount. The longer the cure is postponed by inflicting more easy money and socialist disease (e.g., Dadush's prescription), the more painful the necessary recession will be because the imbalances are greater and become more depended on.

It's not just imbalances as defined as switching from spending/borrowing to saving/investing. It's that entire industries were created to serve an unsustainable consumptive demand rather than productive advancement. It requires more than just saving new capital, but shifting existing capital from entire industries and possibly geographies to others. A human toll is left in the wreckage of these corrections. It is, however, unavoidable.

What is avoidable is compounding the problem through continued interference with the needed correction.

Bernanke/Bush/Obama's current postponement means the next recession (assuming we are - in fact - past "this one") will feel worse than this one. Their fight of postponement is really an attempt to induce even more capital to become malinvested toward less productive industries and to have us become even more dependant on unsustainable behaviors. So there will never be a period in which the hard medicine can be comfortably consumed because the hard medicine IS the recession and the imbalances it wants and needs to address continue to grow in the meantime. So avoiding taking the hard medicine means avoiding curing the disease; allowing it to metasticize, take root, grow and spread.

You know me well and you are correct: I do vehemently disagree with your statement. Short of a major North American landwar, there is virtually no scenario in which a society as productive as ours would experience anything like "50-60-70%" unemployment rates, even if one mistakenly changes the whole system in one yank.

Ron Paul and others have addressed transition plans. They logically begin with the easiest part: balancing the budget while cutting taxes. By taxing less and borrowing less, capital remains in private (productive) hands and out of public (unproductive) hands. Sounds hard, but if you are of the opinion that most of government is value-destructive, it's actually easy. First, bring the troops home and end the American military empire abroad (foreign military bases). Those two actions are somewhere in the $500 billion to $750 billion annually of savings (1/3 to half of our expected deficit this year and 100% of our deficit from three years ago). Other than for providing a platform for safe living and investment, military is a non-productive expense, by definition. Then end most of the "Department ofs", as I call them. Dept of Education, Dept of Interior, Dept of Energy, Dept of Homeland Security, etc. and slash the size of those you keep, emphasizing of course a strong defense (not offense - defense). This is key, bringing home the military does not mean having a weaker defense. It means changing the nature of it and allowing us to invest in true defense rather than wasting investment on overseas bases.

These cuts are - importantly - phased in but transparent and forecast so that the change is digestible.

That's the easy part. The harder part (though made much, much easier by having already shifted to a smaller government that runs a balanced budget) is moving to a harder currency. This involves ending the Fed and installing free banking, which means a banking system that doesn't "create" money with customer deposits. My personal view is the only way to do that is a slow, planned, well understood phase-in. It might take two decades to let happen so that the adjustment is manageable. I believe the huge benefits reaped from freeing capital from government hands would unleash such a lollapalooza of positives on society that shrinking the banking system would actually shift from an economic headwind to a tailwind by the latter years of the process.

As a final aside, in contrast to your assertion, I am not actually a government-installed-gold-standard man, because it relies on government to be well behaved. I am for market-based money, but that's a discussion for another day.

Private Prison Operator Cornell Companies Agrees To Acquisition By Competitor Geo Group

2010-04-19T17:17:00.005-04:00

Long time readers know that Bill Ackman's Pershing Square pitched Cornell Companies' competitor Corrections Corp of America (CXW) last fall (see pitch here). Today, one of Correction Corp's biggest direct competitors Cornell Companies agreed to be taken out by another comp, Geo Group, for a 35% premium, further consolidating the private prison industry (link to press release). TILB views this as very positive for the private prison industry as it further improves the oligopolistic characteristics of an industry that already has reasonable competitive dynamics.

While municipal financial difficulties are a cyclical headwind to any and all budgetary items, our view is the secular tailwind is intact as their scale, expertise and flexibility make them an attractive alternative to states investing huge capital in their own public systems.

Ron Paul Ties Obama In National Rasumessen Poll

2010-04-15T08:41:00.004-04:00

Okay, technically it is 42% Obama and 41% Ron Paul, but that's a statistical dead heat and at this point most people are still learning who the great Congressman from Texas is.

Prediction: nobody reports on this and somewhere Bill Kristol makes an excuse for this.

We hold out some modest hope for actual change...

Link to the poll.

[HT: LB]

Duke 2010

2010-04-05T23:43:00.002-04:00

Duke 2010: worst national champion team in men's hoops of the last 20 years or worst champion of all time?

I can't think of a national champion since at least the 1970s that this year's Duke team would consistently beat...actually, probably since the 1960s at which point my historical knowledge dissipates.

To be fair to Duke, they were the best team of the Final Four, so if any other team in the Final Four had won it all, the question above would not be multiple choice.

Representative Hank Johnson - Georgia Democrat - Worries Guam Will Actually Tip Over And Capsize

2010-04-01T17:11:00.001-04:00

Um, awkward.

[HT: SD]

Pennsylvania State Capital Misses Loan Payment

2010-03-30T16:30:00.003-04:00

As regular readers know, we've been fascinated by the comings and goings in Harrisburg, PA - Pennsylvania's capital city. Harrisburg has withheld payment on a loan obligation to Covanta for a waste-to-energy incinerator financing that Covanta provided (Covanta being a large waste-to-energy operator and thus a partner to municipalities all over the US).

Today, Harrisburg announced that for the third time this year, on Thursday April 1, 2010, it will not meet its legal obligation to Covanta (sadly, not an April Fool's joke). Covanta, chaired by Sam "Gravedancer" Zell, has not yet put Harrisburg into default and is considering its options. Bloomberg article below [emphasis added]:

Harrisburg, Pennsylvania, to Miss Incinerator Loan Payment
2010-03-30 20:17:19.538 GMT

By Dunstan McNichol
March 30 (Bloomberg) -- Harrisburg, Pennsylvania, the capital of the sixth-most-populous U.S. state, will miss an April 1 loan payment to Covanta Holding Corp., said Michael Casey, the city's interim business manager.
Harrisburg faces $68 million in debt service payments this year connected to a trash-to-energy incinerator that Fairfield, New Jersey-based Covanta operates. The payments on the $282 million in incinerator debt are about four times what the city of about 47,000 raises through property taxes, according to its budget.
The city is scheduled to pay Covanta $637,500 April 1. The payment is the fifth installment on a $20.7 million Covanta advance the city guaranteed in 2008 on behalf of the incinerator's manager, the Harrisburg Authority. Covanta runs 64 waste-to-energy facilities in the U.S. and abroad, according to its 2009 annual report.
"We have the cash, but we do not plan to pay them on the first of April," Casey said in a phone interview today. [TILB - Sam Zell is getting Angry!] "They are working with us on a forbearance program for the rest of the year," meaning a plan to give the city some leeway on debt payments, he said.
Casey said the city is talking with the authority, Dauphin County, a guarantor of some of the bonds, and Hamilton, Bermuda- based Assured Guaranty Municipal Corp., their insurer [TILB - Wilbur Ross is getting Angry!], on a plan to restructure the debt while the city draws up a recovery strategy.

Asset Sales

That plan will include selling unspecified city assets, raising the county's trash-dumping fees at the incinerator and refinancing a portion of a $34 million working capital loan that is scheduled to be paid in full in December, Casey said. Mayor Linda Thompson isn't considering a bankruptcy filing, he said.
"And frankly, we see no need of it, the way things are going," he said.
Covanta is cooperating with the city and is awaiting its recovery measures, Jim Klecko, regional vice president for Covanta, said in a telephone interview today from his office in Lancaster, Pennsylvania.
"They have given us a real good feeling that they don't expect to go into bankruptcy," he said.[TILB - "a real good feeling"? How about the cash they are withholding from you??]
In addition to the debt service, the city owes another $12 million in payments on eight series of bonds and notes of its own, according to budget documents.
Thompson didn't return messages seeking comment today.

Missed Payments

Covanta, whose chairman is Tribune Co. owner Sam Zell, reported annual revenue of $1.55 billion in 2009.
The city has missed two payments on the incinerator debt this year. [TILB - oops!]
On March 1 the authority tapped debt service reserves to cover $2 million in payments due on its Series 1998A and 2003 Series A, B and C bonds after Harrisburg failed to honor its guarantee, according to March 8 notices to bondholders. A $425,000 payment, for which there is no such reserve, is due May 1, according to a schedule prepared for the City Council by Cincinnati-based Management Partners Inc., which was hired by Pennsylvania to develop a recovery plan for the city.
Dauphin County, where Harrisburg is located, has sued the city seeking $15 million, including reimbursement of $8.9 million in incinerator swap and debt service payments it has made on the city's behalf since last year, according to the county's legal complaint. [TILB - We love the county vs. city dynamics]
City Controller Dan Miller, who has advocated seeking Chapter 9 municipal bankruptcy protection instead of selling assets, said he doesn't think the city has enough cash to make the Covanta payment along with $4 million in city bond payments and a $1 million payroll that are also due April 1.
"I think we're going to have trouble making those payments, let alone the $600,000 to Covanta," he said in a telephone interview from his office in Harrisburg today. Harrisburg's credit rating was slashed to five levels below investment grade in February by Moody's Investors Service. [TILB - If you cut five levels at once, it implies you weren't paying attention. These don't arise out of left field.]

For Related News and Information:
For Pennsylvania Municipal Issuer data: SMUN PA .
To see U.S. state finances at a glance: MIFA .
Pennsylvania 2020 G.O. bond: 70914plc DES .

--Editors: Mark Tannenbaum, Walid el-Gabry

To contact the reporter on this story:
Dunstan McNichol in Trenton, New Jersey, at +1-609-394-0737 or dmcnichol@bloomberg.net.

To contact the editor responsible for this story:
Mark Tannenbaum at +1-212-617-1962 or
mtannen@bloomberg.net.

Paul Ryan Dismantles The Health Care "Reform" Legislation On The Congressional Floor

2010-03-25T23:07:00.004-04:00

Wisconsin Representative Paul Ryan is quickly establishing a reputation in the republican community as an impassioned, logical, freedom loving voice of reason. A throwback republican of sorts. While certainly not our ideal politician, he's closer to the kind of republican that makes TILB still have hope for the GOP.

Here he blasts several of the most popular health care myths on the floor of the House of Representatives. He shows how it does nothing remotely close to reducing the debt, he rails against the legacy of leverage that we leave to the next generation to shoulder, and he lambasts the idea of government rationing health care rather than individuals making private decisions with their care providers and insurers.

Sadly, nobody listens; nobody cares.

Ron Paul On The "Health Care" Frankenstein Passage

2010-03-21T23:20:00.004-04:00

We lost a chunk of freedom tonight as we continue the process of putting enough weight on our own shoulders that we collapse under its mass.

I can't bring myself to talk about this health care travesty. It's just so sad, immoral and unsustainable. To quote Congressman Ron Paul when asked what it will take to repeal the health care bill, "the bankruptcy of this country will repeal it... It will end, it will end badly and it will hurt the people that many [other] people are very seriously trying to help with medical care... Every country in the world today is on the verge of bankruptcy..."

Anyway, I'll let Congressman Ron Paul tell you about this debacle:

Liberty Quote Of The Day: Jens O. Parsson

2010-03-19T07:04:00.000-04:00

Jens Parsson discusses how the persistent debasement of money kills society in his 1974 book "Dying of Money: Lessons of the Great German and American Inflations". The below quote is reminiscent of Murray Rothbard's description of the early "fun" portions of an inflation as a "heady wine" (click here for Rothbard's in-depth essay on German hyper inflation).

In any case, Parsson makes the point that monetary inflation always ends in a trail of tears, because it is addictive and requires an increasing volume of inflated money in order to keep the party going. As soon as the spigot is turned off, pain comes, so the spigot is never turned off. In fact, it is provides a constantly accelerating flow and ultimately either tragically deluges society in an out of control hyperinflation or, if discipline is somehow re-instituted, ends in a painful deflationary liquidation. Read on for Parsson's quote:

"Everyone loves an early inflation. The effects at the beginning of inflation are all good. There is steepened money expansion, rising government spending, increased government budget deficits, booming stock markets, and spectacular general prosperity, all in the midst of temporarily stable prices. Everyone benefits, and no one pays. That is the early part of the cycle. In the later inflation, on the other hand, the effects are all bad. The government may steadily increase the money inflation in order to stave off the latter effects, but the latter effects patiently wait. In the terminal inflation, there is faltering prosperity, tightness of money, falling stock markets, rising taxes, still larger government deficits, and still roaring money expansion, now accompanied by soaring prices and an ineffectiveness of all traditional remedies. Everyone pays and no one benefits. That is the full cycle of every inflation."
- Jens O. Parsson, Dying of Money: Lessons of the Great German and American Inflations (1974)

[HT: LB]

Germany Tells Greece To Go IMF Themselves

2010-03-18T17:28:00.003-04:00

That headline wrote itself. This NY Times article took a somewhat more modest tack, although the body of the article made the point clearly. All emphasis added and commentary in brackets is from TILB.

As a quick aside, TILB views this as very positive for German Bunds:

March 18, 2010
Germany Backtracks on Europe Rescue for Greece
By MATTHEW SALTMARSH
The New York Times

The burden for resolving Greece’s financial crisis appeared to shift Thursday toward the International Monetary Fund as Germany distanced itself from supporting bilateral or European aid to the heavily indebted country.

Citing legal hurdles, a government official in Berlin said Thursday that Germany believed that any external financial support to Athens, if needed, would best be provided by the I.M.F.

“In the case that the Greeks get into really serious problems, we would support an I.M.F. solution,” said the official, who was not authorized to speak publicly on the matter.

Amid the uncertainty, the euro slipped against the dollar and was quoted at $1.3621 in New York afternoon trading, down from $1.3741 early in the session. European stocks also wilted. The Athens Stocks Exchange General Index ended 3.3 percent lower.

Germany is the euro area’s largest economy, so Berlin’s view on a bailout or other form of debt workout is pivotal.

European governments, including those of France and Germany, had previously signaled that any rescue of Greece, which has been punished by financial markets as a result of its surging deficit, would best be provided from within the euro area.

Berlin initially appeared reluctant to call on the I.M.F., preferring to resolve the matter within the currency bloc — even though some financial officials, like Jürgen Stark, a member of the executive board of the European Central Bank, had signaled their preference for an outside solution.

Since the euro’s inception in 1999, no member has sought support from the I.M.F., which nevertheless helped to bail out a number of East European economies at the height of the recent crisis.

An official from one of Germany’s euro-area partners said Greece might not be able to borrow enough money from the I.M.F. to fund its requirements, given that any loan would probably be limited to a multiple of the modest quota that Athens holds in the Washington-based institution.

Berlin’s about-face on aid to Greece has left some of its European partners scratching their heads about Germany’s intentions.

Daniel Gros, director of the Center for European Policy Studies in Brussels, said the change of heart had been prompted by two factors.

“The first is that this is for the domestic audience,” he said, referring to sentiment among many Germans that Greece should not be bailed out with their money.

“The second is that the strategy the Germans had in mind didn’t work,” Mr. Gros said. “The idea was that the mere political offer of support would be enough” to bolster investor confidence in Greek bonds.

...

The Greek government has been pushing for more clarity on what its European neighbors will do in the hope of bringing down its borrowing costs, which have risen as Greece’s debt troubles have become more acute. The yield on Greece’s benchmark 10-year bonds rose Thursday to 6.265 percent — a spread, or differential, of 3.14 percentage points over comparable German bonds, the European benchmark for safety.

While Berlin believes that Athens can live with the level of interest it is paying on its bonds — and that is not on the verge of a default — the Greek government thinks it should not have to pay so much to borrow, now that it has agreed to measures that are designed to cut its budget deficit to 8.7 percent of gross domestic product.

“The more the Greeks push for something concrete, the more they run into this brick wall,” Mr. Gros added.

Greece, meanwhile, has sought to leave its options open, while expressing frustration at the lack of a solid proposal from its E.U. partners.

Speaking to reporters after meeting E.U. lawmakers in Brussels, Prime Minister George A. Papandreou warned that the government would be hampered in its attempts to enact deficit cuts if the country is unable borrow money more cheaply. [TILB - hilarious. Greece basically threatens to sandbag their austerity "efforts" if they don't get a more equitable borrowing rate.]

An offer of E.U. aid “would be enough to tell the markets: hands off, no speculation, let this country do what it’s doing, let it in peace to be able to move ahead,” he said. [TILB: he must have accidentally left out the word "temporarily".]

If Athens relies on financing from the markets at high interest rates, “that undermines the actual measures that you are taking,” Mr. Papandreou said. “That money then goes to the interest of those who are loaning to you rather than the implementation of a program.” [TILB: ah, such is the nature of borrowing beyond your means.]

...

Speaking in Washington, Caroline Atkinson, the I.M.F.’s director of external relations, said Thursday that the fund had not yet been approached by Athens.

“We expect the euro-zone countries to want to and to plan to resolve this question by themselves,” she said. She added that the I.M.F. was ready to respond to a request from Greece for a loan.

...

On Monday, Jean-Claude Juncker of Luxembourg, who chairs the meetings of euro zone finance ministers, said that a European framework would be created to coordinate bilateral loans, if required, involving all 16 euro-zone members. He added, however, that the final decisions on any package would be made by E.U. heads of government.

As a reason for Germany’s apparent change of position, the German official pointed to Article 125 of the European Union’s governing treaty, which states that the European Union or individual members should not be liable for or assume the commitments of governments.

...

Still, the drip feeding of announcements from Berlin has left some politicians in Europe cold.

“I find what has happened, or rather what has not happened over the past few days and weeks, incomprehensible,” said Guy Verhofstadt, the former Belgian prime minister and the current president of the Liberal Democratic bloc in the European Parliament. “It is incomprehensible because it is precisely a European response that is the quickest and least costly solution.” [TILB: Least costly to whom, exactly? Certainly not to Germany.]

Officials in the German Finance Ministry also appeared to be unaware of their government’s shift in stance. Financial officials in other euro-zone countries were similarly baffled.

“The signals that one gets out of Germany have varied considerably,” said an official from another euro-area country, who was not permitted to speak publicly. “I fail to see what their line is.”

The official said the assumption among euro-area finance ministries is that Greece might require about €25 billion, or $34 billion, to cover near-term liabilities. Athens needs to borrow €53 billion in financial markets this year and must refinance around €20 billion of debt in April and May — at interest rates likely to be high.

The official added that Greece would probably be able to borrow between $12 billion and $14 billion from the I.M.F., assuming the same model used in recent rescues. For example, in 2009 the fund loaned Romania €13 billion, which was about 1,100 percent of that country’s quota at the fund. Greece holds just 0.38 percent of the fund’s quota, which is expressed as 823 million of the fund’s own unit of currency — Special Drawing Rights — each worth $1.53. [TILB: $14 billion ain't gonna be enough, long-term]

The official said other multilateral lenders like the World Bank or the European Investment Bank would not be in a position to lend Greece €10 billion or more. That would mean that the European Union — and Germany — might have to support Greece in any event, perhaps alongside the I.M.F.

He also said that legal impediments to E.U. support did not appear to be insurmountable, although some euro members might need to change national rules.

“We know how we could do it,” he said.

Still, Mrs. Merkel’s change of line will be welcomed by some. Mr. Stark of the E.C.B. told a German newspaper this month that joint financing “could become very expensive, would create false incentives and burden countries with solid finances.” During an interview last month, Otmar Issing, a former top official of the German and European central banks, warned that the Union could not “impose the kind of sanctions that would be needed, and it would make Brussels too unpopular.” “A better way,” he said, “is for Greece to approach the I.M.F. It is the only institution that can impose strict enough conditions.”

Matthew Saltmarsh reported from Paris and Stephen Castle from Brussels.

[HT: LB]

I Heart(ed) Obama

2010-03-18T10:08:00.003-04:00

I miss Mad Magazine - was great to be a kid.

This is perfect. People loved him when he said he wasn't a socialist. His popularity has waned as that's turned out to be untrue.

{HT: Max Headroom]

Even MORE Ebullio! Here's Their Website And The Top News Is Not Their Blow-up

2010-03-17T14:47:00.004-04:00

Just when you'd think the Ebullio story can't get better, you find out they have a super-transparent WEBSITE!!

As long time TILB friend Hatch says, "Ebullio should change the logo from the matador dodging the bull to the matador being gored by the bull." Indeed.

Anyway, on the News and Events part of their website, the second most recent article is a Bloomberg article about blowing up (fair enough, that's at least honest and transparent) and then the most recent article is a press release announcing “with great pleasure” the promotion of one of their traders.

You cannot make this shit up: http://www.ebullio.co.uk/newsevents.html

More Ebullio News: Manager Originally Reported -1.1% Loss In January, Updates That Estimate To -70%

2010-03-17T14:35:00.004-04:00

Wow. This just gets better and better. When we told you Ebullio's manager was crazy, we didn't appreciate how right we were. Check out this Bloomberg article with some quotes from a phone interview Mr. Lars Steffensen provided to the authors. All the service providers are running like rats from a sinking ship. This will make for an awesome spectacle.

A-f'ing-mazing.

Ebullio Commodity Hedge Fund Says January Loss Was 70% Not 1.1%
2010-03-16 18:20:22.592 GMT

By Chanyaporn Chanjaroen and Tom Cahill
March 16 (Bloomberg) -- Ebullio Capital Management LLP said its commodity hedge fund fell almost 70 percent in January, not the 1.1 percent decline originally reported to investors, letters to investors show.

The 1.1 percent drop was announced in the January notice and changed to 69.65 percent in the February report, the documents show. The fund, based in Southend-on-Sea, England, fell another 86 percent last month, taking its plunge in the first two months to 96 percent. The biggest losses were in copper, nickel and tin, according to the February letter.

"The moment we knew the actual January loss, we brought that up to our investors immediately," Lars Steffensen, the founder of the company, said today by phone. He declined to comment on the size of the discrepancy.

The LMEX index of six industrial metals fell 8.2 percent in January, the steepest drop since the end of 2008, before rebounding 6 percent last month. Commodity hedge funds returned on average almost 1 percent last month and lost 2.2 percent during the first two months of this year, according to Chicago- based Hedge Fund Research Inc.

"Extraordinary circumstances" forced Ebullio "to liquidate and/or cancel parts of the physical book and liquidate some long-held speculative positions, mainly in LME non-ferrous metals," Steffensen wrote in the February report, referring to the London Metal Exchange.

Gains in oil, wheat, gold and sugar last month were "drowned out by the hugely negative impact made by copper, nickel and tin," according to the report.
Assets Under Management

Ebullio made 29 percent last year and 92 percent in 2008, according to the reports to investors. The fund’s assets under management shrank to $1.47 million last month, from $42.3 million in November.

"We took the hit," Steffensen said by phone earlier today. "I’ve always bounced back."

The fund is waiving its 2 percent management fee for 2010.

Kinetic Partners LLP, the fund’s auditor, didn’t immediately return a call to its London office seeking comment.

GlobeOp Financial Services is the fund’s administrator, according to the investor letters.

"Estimates are generally developed by fund managers based on their own estimate of profit and loss," GlobeOp Financial Services said in an e-mailed statement today. "There is generally no involvement of the administrator in the development of these estimates."

Steffensen, 42, worked for companies including Gerald Metals Inc. and Next Energy Inc. before setting up Ebullio. The fund also invests in energy, precious metals and agriculture.

Hedge funds are mostly private pools of capital whose managers participate substantially in the profit from speculation on whether the price of assets will rise or fall.

For Related News and Information:
Top commodity stories: CTOP
Top worldwide stories: TOP
To read about commodities hedge funds: TNI HEDGE CMD Top shipping stories: TOP SHIP Technical gauges: BTST
--Editors: Stuart Wallace, John Deane
To contact the reporters on this story:
Chanyaporn Chanjaroen in London at 44-20-7073-3544 or cchanjroen@bloomberg.net or; Tom Cahill in London at +44 207 673 2052 or tcahill@bloomberg.net.
To contact the editor responsible for this story:
Stuart Wallace at +44-20-7673-2388 or swallace6@bloomberg.net

Ebullio Capital Management Loses 95% In Two Months - Then Acts Like It's No Big Deal

2010-03-17T14:18:00.007-04:00

Wow. We really don't know where to begin. TILB received an email from someone saying a manager lost 86.25% in the month of February. When TILB opened the attachment (see below), we noticed that, in fact, the manager had lost 95% in the first two months of 2010. For those of you familiar with the perils of negative compounding, the difference between losing 85% and losing 95% is an additional 67% of losses. So, we scrolled down and, wala, the manager - Lars Steffensen - actually lost 70% in January as well.

But that's not the worst of it.

His February monthly commentary basically brushes over the fact he's down 96%, as if it's just another couple of bad months! He’s literally insane. He talks about how helpful his hedges were, albeit a little too far out of the money, but that they were "money well spent," yada yada yada.

Dude! You just had a month of -70% followed by a month of -85%. In fact, in February, you actually lost more than 100% of the entire fund on metals positions alone.

He even goes on to give a fucking monthly commentary on the macro picture. Who cares what you think, dude? You’re not even talking about the fact you’ve lost 19 out of every 20 cents in 60 days. Look at this:

Since our getting long against conviction play early January 2010, we have been doing some thinking and come to the conclusion that the Japan scenario has at least been tried and tested in the real, civilized world, whereas the hyperinflation (discounting Weimar Germany and various kleptocratic African quasi States) has not.

Dude, you were down 95%. Why are you giving market commentary? What world do you live in?

After searching further back into my email box, I found this old hedge fund industry rag news snip-it on Ebullio from fall 2009:

Opalesque Exclusive: Ebullio plays hard in the commodity markets as it now owns most of the tin traded on LME - fund up 24% YTD
Thursday, October 15, 2009

By Benedicte Gravrand, Opalesque London:
We heard last week that an investor had been buying around 90% of the tin traded on the London Metal Exchange (LME), in the form of physical stocks and contracts.

Since early summer, the dominant position has caused the tin market on the LME to become "disorderly" and distorted prices, Reuters reported.

Rumors abounded but nobody knew for sure who the mystery buyer was. Then the revelation came: it was......................

TILB cannot believe they didn't lose every investor they had. Amazing. Let us know what you think.

Ebullio Capital Management February 2010 Monthly Update

Mike Leach Does Not Take Mediocrity Quietly

2010-03-16T09:38:00.003-04:00

Former Texas Tech Red Raiders head football coach, Mike Leach, is far and away TILB's favorite coach in sports. I'm not saying that as a joke. The guy is a football genius and is wired to destroy opponents. That's the point of football and he does it brilliantly. Many people don't like him because he uses his players like pawns, but the man wins football games. Period. Actually, not "period." He does it with substantially inferior player talent and financial support. And he forces a much higher level of academic rigor onto his team than most. He is, in short, an offensive savant (read this great article on Mike Leach by Michael Lewis - author of Lair's Poker, The Blind Side, Moneyball and a few other best sellers)

So, I love Mike Leach. The below video shows Leach letting his team know what he thinks about their 8-4 record following a lackluster win over bottom-dweller Baylor (they ultimately finish 9-4). The man stands for excellence. By the way, this is fairly tame compared to some classic Earl Weaver or Bobby Knight videos. I suspect if Bill Parcells locker room speeches were widely available, they'd have a similar tone to them.

{HT: TD]

The Borg - I Mean Obama Administration - Intend To Pay Homeowners To Sell Their Houses

2010-03-09T09:13:00.004-05:00

"Have you made a horrible decision and find your mortgage 70% underwater? Please let us give you $1500 of Chinese, I mean tax payer money as a reward! And we'll strong arm banks to let you out unscathed in the process. Congratulations on your hard won earnout."

Ah, the Borg, resistance is futile.

I am so happy they have not given up on their command and control efforts to manipulate our economy from their proverbial perch high up in the moral tower that is White House. What these puppeteers don't realize is the problem has little to do with insolvent homeowners not wanting to sell their homes via short sale and has everything to do with banks wanting to get paid back the money the lent (crazy, I know!).

The NY Times wrote about this on Sunday March 7th. Love the headline. All emphasis added [and TILB comments in brackets].

March 7, 2010
Program Will Pay Homeowners to Sell at a Loss
By DAVID STREITFELD
In an effort to end the foreclosure crisis, the Obama administration has been trying to keep defaulting owners in their homes. Now it will take a new approach: paying some of them to leave.

This latest program, which will allow owners to sell for less than they owe and will give them a little cash to speed them on their way, is one of the administration’s most aggressive attempts to grapple with a problem that has defied solutions.

More than five million households are behind on their mortgages and risk foreclosure. The government’s $75 billion mortgage modification plan has helped only a small slice of them. Consumer advocates, economists and even some banking industry representatives say much more needs to be done.

For the administration, there is also the concern that millions of foreclosures could delay or even reverse the economy’s tentative recovery — the last thing it wants in an election year. [TILB - ah, the political truth...]

Taking effect on April 5, the program could encourage hundreds of thousands of delinquent borrowers who have not been rescued by the loan modification program to shed their houses through a process known as a short sale, in which property is sold for less than the balance of the mortgage. Lenders will be compelled to accept that arrangement, forgiving the difference between the market price of the property and what they are owed. [TILB: I'm sure banks will sign up left and right to fore go their rights]

...

The problem is highlighted by a routine case in Phoenix. Chris Paul, a real estate agent, has a house he is trying to sell on behalf of its owner, who owes $150,000. Mr. Paul has an offer for $48,000, but the bank holding the mortgage says it wants at least $90,000. The frustrated owner is now contemplating foreclosure. [TILB - The guy is SEVENTY PERCENT UNDERWATER; unless he wants to keep paying for his mortgage, he should have absolutely no say in this matter! What world do I live in? What is this, Russia? HOW IS THIS EVEN A QUESTION?]

To bring the various parties to the table — the homeowner, the lender that services the loan, the investor that owns the loan, the bank that owns the second mortgage on the property — the government intends to spread its cash around.

Under the new program, the servicing bank, as with all modifications, will get $1,000. Another $1,000 can go toward a second loan, if there is one. And for the first time the government would give money to the distressed homeowners themselves. They will get $1,500 in “relocation assistance.” [TILB - Why does a guy that probably put close to no money down get a $1500 windfall but the lender gets ZERO?! Note, the $1000 goes to the servicer(s) of the loan(s), not the lender(s). This is crazy.]

Should the incentives prove successful, the short sales program could have multiple benefits. For the investment pools that own many home loans, there is the prospect of getting more money with a sale than with a foreclosure. [TILB - Dear David Streitfeld c/o The New York Times: Use your brain. If the lender thought they'd get more back doing a short sale, they already have the ability to pull the trigger. This has zero impact on that reality.]

For the borrowers, there is the likelihood of suffering less damage to credit ratings. And as part of the transaction, they will get the lender’s assurance that they will not later be sued for an unpaid mortgage balance.

For communities, the plan will mean fewer empty foreclosed houses waiting to be sold by banks. By some estimates, as many as half of all foreclosed properties are ransacked by either the former owners or vandals, which depresses the value of the property further and pulls down the value of neighboring homes. [TILB - This must be heaven, because everyone wins! The lender, the borrower and the community! How exciting!]

...

Under the new federal program, a lender will use real estate agents to determine the value of a home and thus the minimum to accept. This figure will not be shared with the owner, but if an offer comes in that is equal to or higher than this amount, the lender must take it. [TILB - Right. This should work. Let's see, we're going to pay a real estate agent to come up with a price. No matter what price he/she comes up with, the bank would be FORCED to sell at that price. I bet they'll err to the high side (stop laughing at me, it hurts my feelings).]

Mr. Paul, the Phoenix agent, was skeptical. “In a perfect world, this would work,” he said. “But because estimates of value are inherently subjective, it won’t. The banks don’t want to sell at a discount.”

There are myriad other potential conflicts over short sales that may not be solved by the program, which was announced on Nov. 30 but whose details are still being fine-tuned. Many would-be short sellers have second and even third mortgages on their houses. Banks that own these loans are in a position to block any sale unless they get a piece of the deal.

“You have one loan, it’s no sweat to get a short sale,” said Howard Chase, a Miami Beach agent who says he does around 20 short sales a month. “But the second mortgage often is the obstacle.” [TILB: This is the reason short sales are less common than one might expect. Second lien holders can obstruct the process. But that is okay, that is their contractual right. They are owed money by the borrower and he/she is trying to shirk, generally, 100% of his obligation to them. I might hold up the process too if someone were trying to stiff me and then ask me for a favor.]

Major lenders seem to be taking a cautious approach to the new initiative. In many cases, big banks do not actually own the mortgages; they simply administer them and collect payments. [TILB: This is servicing] J. K. Huey, a Wells Fargo vice president, said a short sale, like a loan modification, would have to meet the requirements of the investor who owns the loan.

“This is not an opportunity for the customer to just walk away,” Ms. Huey said. “If someone doesn’t come to us saying, ‘I’ve done everything I can, I used all my savings, I borrowed money and, by the way, I’m losing my job and moving to another city, and have all the documentation,’ we’re not going to do a short sale.” [TILB: Boom. Principled.]

But even if lenders want to treat short sales as a last resort for desperate borrowers, in reality the standards seem to be looser.

Sree Reddy, a lawyer and commercial real estate investor who lives in Miami Beach, bought a one-bedroom condominium in 2005, spent about $30,000 on improvements and ended up owing $540,000. Three years later, the value had fallen by 40 percent.

Mr. Reddy wanted to get out from under his crushing monthly payments. He lost a lot of money in the crash but was not in default. Nevertheless, his bank let him sell the place for $360,000 last summer.

“A short sale provides peace of mind,” said Mr. Reddy, 32. “If you’re in foreclosure, you don’t know when they’re ultimately going to take the place away from you.”

Mr. Reddy still lives in the apartment complex where he bought that condo, but is now a renter paying about half of his old mortgage payment. Another benefit, he said: “The place I’m in now is nicer and a little bigger.” [TILB - the market at work.]

First Citizens BancShares, Inc. (Ticker: FCNCA): Investment Write-up

2010-03-07T23:30:00.001-05:00

What follows is an investment write-up I recently put together for an investment club I'm a member of. I've made some slight tweaks since the original posting on 2/2/10. For those of you that have followed TILB, you probably know that I have something of a problem with the FDIC and the way it handles assisted transactions. I decided to do some research and figure out how to exploit the opportunity so that I could at least recoup my share of the economic devestation the FDIC wreaks upon our society. There are other good banks available as well.

As a disclaimer: 1) I may not ever make another disclaimer again but you should assume the factset of this disclaimer is always true; 2) I own shares in First Citizens BancShares so consider me very biased; 3) Do your own work. If you buy or sell this based on some random write-up you found on the internet, you are taking very real, independent risk. You absolutely should not rely on my work or views to be accurate or current; 4) I may increase, decrease or entirely exit my stake in this business (or any other investment opportunity) at anytime I want without informing anyone; 5) Please recognize this is a bank being recommended in the middle of an ongoing credit contraction, so use a double dollop of caution.

-----------------------------------------------------------------

First Citizens Bancshares, Inc. - $172/share - Groundhog Day 2010 - Ticker FCNCA/B
Over the past few months, I've been migrating my portfolio from some of the juicier stuff offered twelve to eighteen months ago into conservative, stable investments that offer long-term double digit return potential albeit perhaps at the expense of not being short-term multi-baggers.

First Citizens BancShares is a family-controlled Raleigh, North Carolina based bank holding company (BHC) that just acquired its third loss-share via an FDIC assisted transaction. It trades for 1.1x stated book, though I suspect book will accrete faster than normal over the next few years implying today's purchase price is really at or slightly below book. I've been an owner since this fall and it seems more clear to me now than ever that this conservatively managed bank is exceedingly well positioned to expand its deposit franchise both organically and via acquisition (the latter method being self evident, at this point). I believe downside is fairly limited.

The BHC refers to itself as "BancShares" and is a holding company that operates two primary brands: First-Citizens Bank & Trust (FCB) as well as IronStone Bank a federally chartered thrift ("IronStone" - a solid sounding name if there ever was one - not simply iron, not simply stone, but ironstone). In any case, BancShares is a well positioned BHC with a long track record - it's more important brand, FCB, was founded in 1898.

The FCB arm has been the acquirer in each of the three FDIC assisted transactions - Temecula Valley Bank, CA on 7/17/09, Venture Bank, WA on 9/11/09 and First Regional Bank, CA on 1/19/10. I believe most FDIC assisted transaction are low risk and most offer attractive upside.

By my tally, only two banks have participated in more than three FDIC assisted transactions since the onset of the crisis, both of which are privately controlled banks based in Minnesota (each getting four deals). Not only has FCB acquired three failed banks, it has done so in an incredibly risk-averse manner. It has acquired $4.54 billion of assets (before acquisition accounting fair value markdowns) but did so with loss-sharing agreements with the FDIC covering 88% of those acquired assets, significantly limiting BancShare's downside. This compares to less than 80% coverage for the typical loss-share backed transaction.

Along with those $4.54 billion in assets, BancShares acquired $4.1 billion of deposits and deepened its footprint in two geographies that it was already involved with: Southern California and Washington's Puget Sound counties. Both face obvious cyclical headwinds but have long-term secular tailwinds. Also, each is likely to be an ongoing epicenter of bank failure, leading to incremental opportunity for FCB. [As a brief aside, I think the Pacific Northwest is going to be the Georgia of 2010]

The acquisition of $4.5 billion of assets and $4.1 billion of deposits compares to its June 30, 2009 balance sheet of $17.3 billion of assets and $14.4 billion of deposits. This means BancShares added around 25% to each assets and deposits during the past seven months (June 30th is used because it's the last balance sheet that predates any of the three transactions). This was all accomplished without raising any new capital or taking on much in the way of incremental risk.

To show you the limit of what can happen, the FDIC assisted East West Bank of Pasadena, CA in acquiring United Commercial Bank in November 2009. East West had $12.5 billion of assets and about $10.5 billion of deposits beforehand and added $10.2 billion of assets and $7.5 billion of deposits (with $7.7 billion of loss-sharing). East West Bank thus added 82% and 71% to assets and deposits, respectively. That implies that from the perspective of the FDIC, BancShares has ample flexibility to continue acquiring.

BancShares has not paid a deposit premium for any of the acquired failed institutions.

Capitalization: 8.76 million A shares and 1.68 million B shares with identical economic value, but class B holding 16 votes per share. The overwhelming majority of equity is tangible equity.

Family Controlled: The Holding family controls and runs FCB. They and their family and trusts continue to own well in excess of BancShares votes. They pay themselves fairly - only three employees received over $1 million in total compensation during 2008, none received over $2 million. Two of those employees, Lewis Holding (Chairman & CEO $1.9 million) and James Hyler Jr. (Vice Chairman and COO $1.1 million) retired in early 2009 after 40 and 25 years of service, respectively. Frank Holding Jr. ($0.6 million and 25 years of service) was named Chairman and CEO. His father is the Executive Vice Chairman and has 40 years of service ($1.9 million). Neither retiring executive received any sort of unusual retirement benefits. With a $1.8 billion market cap and insiders owning more than half of it, it's fairly clear that they make money when we do: through building and distributing value to shareholders. No golden parachutes exist.

The company has not issued new shares in many years.

Well Capitalized: If the fact that in the past seven months the FDIC has allowed BancShares to make three acquisitions - including one last week - doesn't provide a hint that BancShares is well capitalized, then nothing will.

BancShares refused TARP money and is considered well capitalized by virtually every objective standard. The company ended 2008 with 13.2% Tier 1 capital ratio, 15.5% total risk based capital ratio and 9.9% leverage capital ratio. According to a recent 8-K, 2009 ended with 13.3%, 15.6% and 9.5%. The FCB subsidiary was 12.7%, 15.1% and 8.7%. Each of these is well in excess of the minimum requirement to be considered well-capitalized (6%, 10% and 5%). While all details haven't yet been released by BancShares about the most recent acquisition (First Regional Bank on 1/29/10), I expect it will not meaningfully negatively impact either BancShares' overall or FCB's specific capitalization scores. BancShares also has a TCE ratio in excess of 8% (calculated before the most recent transaction).

BancShares continues to increase allowances for losses faster than chargeoffs are coming through, despite the fact that both metrics have begun moderating on a quarter over quarter basis, creating some hope that the worst is behind BancShares. The conservative reserving and modest trend improvement both provide hope for reserve release at some point in the future.

Statements like the following one, from a recent 10-Q, provide a qualitative reflection on management's conservative approach [emphasis added]:
"Financial institutions frequently focus their strategic and operating emphasis on maximizing profitability and measure their relative success by reference to profitability measures such as return on average assets or return on average shareholders' equity. Historically, we have placed primary emphasis upon asset quality, balance sheet liquidity and capital conservation, even when those priorities may be detrimental to short-term profitability."

Operating Performance: Over the past fifteen years, BancShares has earned approximately a 10% ROE. That average has been pulled down somewhat by the last several years as the bank was around an 11.5% ROE business for many years through 2000. BancShares earned $11.08 in CY09 vs. $8.73 in CY08, however $6.12 of 2009 was due to acquisition gains from the two 2009 transactions. Book value is approximately $150 per share (tangible book value is about $140 per share).

Chargeoffs in 2009 on non-loss-share assets was 0.56% vs. 0.40% in 2008, though it declined modestly in Q409 at 0.50% vs. 0.62% in Q408. Provisions grew to $77 million vs. $66 million in 2008.

PPOP in 2009 was around $154 million off from $205 million in 2008. Much of this decline is to be expected because as BancShares takes over more troubled assets and new banks, it increases its cost structure. Initially, however, it does not proportionally increase its interest income due to the fact that a large portion of those acquired assets are non-earning assets until they are worked out and the cash is redeployed into earning assets. PPOP in the fourth quarter was somewhat higher than the 2009 annualized rate at $48 million (or $192 million annualized). I expect that over time, it will continue to grow.

Recurring profitability, over time, will expand substantially as the $4.5 billion of assets acquired is redeployed without new equity needing to be raised. More accurately, the fair value of the assets acquired is closer to $3.5-4.0 billion (we don't yet have that detail for First Regional Bank), so the redeployment opportunity is probably more like $3.5-4 billion. In essence, BancShares has increased its loan portfolio and deposit franchise without needing to raise fresh equity. In fact, the growth has come without any meaningful change in BancShares risk metrics because each transaction has been immediately and substantially accretive to book value (described below in the Assisted Transaction section). As such, incremental spread will accrete undiluted to owners. This will improve returns to equity substantially. Over time, I'd expect an incremental $40-50 million of annual income (and growing) from these acquisitions.

I estimate that BancShares could earn in excess of $25 per share on a normalized basis in three years as assets grow from $21 billion and equity grows to over $2 billion. Upside optionality exists in the form of further assisted transactions, faster deployment of excess capital, sustainably higher NIM, and better than expected charge-off experience which releases reserves back to owners.

Steep Yield Curve: While my assumptions do not project substantial NIM spread percentage expansion, it is clearly quite possible. The yield curve is approximately as steep as it has ever been and the lending environment remains very favorable to lenders. This combination amounts to a great environment for banks to operate in, at least for new business. Legacy business obviously remains a challenge for most players as they deal with the less attractive book of assets from the several years leading up to the crisis. As older loans mature and cash is redeployed in a more attractive lending environment, it seems reasonable to expect that this roll leads to average profitability growing over time, even if the size of the asset base stayed the same. I expect that assets will continue to grow as BancShares continues to deploy some of its excess capital and it hunts for additional transactions.

Integration Risk: As with most banks that are larger than $10 billion of assets, BancShares has some history with acquisition and integration. Since 1990, but excluding the three recent assisted transaction, BancShares has acquired nine companies. It wisely stopped buying banks in 2003 as quality and price both degraded. Rather than acquire overpriced banks during the past ten years, BancShares has focused on organic growth of FCB and it has developed its IronStone brand growing it from its founding in 1997 to a $2.1 billion thrift today. I believe the BancShares management team will comfortably manage the integration of the FDIC assisted transactions.

How Does An Assisted Transaction Work: When an FDIC-insured depository institution fails, the FDIC typically conducts an auction to find the highest bidder (actually, to find the "least costly" solution). Some people bid for the entire bank including all assets and liabilities while others bid on pieces. The FDIC seeks to minimize losses to its Deposit Insurance Fund (DIF). This is the normal process.

Historically bidders want to avoid buying bad assets for two reasons: 1) they require management, so there's a personnel cost; and 2) they tie up capital that could otherwise be productively deployed in performing assets. However, during the ongoing crisis, the FDIC was finding that so many bidders were excluding such a large number of assets from their bids that the FDIC began promoting an option to buyers called a "loss-share" agreement where the FDIC covers 80% of losses up to a pre-determined threshold and then 95% of losses beyond that threshold.

In practice this works approximately as follows: the FDIC sets a loss threshold for bidding purposes. This is the threshold where the loss-share triggers from 80% to 95%. For example, on a $100 million asset bank, if we expect losses to the portfolio of $35 million and the loss threshold for bidding purposes is set at $20 million, then the FDIC will absorb losses calculated as 80% x $20 + 95% x ($35 - $20) = $30.25 million (we'll round to $30). Further, because capital is tied up in these troubled loans and resources must be focused on working out those loans, the bidder needs to charge their bid for those carrying costs. Those might be $11 million. As such, the bidder will take the banks pre-existing reserves as its "equity" (call it $10 million for this example), subtract $35 million of losses and $11 million of carrying costs, then add back the FDIC's loss share of $30 million for a total bid of negative $6 million (+$10 of beginning equity - $35 - $11 + $30 = -$6 million). If we were to win the bid, the FDIC would cut us a check for $6 million to take over the bank (and loss-sharing reimbursements would come over time as realized).

All of this is fine, but it still leaves the newly acquired bank with zero equity. A financial buyer (which these days comes in the form of a blind pool) might have to overcapitalize the bank with fresh capital, but a strategic buyer can take its existing capital and apply it to the newly acquired bank. In any case, for BancShares we could assume they'd need to contribute/tie-up $10 million of capital to acquire this hypothetical bank which would make it well capitalized. In essence, they buy this bank at 1.0x book with book being the newly contributed or assigned capital.

This is attractive for a variety of reasons. Importantly, the carry cost asset (the $11 million in our example) is based on a number of assumptions about how long it will take to liquidate bad assets, what the opportunity cost of that capital is, the resources needed to manage those assets, discount rate, etc. The bidder will generally be conservative in this assessment. In the extreme case, if the buyer were to liquidate all of the bad assets for zero, the book value would immediately increase by $6 million (60%) as we'd lose $5 million on the bad assets after the loss-share but we'd accrue the $11 million carry cost asset in its entirety.

This extreme scenario will never happen because the FDIC is both your partner in the assets, your source of future attractive deals, and a key regulator. As such, you would never completely screw them. However, you can see that even if the loss-share portfolio performs extremely poorly, it may actually be a positive event for BancShares. The result is that it is highly likely that the acquisition will end up being at less than book value and that the bank will be overcapitalized and capable of making attractive loans in a lending-friendly environment.

Actual Assisted Transactions:
Temecula Valley Bank - On July 17, 2009, FCB acquired Temecula Valley Bank (TVB) from the FDIC in an assisted transaction. TVB operated eleven branches in Southern California (San Diego and Temecula Valley east of SD). Prior to being shut down, TVB had $1.38 billion of assets and $0.97 billion of deposits (this excludes $304 million of brokered deposits the FCB refused). FCB purchased the $1.4 billion of assets at a $135 million discount. Day one, FCB wrote down the carrying value of the loan portion of TVB's asset portfolio from $1.21 billion to $0.86 billion and its REO from $66 million to $58 million. The bulk of the remaining assets were cash or cash-like, readily marked investment securities and a small amount of "other" assets.

No cash was paid by either FCB or the FDIC at closing. In essence, this was a zero bid. Losses are 100% FCB's on the first $193 million, then split 80/20 FDIC/FCB until losses meet $464 million and then are 95% absorbed by the FDIC thereafter (i.e., the loss threshold set by the FDIC was at $464 million). The term of the loss-share on residential assets is ten years, whereas non-resi real estate is five years with respect to loss-sharing and eight years with respect to loss recoveries. FCB recorded a $103 million loss-share receivable at the time of acquisition and in the first two and a half months identified $32 million in net losses to submit to the FDIC.

In summary, when the net assets of TVB were adjusted upward for the $103 million loss-share offset by the marking of the existing assets an liabilities, FCB records a $58 million "gain" which is effectively $58 million of equity that FCB can use to support the $856 million of loan assets that FCB acquired. FCB likely needed to use another $30 million of its capital to support those assets.

Venture Bank - On September 11, 2009, FCB acquired Venture Bank (VB) from the FDIC in an assisted transaction. VB was located in Seattle/Olympia Washington and operated eighteen branches. Prior to being shut down, Venture Bank had $0.85 billion of assets and $0.71 billion of deposits that FCB inherited (as well as $57 million of other liabilities). FCB purchased the $0.85 billion of assets at a $110 million discount. Day one, FCB wrote down the carrying value of VB's loan book from $650 million to $456 million and its REO from $52 million to $43 million. The bulk of the remaining assets were cash and cash-like investments, investment securities that are easily marked, a small amount of "other" assets.

The FDIC paid to FCB $19.4 million of cash at closing (a "negative" bid). The loss-share was tighter on VB as well. All losses are shared 80/20 FDIC/FCB until losses meet $235 million and then are 95% absorbed by the FDIC thereafter (i.e., the loss threshold set by the FDIC was at $464 million). The term of the loss-share on residential assets is ten years, whereas non-resi real estate is five years with respect to loss-sharing and eight years with respect to loss recoveries. FCB recorded a $139 million loss-share receivable at the time of acquisition and in the first nineteen days identified $8 million in net losses to submit to the FDIC.

In summary, when the net assets of VB were adjusted upward for the $139 million loss-share and the $19 million in cash from the FDIC, FCB records a $46 million "gain" which is effectively $46 million of equity that FCB can use to support the $456 million of loan assets that FCB acquired, meaning that very little to no new capital is required for FCB to take on VB. Further, the faster FCB can put losses to the FDIC, the faster it frees up its capital and resources for productive redeployment.

First Regional Bank - On January 29, 2010 FCB acquired First Regional Bank (FRB) from the FDIC in an assisted transaction. BancShares has not released in-depth detail on the FRB acquisition yet. The basics are that FRB was located in Los Angeles, CA and operated thirteen locations. Prior to being shut down, First Regional had $2.17 billion of assets and $1.87 billion of deposits that FCB inherited. $2.0 billion of the assets were acquired with loss-sharing. Regionally, this fits in with FCB's Temecula Valley Bank acquisition, giving them ample opportunity to continue an in-fill branch strategy or to acquire other contiguous bank footprints.

Return Opportunity: I'm sure nobody follows my write-ups particularly closely, but those that re-read them will notice I am not a fan of valuation targets. However, recognizing most VIC members want something tangible, I'll note the following.

Over the past 15 years, FCNCA has generally traded at a price to book of between 1.1x and 1.9x, creating a valuation arbitrage between the capital BancShares is deploying in FDIC assisted transactions and the market valuation multiple it receives on its book.

Given our acquisition price is at or near book value, it is difficult for me to imagine that over an extended period of time, our shareholder returns lag the returns on equity that BancShares generates. If the bank did no further transactions and were simply to generate 10% ROEs for the next five years, our return would be about 60%. Further, if the P/B were to expand from 1.1x to 1.5x, that would add an incremental 36% to the return. Combined, it seems reasonable that our total return over the next five years will be around 100% or a 15% annualized return. I believe this is achievable with low downside risk and substantial upside optionality from things like the attractive lending environment that prevails, improved scale leading to cost efficiency, "winner" banks receiving premium valuations and potential future attractive acquisitions.

Risks:
Integration: while I believe this is very manageable, it is of course a real risk. It is mitigated from a portfolio standpoint by the loss-shares with the FDIC. This means that the primary integration risk is around the "distraction" element of integration.

Underperformance: BancShares generated below average economic returns during the six years leading up to the crisis. While the conservatism which led to those below average returns during the boom has allowed them to be aggressive when others were licking their wounds, it is clearly possible that below average returns persist.

Macro: Everyday leads to further de-risking of the "macro" as some amount of legacy loans mature or amortize and new, more attractively underwritten loans replace them. However, clearly the macro risk remains heightened for all banks. One further mitigant is that given BancShare's relatively strong balance sheet, the macro "risk" also is "opportunity" for the survivor/winner banks as marketshare becomes available and assisted transactions become increasingly juicy.

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Post Script:
FCB pioked up yet another (its 4th) assisted transaction this weekend when four more banks failed. Two were not acquired by anyone and two were acquired by strategic buyers.

Fortunately, FCB was one of the strategic buyer, acquiring Sun American Bank in Boca Raton, FL (with 12 branches scattered across Boca, Palm Beach and Miami-Dade/Broward)

Link to FCB's press release on the acquisition.

This deal is FCB's fourth FDIC assisted transaction in the past eight months and second this year.

As of Dec. 31, 2009, Sun American Bank reported total assets of $536 million, loans of $424 million and total deposits of $443 million.

The FDIC and First-Citizens Bank & Trust Company entered into a loss-share transaction on $433.0 million of Sun American Bank's assets.

Also, we still haven't had much detail released on the First Regional Bank acquisition. A few sprinkles were covered in the recently filed 10-K, but nothing worth mentioning.

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Let me know what you think and remember, invest at your own peril. I probably know nothing about investing, so you probably should ignore me.

Senator Jim Bunning Folds

2010-03-02T20:59:00.004-05:00

Well, I guess he got what he wanted. He managed to get the Senate to sacrifice its "black liquor" subsidy to pay for the unemployment extension. At least he had principles, even if the fireworks didn't fully manifest. It feels somewhat anti-climactic (though perhaps not to holders of Boise warrants - you know who you are).

I'll always remember Bunning as "that guy that held up the Senate at gun point...and retired his seat creating an opportunity for Ron Paul's son Rand Paul to be elected to the U.S. Senate." Ah, you remember him, don't you? You know, That Guy? Oh, yeah, That Guy.

From this WSJ article:

WASHINGTON—The Senate Tuesday reached a deal to lift Sen. Jim Bunning's blockade of a bill to extend unemployment benefits, following new moves by Mr. Bunning's fellow Republicans to distance themselves from his tactics.

The agreement allowed Mr. Bunning (R., Ky.), who had complained that the $10 billion bill was not paid for, to offer an amendment that would fund the legislation by rescinding a tax credit for a paper manufacturing byproduct.

His amendment was expected to fail later Tuesday night. After that vote, Mr. Bunning was set to lift his objection to the underlying bill, which was expected to pass.

Mr. Bunning argued that the unemployment bill violated congressional rules requiring new initiatives to be paid for. Democrats said the extension was emergency legislation, exempting it from those rules. The public relations battle appeared to be playing out in the Democrats' favor as more than 100,000 jobless workers saw their unemployment benefits dry up this week.

Democrats also agreed to allow Mr. Bunning to offer two amendments on Wednesday to a longer-term extension of unemployment benefits and other programs. Both amendments are expected to propose ways of paying for that larger measure.

After the deal was reached, Mr. Bunning reiterated his argument that federal spending was out of control.

"If we cannot pay for a bill that all 100 senators support, how can we tell the American people with a straight face that we will ever pay for anything?" he said. "That is what senators say they want, and that is what the American people want."

Democrats said Mr. Bunning had been offered the same deal last week but refused to take it. "The real question in this debate is who we are as a nation," said Sen. Richard Durbin (D., Ill.). "Do we care about these people, these breadwinners who are down on their luck?"

Mr. Durbin objected to Mr. Bunning's proposal to pay for the bill by rescinding a tax credit for "black liquor," a paper manufacturing byproduct, saying this revenue source was already set aside for another measure.

Mr. Bunning had held up the unemployment-benefits extension by objecting to Democrats' "unanimous consent" request to advance the legislation, a routine procedure that requires all senators to go along.

Jim Bunting Gives The Finger To...Well, To Everyone

2010-03-01T21:51:00.006-05:00

...and we here at TILB fucking love it.

Before reading the below article, I didn't know jack about Jim Bunting save for one thing: he is retiring and his resignation has paved the way for the very real possibility that Ron Paul's son Rand Paul is elected to the U.S. Senate as Bunning's replacement.

That fact alone makes Bunning a hero in our eyes: even accidentally paving the way for potentially putting a Paul in the Senate is deserving of hero's praise.

But now we've learned one additional piecce of information about Senator Jim Bunning: he is single handedly holding up the extension (yet again!) of socialized unemployment and healthcare benefits. Workers already have had them extended from 26 weeks of state provided benefits to 26 weeks of state benefits plus 73 weeks from the Federal government! WTF!

Now without this extension, everyone is getting cut off once their current tier of benefits expires. While obviously it sucks tremendously for needy unemployed people, it is principled. All Bunting is saying is, (paraphrasing) "we need to cut an equal amount from somewhere else in the budget. I'm not going to be responsible for increasing the deficit any further given we already can't pay for what we have."

It's literally 99 to 1 in the Senate but it takes unanimity to extend an existing law without going through the traditional legislative process of actually passing a new law. As The Great Jim Bunning said on the Senate floor:

"If we can't find $10 billion to pay for something that we all support, we will never pay for anything on the floor of the U.S. Senate."

Amen Saint Bunning. Amen.

Oh, and because he's retiring and is basically untouchable as a result, he's literally flouting his opposition, including flicking off the media. Further, he actually told the Honorable Gentleman from Oregon, "Tough shit" when Senator Jeff Merkley criticized Bunning's stance.

I don't want to know anything else about the guy. Don't ruin this image of perfection.

I'm sure learning additional information would sully him in my eyes. But for now, he's perfect. On the one hand, he's going Mantan Moreland on them and putting his dick in the Senate's proverbial mashed potatoes while providing space for Rand Paul on the other.

Genius.

I'm gonna stick my dick in the mashed potatoes sound bite Beastie Boys sound bites

Stay strong, Jim. Stay strong.

Here's the Yahoo! article.

[HT: TD]

The Anatomy Of A Failed T Bill Auction

2010-02-26T10:18:00.006-05:00

So, the auction didn't actually "fail", per se. But this excellent Seeking Alpha piece breaks down a very strange Treasury Bill auction earlier this week. Very little buying from traditional sources forced primary dealers and - perhaps - The Fed to step into the breach. Here is an excellent breakdown on what was a very weak Bills auction yesterday.

We recommend clicking the above Seeking Alpha link and reading the article in its entirety, in order to understand how a Treasury auction works and what makes for a "strong" vs. a "weak" auction. What happened on February 23rd was unquestionably "weak", though to be fair, zero percent interest rates wouldn't drive me to bid either.

Here is a partial description from his article:

Now here’s where things get odd.

Of the competitive bids (meaning those bids coming from folks who care about yield), roughly 70% went to Primary Dealers (investors who HAVE to buy the debt and who usually turn around and try to sell it afterwards). To put this number into perspective here is the percentage of competitive purchases made by Primary Dealers in the last four 4-week Treasury issuances:

Date of 4-Week Treasury Auction
Primary Dealers as % of Competitive Buys

January 5 2010
42%

January 12 2010
70%

January 20 2010
60%

January 26 2010
67%

February 2 2010
51%

February 9 2010
51%

February 17 2010
61%

February 23 2010 (yesterday)
70%

You’ll note that during the stock market correction that took place during the end of January/beginning of February, Primary Dealers didn’t need to buy many Treasuries since investors were fleeing stocks and buying short-term Treasury debt as a safe haven.

You’ll also notice that yesterday’s auction featured MORE buys from Primary Dealers than almost any of those occurring in 2010. Remember, Primary Dealers HAVE to buy Treasuries. So to see them buying a high percentage of Treasuries at debt auctions means that few investors who can pick and choose what to buy are actually looking to buy US debt.

In plain terms, a debt auction that features a high percentage of competitive buys coming from Primary Dealers is BAD NEWS. It means investors generally aren’t buying US debt. It also means that foreign governments (those who have funded US debt auctions for decades) aren’t buying much anymore either.

So the fact we’ve have three short-term auctions in which more than two thirds of competitive buys came from Primary Dealers is worrisome to see the least.

Now here’s where it gets even worse.

Of the remaining competitive buys (about $8.86 billion), only 32% came from Direct Bidders or those who bought debt directly from the Treasury: orders that can easily be tracked. The other 68% ($5.9 billion) came from Indirect Bidders: folks who we cannot track.

Even more bizarre, only $5.9 billion in Indirect Bidder competitive buys were ACTUALLY OFFERED. So we had a 100% acceptance rate for Indirect Bidder competitive buys.

Let’s put this in perspective:

Date of 4-Week Treasury Auction
Indirect Bidder Acceptance Rate

January 5 2010
71%

January 12 2010
22%

January 20 2010
77%

January 26 2010
43%

February 2 2010
63%

February 9 2010
87%

February 17 2010
82%

February 23 2010 (yesterday)
100%

This means that the Treasury took up EVERY single cent of competitive bids coming from indirect buyers. Remember, indirect buyers are usually assumed to be foreign governments (even the Treasury website admits this).

If this was the case yesterday, then foreign governments barely bought much of anything in yesterday’s auction (only 19% of total debt issued). Moreover, it implies that Primary Dealers (those having to buy) had to gorge on the auction to make up for the fact that few if any foreign governments are interested in buying our debt anymore (including even short-term debt).

Or…

One could potentially argue that this indirect buying came from the Fed covertly buying under the guise of an indirect bidder (the Treasury recently changed the definition of what qualifies for an indirect bidder to make it more vague). It IS rather odd that every single cent of competitive bidding coming from indirect buyers was filled. It’s almost as if the indirect buyers knew precisely WHAT yield to accept… OR were simply trying to take up the slack in what was already a VERY weak auction.

I cannot tell you which of the above is true. Heck, neither of them could be and something completely different could be happening. But regardless, something very, VERY strange is going on in US debt auctions.

I wrote earlier this year that bonds, not stocks, would be the big story of 2010. We’re only into February and there are already some very unusual things happening on both the long (30 year) and the short (4 week) ends of the Treasury curve. And with the Fed’s Quantitative Easing Program scheduled to end in March, things are about to get a whole lot more interesting (barring of course an extension of the QE or QE 2.0).

Keep your eye on US Treasuries. Stocks, despite being so popular with investors are usually the LAST to get what’s coming down the pike. And investors just parked $30 billion for a month with Uncle Sam at virtually NO YIELD yesterday.

Put another way, someone(s) is/are willing to not make money just for the sake of insuring return OF capital (the US can always print money to return it) rather than any return ON capital.

[HT: TD]

Japanese Collapse: The Pending Sovereign Ruin

2010-02-25T12:30:00.004-05:00

As we have been saying for some time, Japan is well past the point of no return. The country faces financial collapse brought on by two decades of unbelievable profligacy. With 10 year JGB rates at 1.5% or so vs 3.5% for the rest of the G-7, Japan's cost of financing is unbelievably cheap despite having debt to GDP of nearly 200% (vs. just over 100% for Greece and about 80% for the US, both of whom are wildly over indebted). Japan has managed to pull this off for a variety of reasons including a) they've run a large trade surplus; b) they've been dealing with price deflation that has allowed even very low nominal interest rates to still be positive real interest rates; and c) 95% of Japan's sovereign debt is financed internally.

Japan's population began shrinking a few years ago and the demographics are such that new retirees are outnumbering new workforce entrants, leading to a dis-savings trend (you save during your working years and spend during your retirement years), meaning that the ability to internally fund Japan's debt is evaporating (simply rolling the existing debt will be increasingly difficult, much less continuing to run deficits, which Japan's is >10% of GDP). Replacing that internal funding with external funding is a non-starter because if Japan's cost of funding were to exceed 3%, nearly 100% of Japanese federal tax receipts would be consumed by interest expense. So going to the external market and competing at G-7 type interest rates would quickly lead to total collapse.

As such, Japan's central bank (the BOJ) will almost certainly have to monetize the debt, leading ultimately to a hyper-inflationary depression. Japan knows this. It has burned through six ministers of finance in the past 18 months (akin to Secretary of the Treasury), the fifth of which committed suicide rather than resigning. On top of that Japan's currency has stayed remarkably strong, staggering its export oriented economy.

We predict much higher rates (ultimately greater than 10%) and a much weaker Yen (surpassing 150 to the dollar and possibly 200). This will devastate Japanese savings, force austerity and likely make Japan default or rework its sovereign debt. Assuming this happens, hopefully it happens soon enough that the US has enough time to reflect on Mad Scientist Bernanke's experiment as conducted by Japan and we choose to retrench and not pursue these horrible, suicidal crippling policies of deficits and inflation.

The piper will ask to be paid someday. Be ready.

Anyway, enjoy the slide deck.

Japan - Past the Point of No Return - Katsenelson

HT: TD

The Fabian Socialists Are Winning

2010-02-22T14:27:00.006-05:00

The Fabian Socialist movement, first begun over one hundred years ago, is moving faster today than ever before. The success of their slow evolutionary drive toward central planning was highlighted a few days ago when we presented our Depressing Chart of the Day, shown to the right. It shows that the total of federal, state and local government spending as a percent of GDP has skyrocketed over the past few years, approaching 50% of all GDP.

By coincidence, your intrepid author is in the midst of Hayek's "The Road to Serfdom". In the excellent book is the excerpt that follows. TILB highlighted several points below [all emphasis added], but most important is the emphasis on Germany in 1928 (immediately prior to Nazi rule).

Of additional note is the description on how socialism is most effective in a republic or democracy - by taking the power away from elected leaders and handing it to non-elected bureaucrats (a modern day example would be the Federal Reserve's central planning role in determining the amount and price of money).

The words that follow are from Hayek published in 1944.

We can rely on voluntary agreement to guide the action of the state only so long as it is confined to spheres where agreement exists. But not only when the state undertakes direct control in fields where there is no such agreement is it bound to suppress individual freedom. We can unfortunately not indefinitely extend the sphere of common action and still leave the individual free in his own sphere. Once the communal sector in which the state controls all the means, exceeds a certain proportion of the whole, the effect of its actions dominate the whole system. Although the state controls directly the use of only a large part of the available resources, the effects of its decisions on the remaining part of the economic system become so great that indirectly it controls almost everything. Where, as was, for example, true in Germany as early as 1928, the central and local government authorities directly control the use of more than half of national income (according to an official German estimate then, 53 per cent), the control indirectly almost the whole economic life of the nation. There is, then, scarcely an individual end which is not dependent for its achievement on the action of the state, and the "social scale of values" which guides the state's action must embrace practically all individual ends.

It is not difficult to see what must be the consequences when democracy embarks upon a course of planning which in its execution requires more agreement than in fact exists. The people may have agreed on adopting a system of directed economy because they have been convinced that it will produce great prosperity.

In the discussions leading to the decision, the goal of planning will have been described by some such term as "common welfare," which only conceals the absence of real agreement on the ends of planning. Agreement will in fact exist only on the mechanism to be used.

But it is a mechanism which can be used only for a common end; and the question of the precise goal toward which all activity is to be directed will arise as soon as the executive power has to translate the demand for a single plan into a particular plan. Then it will appear that the agreement on the desirability of planning is not supported by agreement on the ends the plan is to serve.

The effect of the people's agreeing that there must be central planning, without agreeing on the ends, will be rather as if a group of people were to commit themselves to take a journey together without agreeing where they want to go: with the result that they may all have to make a journey which most of them do not want at all.

That planning creates a situation in which it is necessary for us to agree on a much larger number of topics than we have been used to, and that in a planned system we cannot confine collective action to the tasks on which we can agree but are forced to produce agreement on everything in order that any action can be taken at all, is one of the features which contributes more than most to determining the character of a planned system.

It may be the unanimously expressed will of the people that its parliament should prepare a comprehensive economic plan, yet neither the people nor its representatives need therefore be able to agree on any particular plan. The inability of democratic assemblies to carry out what seems to be a clear mandate of the people will inevitably cause dissatisfaction with democratic institutions.

Parliaments come to be regarded as ineffective "talking shops," unable or incompetent to carry out the tasks for which they have been chosen. The conviction grows that if efficient planning is to be done, the direction must be "taken out of politics" and placed in the hands of experts-permanent officials or independent autonomous bodies [TILB - see the Federal Reserve for a modern day socialist example].

The difficulty is well known to socialists. It will soon be half a century since the Webbs began to complain of "the increased incapacity of the House of Commons to cope with its work."' More recently, Professor Laski has elaborated the argument:

"It is common ground that the present parliamentary machine is quite unsuited to pass rapidly a great body of complicated legislation. The National Government, indeed, has in substance admitted this by implementing its economy and tariff measures not by detailed debate in the House of Commons but by a wholesale system of delegated legislation. A Labour Government would, I presume, build upon the amplitude of this precedent. It would confine the House of Commons to the two functions it can properly perform: the ventilation of grievances and the discussion of general principles of its measures. Its Bills would take the form of general formulae conferring wide powers on the appropriate government departments; and those powers would be exercised by Order in Council which could, if desired, be attacked in the House by means of a vote of no confidence. The necessity and value of delegated legislation has recently been strongly reaffirmed by the Donoughmore Committee; and its extension is inevitable if the process of socialisation is not to be wrecked by the normal methods of obstruction which existing parliamentary procedure sanctions."
And to make it quite clear that a socialist government must not allow itself to be too much fettered by democratic procedure, Professor Laski at the end of the same article raised the question "whether in a period of transition to Socialism, a Labour Government can risk the overthrow of its measures as a result of the next general election"-and left it significantly unanswered.

It is important clearly to see the causes of this admitted ineffectiveness of parliaments when it comes to a detailed administration of the economic affairs of a nation. The fault is neither with the individual representatives nor with parliamentary institutions as such but with the contradictions inherent in the task with which they are charged.

They are not asked to act where they can agree, but to produce agreement on everything--the whole direction of the resources of the nation. For such a task the system of majority decision is, however, not suited. Majorities will be found where it is a choice between limited alternatives; but it is a superstition to believe that there must be a majority view on everything.

We are fast approaching a tipping point. In the course of a decade, we have gone from the government representing an already egregious one third of economic outpoint to one that represents 44% of our economy. It seems likely not to shrink as the current administration clearly believes in its just and beneficent wisdom and will impose that wisdom upon us, whether we want it or not.

To be fair, the trend of the graph at the top of this page is party neutral - both donkeys and elephants share the blame - having built over the course of 80 years. The acceleration, though, is perhaps most frightening of all. TILB is not sure what will cause a secular shift back toward freedom and away from centrally planned oppression. We suspect that, in the end, the will of the people must exert itself and reclaim lost liberty.

Lord hear our prayers...

The Borg, I Mean Obama Administration, Proposes Federal Price Controls On Health Insurers

2010-02-21T22:57:00.004-05:00

Good lord, our president has no shortage of self-assuredness in his ability to control all aspects of society. Thomas Sowell preciently warned us of this prior to the 2008 election.

The Administration is apparently going to take another crack at health insurance reform (rather than healthcare reform) by imposing federal price controls on the insurance industry. The modicum of respect that I retain for the man declines everyday as his populist exploitations accumulate.

I mean, federally imposed price controls have worked so well in other areas of the economy. Fortunately, this effort is unconstitutional and clearly impedes states' rights and oversteps constitutionally limited federal authority. Unfortunately, we all know that Obama views the constitution as a simple set of best practices recommendations rather than the fundamental underpinning of the relationship between man and his servant government.

If it is not yet screamingly obvious that price controls reduce competition, reduce service quality, and impair productivity, then it never will be. There is not one sector of the economy that the government has ever successfully improved through price controls.

Here is the New York Times article on the topic of The Administration's efforts to set prices.

What's ironic is that every industry the government is heavily involved subsequently earns a terrible reputation: public schools, health care, banking, insurance, defense, etc. These are businesses that have costs that rise in excess of inflation and productivity gains that lag it. However, industries that are relatively more free such as high tech, retail, and consumer goods reflect the opposite: improving productivity, declining costs, and increasingly customer friendly prices and products.

The obvious answer is to free the health care and insurance sector of governmental interference and watch them blossom. Sadly, this will not happen under the rule of a man that believes he can impose better outcomes than individuals would receive through freedom (or, in the case of insurance, local judgement).

The Revolution Marches Forward

2010-02-17T15:17:00.001-05:00

I have nothing to add.

Harrisburg. Pennsylvania Makes Official Its March Toward Default

2010-02-14T17:39:00.003-05:00

As we discussed last week, Pennsylvania's state capitol city - Harrisburg - is insolvent. This week, Harrisburg makes it official by passing a budget that excludes paying their financing obligations. Chapter 9 feels right around the corner...

Reuters provides the story. Article included below [emphasis and comments added]:

PHILADELPHIA, Feb 14 (Reuters) - Harrisburg, Pennsylvania, moved a step closer to defaulting on a bond payment when its city council passed a 2010 budget that does not include $68 million in debt repayments on an incinerator.

Without the debt provision in the $65 million budget, the state capital may miss a March 1 payment of $2.072 million, a rarity for a municipal bond issuer. [TILB: a "rarity" indeed, although we suspect that like homeowner mortgage default, this will become less rare over the next few years]

Joyce Davis, a spokeswoman for Mayor Linda Thompson, confirmed the council's decision -- taken at a special session on Saturday -- and said the mayor is not commenting for now on the implications of exclusion of the debt payments from the budget.

The council also defeated a plan to sell city assets to help pay down the debt which is guaranteed by the city on behalf of the Harrisburg Authority, a separate municipal entity that owns the incinerator. Council members also rejected Thompson's plan to raise property taxes and water rates.

The $2.072 million payment is the latest installment on a $300 million bond owed on the construction of the incinerator. An additional $637,000 is due on April 1.

City Controller Dan Miller said last year's payments on the incinerator were made from a debt service reserve fund that is now depleted.

Debt payments on the incinerator total $68 million in 2010, or more than the city's general fund budget of about $60 million, Miller said.

Miller said on Feb. 9 he would "not be surprised" if Harrisburg fails to meet the March 1 payment.

Asked whether the city may file Chapter 9 bankruptcy as a way to get its debts under control, Miller said that was a "possibility."

The tax-exempt municipal bond market, which states, cities and municipalities use to raise the funds to build roads, schools and hospitals, is viewed as very safe with a far lower default rate than the corporate bond market.

Just 54 municipal bond issuers rated by Moody's Investors Service defaulted on their debt between 1970 and 2009, the agency said on Thursday. The average five-year historical cumulative default rate for investment-grade municipal debt was 0.03 percent in the period, compared with 0.97 percent for corporate issuers.

The recession has raised concerns of an increase in defaults as states, cities and towns struggle to balance budgets as required by law in all states except Vermont.

So far, however, those fears have not been realized and ratings agencies have played down the likelihood of a spike in defaults.

Fitch Ratings in January cautioned cities against using the threat of bankruptcy as a weapon to win concessions from labor unions. Even talk of bankruptcy can become self-fulfilling and undermines investor confidence in the market, it said.

Hayek Vs. Keynes

2010-02-14T14:04:00.002-05:00

DJ Freddy Hayek b-slaps DJ Maynard, in this rap video.

TILB Depressing Chart Of The Day: Government Spending As A Percent Of GDP

2010-02-10T16:09:00.004-05:00

This basically speaks for itself. It is all government spending: federal, state and local. The data series can be found here.

Another way to think of this is that 45% of your productive effort goes to supporting The State. While you may say, "but that's impossible because the sum of the average tax rate we pay doesn't get to 45%", then you just figured out what government borrowing allows for.

Paying off that debt (without defaulting) means one or a combination of higher explicit taxes, higher implicit taxes (money printing), or massively reduced government spending in the future. Guess which one of these is unlikely.

If you just vomited in your mouth and subsequently swallowed it, you're not alone.

Pennsylvania's Capital City, Harrisburg, Faces Bankruptcy

2010-02-07T21:22:00.004-05:00

Somehow we missed this news during January. Hopefully it continues to develop toward a filing.

Awesomely, Pennsylvania's capital city - Harrisburg - is insolvent and on the brink of filing for Chapter 9 bankruptcy.

As reported in this link to WGAL's website, you can see that Harrisburg's new mayor is dealing with all sorts of tough decisions in her first few weeks in office.

TILB's advice to Mayor Thompson: take a page from Arnold's book and start issuing your own scrip. Seems like s no-brainer.

Emphasis added [and comments added in brackets]

WGAL.com
Harrisburg Facing Bankruptcy; Mayor Proposes Tax Hike, Leasing Assets
Official: Incinerator Primary Cause Of Financial Woes

HARRISBURG, Pa. -- After just a few weeks in office, Harrisburg Mayor Linda Thompson is facing financial problems that could put the city in bankruptcy before the year is out.

City officials blame the incinerator facility, now over $228 million in debt, for the city's financial troubles.

That's not an option she even wants to consider at this point, but any successful plan must solve the financial drain of the city's incinerator.

The incinerator is currently $288 million in debt and is the primary cause of Harrisburg's financial problems.

Officials said it doesn't begin to produce the revenue needed to pay off the debt of repairing and operating the facility over the years.

Former City Council vice president Dan Miller said it's been a financial drain for decades.

"It's such a problem because for 25 years, the true problem of the incinerator has never been addressed," said Miller. "It's been refinanced repeatedly and pushed down the road, always waiting for someone else to solve the problem."

Now, he said, the city must solve the problem.

Miller said he believes the city should consider going into Act 47, the first step before bankruptcy. That would allow the city to negotiate with the people it owes to come up with realistic plans to settle debts.

Miller said raising taxes and other fees, or selling off revenue-producing city assets like the parking garages and water and sewer operations, will only create new problems.

Mayor Thompson Proposes Budget Amendments
Thompson addressed City Council Tuesday night with her own plans to fix the financial crisis.

City council member Wanda Williams said Thompson's proposed tax hike is "an outrageous amount" to increase any taxes. [TILB - I love this! "We can't cut spending" and "we can't sell our precious assets" and "we can't raise taxes"! Guess what you can do, loser: File BK.]

Thompson is proposing to increase water rates by 40 percent and cut overtime funding for the police and fire department.

At the meeting, Thompson also proposed what she called tough decisions, which include:
A 20 percent property tax increase
Cutting costs for trash collection
Merging Harrisburg dispatch with the Dauphin County 911 center

Thompson said her cuts would save the city about $8 million. She said her proposals will close the nearly $4 million gap in the budget, allow the city to make payroll next month and help ease the financial pain of the incinerator debt.

But not everyone is happy with the mayor's recommendations.

"I'm disturbed by it," said one taxpayer. "To me, a property tax increase as well as a water rate increase would be something I find objectionable." [TILB - while we totally agree, Johnny Taxpayer needs to recognize that these are symptoms of the debt and spending problem. It's like getting herpes from unprotected but enjoyable sex and then saying you find the sores "objectionable".]

Thompson said she is also considering selling or leasing the city's assets, including parking garages and City Island. [TILB - Honestly, this is a great idea...I mean, other than the fact that this is a horrible time to sell these sorts of assets. Maybe some public REIT with overpriced equity financing will provide the necessary bid. Why should municipalities be in the business of managing parking garages anyway?]

City council will look into the mayor's budget proposal at Thursday's budget and finance committee meeting.

Expect more of this sort of thing.

The Final Countdown: Greek Sovereign Default

2010-01-29T10:38:00.006-05:00

The aptly named band Europe brought us the epic music video and song "The Final Countdown" about 20 years too early (I mean, who cares about the countdown to the end of communism - let's talk about the PIIGS sovereign default).

As I read all these articles about Greece's impending doom, it's hard not to hear in the back of my head the implied complaint, "why won't they just lend us the money for free? This doesn't make any sense. Just lend us the money for free!"

[emphasis added and comments in brackets]

Europe Weighs Possibility of Debt Default in Greece
New York Times
By STEPHEN CASTLE and MATTHEW SALTMARSH

European leaders are quietly considering whether to come to the aid of their troubled neighbor Greece amid fears that the nation might default on its debts and unleash another round of financial crisis.

Only a month after Dubai was rescued by its neighboring emirate Abu Dhabi, Germany, France and other European powers are discussing whether Greece might need a bailout too.

After a decade of debt-fueled profligacy, Greece is confronting what amounts to a run on the bank. And, despite repeated assurances from Athens, the nation’s strained finances have put already jittery financial markets on edge. On Thursday, the worries stretched all the way to Wall Street, where the stock market sank 1.1 percent.

Some economists worry that Greece’s troubles could have deep and lasting repercussions for Europe. The crisis poses complex challenges for the euro, which Greece adopted in 2001. The currency sank to a six-month low against the dollar and yen on Thursday.[ironically, TILB thinks letting Greece go could be an incredibly strong event for the euro]

“Greece failing is not an option, and lots of people think that we will have to intervene at some stage,” said one European finance official, who was not permitted to speak publicly on the matter. “It doesn’t have to happen, and we hope it won’t, but it would be better than seeing a default.”

...

But doubts have intensified over the credibility of the drastic austerity measures put forward to try to get Greece’s budget under control, in spite of concerted efforts by the Greek government to calm the markets.

Investors worry that the crisis in Greece could touch off a domino effect across Southern Europe. Many are fleeing bond markets in Portugal, Spain and Italy out of concern the troubles might spread. [TILB - Collectively known as the PIIGS when Ireland is included]

The market’s judgment has been swift and brutal. On Thursday, the difference between the interest rates on Greek and German bonds — a measure of the risk investors perceive in the Greek debt — rose to nearly four full percentage points, its highest level since the euro was adopted.

Officials in Athens, Frankfurt and Brussels remained adamant that Greece was not at risk of being forced to abandon the euro. [TILB - of course not. Could you imagine if they said, "hey, we're thinking of going back to the Drachma so that we can print our way out of this debacle?" That would be amazing.]

As a condition of any aid package, the Greek government led by Mr. Papandreou would be asked to provide a more detailed program to bring the country’s deficit — currently equal to 12.7 percent of gross domestic product — under control. European Union rules call for a maximum of 3 percent. Officials insist that any bailout must not put into doubt the credibility of the euro.

Another condition of any aid would be further guarantees over the reliability of Greece’s economic data. Last year the newly elected government in Athens announced a sharp upward revision of its deficit figures, which have since been exposed as seriously flawed.

Next week, the European Commission is expected to propose greater powers for the European statistical agency, Eurostat, to audit the accounts of national governments. [TILB - watch Czech president Vaclav Klaus give this interview where he presciently assesses the fact that the EU and the Euro are forfeitures of sovereignity and freedom, then watch the slow leech of powers from the states to the centralized United States of Europe]

The latest moves reflect a continuing skepticism among euro-zone members over the practicality of the plans put forward so far by the Greek government. Athens wants to reduce the deficit to 3 percent of G.D.P. by 2012, an objective described as unrealistic by one European diplomat, also speaking on condition of anonymity. These plans are also to be assessed by the commission next week.

Greece’s budget deficit is four times the E.U. limit, while the country’s debt amounts to 113 percent of G.D.P. But officials insist that, because Greece is not one of the euro zone’s larger economies, the problems created by its grim public finances can be absorbed. The Greek economy represents about 2.5 percent of the euro area’s G.D.P. [TILB - Japan is over 200% sovereign debt to GDP and the US is a bit over 80%. Carmen Reinhardt and Kenneth Rogoff show that 90% is the threshold past which few survive, as well as 60% externally financed debt to GDP - this latter point has been Japan's saving grace, though that is likely over]

...

For Greece’s neighbors, there is the possibility of a domino effect, with investors subsequently moving on to test the resilience of another heavily indebted member of the euro area — possibly Italy, whose debt is also 113 percent of its gross domestic product.

...

One option, deemed unlikely, would be issuing a sovereign bond for the entire 16-nation euro area. That would probably require complex legal changes among members. [TILB - see prior Vaclav Klaus reference]

...

On Monday, Greece paid a hefty 6.22 percent rate to borrow money in the bond market, underscoring investors’ concern. [TILB - and it's much more expensive for them already, just five days later. If memory serves us well, they have a number of huge maturities in April/May that will be challenging to finance affordably without German backstop...]

In an interview this week, the Greek finance minister, George Papaconstantinou, acknowledged that the high rates were punitive but asked that investors keep faith. Greece needs to raise at least 53 billion euros this year, much of it this spring.

People think this is news?

As we've been saying for a year, just wait until Japan blows. It's situation is nearly twice as bad as Greece's. Despite having 40% of the U.S.'s GDP, it has as much debt. If its blended cost of funding goes up from 1.5% to a bit over 3%, 100% of its tax revenue will be absorbed by interest expense. We're talking about the second largest economy in the world and it literally has no other options than massively debasing its currency or defualting on its debt (or, more likely, both). That's what they get for following Bernanke's wicked advice.

The sooner Japan blows, the better for the U.S. - I suspect our only hope of not suffering the same fate is to witness Japan's meltdown after having followed a similar prescription.

And as to Europe, just wait until Greece's implosion lights up Italy, which is a very large economy. That is the real worry the EU is facing: do we let Italy go?

Which brings us full circle, to The Final Countdown...

Why Don't You Start Calling Me Gordon?

2010-01-29T10:25:00.001-05:00

Wall Street 2: Money Never Sleeps

State Of The Union - Summary: "It's A Shitshow Out There"

2010-01-27T21:38:00.003-05:00

Watching Obama's debacle of a State of the Union address reminds us of Thomas Sowell's prescient analysis from almost a year and a half ago.

Sowell link.

As an aside, did anyone else find Obama referencing the Constitution at the beginning of his speech ironic?

U.S. Rail Data Crushingly Negative

2010-01-19T10:24:00.004-05:00

[HT: Max Headroom and LB]

The weekly railroad traffic data collected by the Association of American Railroads (AAR) did not have a particularly difficult comp in January. You may recall that in January 2009, it seemed as if the world had stopped as retailers and suppliers were crushed by excess inventory that needed to be burned off. Those same businesses allegedly just stopped placing orders leading to the collapse in rail volumes during November and December of 2008 in the below graph. January 2009 was no better.
2010 - Jan 14 - AAR Data

So January 2010, even if still in the teeth of a recession, should at least have the benefit of not dealing with an excess inventory problem. It should have been better than January 2009.

But alas. In fact, the first week of January is comping well below the worst average month in all of 2008 or 2009 (or any month for YEARS, for that matter). Green shoots?

From the AAR's weekly rail data release (emphasis added):

WASHINGTON, D.C. – Jan. 14, 2010 – The Association of American Railroads today reported that freight rail traffic is off to a slow start in 2010 with U.S. railroads originating 236,796 carloads for the week ending Jan. 9, 2010, down 12.4 percent compared with the same week in 2009 and down 28 percent from the same week in 2008. In order to offer a complete picture of the progress in rail traffic, AAR will now be reporting 2010 weekly rail traffic with year-over-year comparisons for both 2009 and 2008.

Helicopter Ben, your authotization to continue debasing has arrived. Continue your destructive ways freely.

California Debt Is Downgraded: Schwarzies Prepare For A Comeback!

2010-01-14T07:04:00.000-05:00

TILB is so incredibly thankful that - as we informed our readers over and over again last spring and summer (click here for all TILB posts referencing Schwarzies) - California has not at all fixed its budget woes. It has another $20 billion deficit expected in the coming 18 months.

It seems as if California lawmakers think this problem might solve itself. That somehow, they are going to miraculously bring in another $14 billion in tax "revenue" - annually mind you - over any reasonably near term period.

Spoiler Alert: Ain't gonna happen. In fact, the more you raise taxes when you are already a high tax regime like California, in the long run, the less tax "revenue" the state can expect to receive. It will actually worsen its problem by driving out marginal growth and productive investment.

The obvious solution is not to try to raise another $14 billion per year - it's to cut $14 billion more in spending per year. Free that capital up so that your citizenry can productively deploy it rather than having a bunch of proven morons in Sacramento deploy it destructively.

As we promised back in July 2009, TILB stands ready to laugh in California's face as their legislature acts like a political set of keystone cops.

Below and linked here is a Reuters article discussing the S&P downgrade [emphasis added and comments in brackets are TILB's].

UPDATE 4-California debt rating cut as cash crunch looms
8:03pm EST* S&P sees budget solution possibly crimping economy

* $19 bln shortfall tougher to close than last year's-S&P [no shit - you can't cut the fat you already cut, so it's all new fat here]

* Cash crunches seen in March, July, but RANs to be paid (Recasts, adds debt insurance costs and comparison)

By Jim Christie and Peter Henderson

SAN FRANCISCO, Jan 13 (Reuters) - California's main debt rating was cut on Wednesday by Standard & Poor's, which said the government of the most populous U.S. state could nearly run out of cash in March -- and another rating cut might follow.

The state government's budget gap of nearly $20 billion over the next year and a half leaves it in a precarious situation, requiring tax increases or spending cuts, either of which may slow economic recovery, the agency said in a statement.

"If economic or revenue trends substantially falter, we could lower the state rating during the next six to 12 months," S&P said after cutting the rating on $63.9 billion of California's general obligation debt one notch to A- from A.

The new level is four notches above "junk" status, a level at which many investors refuse to buy debt.

"The big question is, is there any fear they will get downgraded out of investment grade (so) you may have to sell ... that's where I think it would get interesting or hairy," said Eaton Vance portfolio manager Evan Rourke.

Bond prices did not move much, though, since many expected the downgrade, he said.

S&P's downgrade was overdue because the state's revenues have been so weak, said Dick Larkin, director of credit analysis at Herbert J. Sims Co Inc in Iselin, New Jersey. "Frankly I can't understood why it took S&P so long," he said. "They could have made that decision back in September." [September? Try March.]

$1 BILLION SHORT IN MARCH

California already had the lowest debt rating of any U.S. state before the downgrade, and 39 state governments are struggling with shortfalls this fiscal year, according to the nonpartisan Center on Budget and Policy Priorities.

Many are begging for more federal funds and caught between cutting social programs, raising taxes, or both.

The housing market implosion was felt especially strongly in California, a subprime mortgage lending center. Its double-digit unemployment rate, one of the highest in the United States, is expected to endure for a year or more.

California's government resorted to issuing IOUs last year for the second time since the Great Depression when it nearly ran out of cash. Officials are scrambling to raise $1 billion for March and the shortfall could be worse in July, S&P said. [sounds like Schwarzies are coming back; we're almost giddy with excitement!]

State Treasurer Bill Lockyer's spokesman Tom Dresslar said S&P's downgrade "highlights the critical need for the legislature and the governor to produce a swift budget resolution that is credible to the market."

"Standard & Poor's makes it clear the failure to act in a timely manner and with credibility threatens to further lower our GO rating," Dresslar said, adding that a further cut would hit taxpayers already paying higher interest rates than people in some emerging economies.

The cost to insure California's debt with credit default swaps is now higher than debt of developing countries, such as Kazakhstan, Lebanon and Uruguay. It costs $277,000 per year for five years to insure $10 million in California debt, compared with $172,000 for Kazakh debt. [phenomenal]

George Strickland, a municipal bond mutual fund manager at Thornburg Investment Management said S&P still has California GOs rated too high. Moody's Investors Service has a Baa1 rating on the debt and Fitch Ratings rates the bonds BBB.

"There's another notch to go before they hit bottom," Strickland said, adding that he expects another long and ugly battle to fill the state budget's shortfall.

Governor Arnold Schwarzenegger less than a week ago unveiled a plan to balance the state's books, largely with spending cuts that he described as draconian and which leaders of the Democrat-controlled legislature sharply criticized. [I can't wait to see the Donkey-proposed alternative - Lord willing it involves more unconstitutional minting of Schwarzies by Sacramento]

S&P said "timely progress" on a budget fix would be impeded by previous reliance on one-time measures, fewer choices for one-time cuts, extraordinary reliance on federal aid in Schwarzenegger's plan, and California's unusual requirement for a supermajority of lawmakers to pass a budget.

The Republican governor's budget plan also said that while the state government faces cash challenges in March, it will have sufficient cash to repay $8.8 billion in revenue anticipation debt in May and June as scheduled. [whether true or not, what else can they say? Any other statement would be a hand delivered invitation for the ratings agencies to slash the G.O. rating further]

State Finance Director Ana Matosantos along with Lockyer and State Controller John Chiang said on Monday they are working together so the state government honors its RAN debt.

Bond payments are by law a top state priority and state Finance Department spokesman H.D. Palmer said they will be honored: "Even though we've got to make some decisions in managing March we absolutely have ample cash on hand to make our RAN payments in May and June on time and in full."

Larkin said the three major rating agencies will hold off on more downgrades to California's credit rating to avoid roiling the municipal debt market, even in the event budget talks between Schwarzenegger and lawmakers drag on.

"They'll give the state an awful lot of rope," Larkin said. "For a state to go below investment grade would cast a pall on every state and local issuer out there." [at least market participants publicly acknowledge that the ratings agencies are pussies]
(Reporting by Jim Christie, Peter Henderson, Karen Brettell and Joan Gralla; Editing by Andrew Hay, Gary Hill)

Hayman Capital's Kyle Bass Gives Interview On CNBC

2010-01-13T09:01:00.004-05:00

Kyle Bass of Hayman Capital (enjoy a past letter of his here) will be testifying in front of the Congressional Financial Crisis Inquiry Commission (FCIC) today as a market participant playing counterpunch to a bunch of big name bankers that are there to defend the role of banks in the crisis. Hopefully Lloyd talks more about how Goldman is doing "God's work."

Bass talks to David Faber in this video about capital adequacy of banks, Freddie and Fannie, and the looming meltdown of Japan (further proof of The Singularity risk).

Enjoy.

Jeffrey Gundlach, CEO Of DoubleLine Capital, Responds To Lawsuit From TCW

2010-01-11T17:36:00.002-05:00

Gundlach strikes back at TCW and defends his honor.

Dear Friends of DoubleLine:
I am writing to address briefly the business dispute between Trust Company of the West and my new firm, DoubleLine Capital LP. As has been widely reported in the press, TCW filed suit last week against DoubleLine, me and some of my trusted colleagues. I have referred TCW's unfortunate litigation tactics to my legal team and expect this matter to be handled as a business dispute in the ordinary course. My portfolio management and trading teams and I continue to focus on the work of building DoubleLine and managing our clients' accounts. We are dedicated to the well being of our clients and to delivering on our promise to treat our clients' precious capital as our own.

DoubleLine has made remarkable progress in the past few weeks. We have in place our seasoned Mortgage, Corporate, Emerging Markets and Core Fixed Income teams; the Securities and Exchange Commission has approved our application to become a registered Investment Adviser; we have occupied our new permanent office and trading space in downtown Los Angeles; and we have established separate accounts on behalf of our initial clients. We look forward to sharing further news of our progress in the days and weeks ahead.

While I am resolved not to let TCW distract me or my team, TCW has disseminated certain smears and innuendoes that I am unwilling to let pass without at least a brief comment.

First of all, I was a loyal and extraordinarily productive employee of TCW for over 24 years. I have very good feelings toward many of the people with whom I worked there. And I am proud of the significant contributions by my teams and myself to the historic success of TCW.

In January 2009, TCW's parent, Société Générale, publicly announced that it was no longer interested in being in the money management business in a meaningful way. Soc Gen has since wound down direct involvement in its primary money management arm and discussed plans for an IPO or other paths of divestiture of TCW sometime before 2014. I became deeply concerned about the extended period of uncertainty: how would the divestment of TCW occur? How would that uncertainty affect me, my colleagues, the business and our clients? I know that other senior managers at TCW shared the same concerns at the time and do so to this day.

In response, in my last few months at TCW, I explored avenues to purchase the business, overtures that were rebuffed. Although I had begun to consider other options, I fully expected up until my dismissal on December 4 that, if I left TCW, I would do so in a negotiated transaction that was accommodative to clients as well as mutually beneficial for TCW and myself. It is unfortunate that TCW elected to take another route.

A second deeply disturbing element of TCW's actions has been its invasion and searching of locked drawers in my office at TCW's headquarters in downtown Los Angeles and of a small personal office I kept in Santa Monica. I personally paid the rent and all other expenses for the operation of this office. After seizing these offices, TCW refused to allow me to collect my personal possessions, and the salacious disclosure in TCW's lawsuit of certain of the items apparently taken there from is a transparent attempt to embarrass me and harm my business. While these actions will no doubt be subjects of litigation, suffice it to say that I had every expectation of privacy in these spaces, which stored vestiges of closed chapters of my life.

Notwithstanding TCW's scorched earth legal policy, I am certain that no employee of TCW, past or present, friend or foe, can honestly say that they ever had any experience with me, either in the office, on the road or in any meeting, in which there was any improper activity consistent with the innuendoes, smears and gross distortions to which TCW has shamelessly subjected me in its lawsuit.

I assure you that I remain the worthy fiduciary in whom you have entrusted your investments over many years. Together with my team, I navigated the treacherous credit crisis markets and protected and grew your principal while others failed. I believe that we at DoubleLine have earned your trust, and hope that you will continue to permit us to protect and make money for you and with you.

Sincerely,

Jeffrey Gundlach
Chief Executive Officer
DoubleLine Capital LP

Contact Information
phone: 213-633-8200

Thank Goodness For Food Stamps - These Job Seekers Would Do Anything For A Job If One Simply Existed

2010-01-06T18:05:00.005-05:00

This past Sunday, The New York Times ran a front page article on the massive increase in people living off food stamps alone (no other income whatsoever).

Peppered with sad tales like that of Isabel Bermudex who went from a poor upbringing to earning $180,000 in one year as a real estate agent during the boom before falling back to nothing, the article is intended to tug at the heart strings. It emphasizes the desperate straights of these unemployed and incomeless folks and how badly they want an honest day's work.

Throughout the article, people talk about wanting - but not being able to find - jobs and the terrible situation they'd be in without government handouts.

We certainly don't doubt it.

What we do doubt is that the solution is more handouts; more government. Government interference is the problem - it is what prevents most people from finding gainful employment. We have a huge excess supply of labor that allegedly wants nothing more than employment (10% unemployed). Any income is better than no income, all else being equal. However, our strict minimum wage legislation prevents the natural market clearing mechanism from taking place. As any freshman econ major can tell you, virtually any amount of supply of goods or services that has positive value can be cleared at the right price. Further, because we pay people not to work when they lose their jobs, the hurdle for accepting new work is artificially raised by the government subsidy the individuals receive.

The minimum wage and welfare-type programs are painful legacies of the New Deal era that oontinue to wreak havoc today. The people in the article below continue to suffer from F.D. Roosevelt's mad science. TILB used to think the minimum wage level didn't particularly matter because during the long period of full employment it really didn't. However, during periods of economic downturn, minimum wage basically puts a chokehold on remployment - not allowing labor prices to reset and preventing companies from hiring.

In reality, the minimum wage and other cost raising government interferences like it are nothing but Chinese economic stimulus legislation.

As our policies make it impossibly uneconomic for Americans to be employed in America by American companies, the government is basically encouraging those same companies to send wages and much needed investment capital overseas to countries that have more friendly policies toward their populous - policies that don't legally prevent citizens from working for a wage they'd happily accept and worse, that pay people not to work!

Only a government official or tunnel visioned theoretical academician could come up with this foolishness. Sadly, we seem to have returned to this sort of thinking at our highest levels. It virtually guarantees that our country will struggle to reach a full recovery.

Sometimes we wonder if that underperformance and increase of government supplicants isn't actually the goal of the left; to enslave the underemployed and undereducated to resources provided by their friendly congressman.

Intentional or not, that is the outcome of these thoughtless laws.

Article excerpts below.

January 3, 2010
The Safety Net
Living on Nothing but Food Stamps
By JASON DEPARLE and ROBERT M. GEBELOFF

CAPE CORAL, Fla. — After an improbable rise from the Bronx projects to a job selling Gulf Coast homes, Isabel Bermudez lost it all to an epic housing bust — the six-figure income, the house with the pool and the investment property.

Now, as she papers the county with résumés and girds herself for rejection, she is supporting two daughters on an income that inspires a double take: zero dollars in monthly cash and a few hundred dollars in food stamps.

With food-stamp use at a record high and surging by the day, Ms. Bermudez belongs to an overlooked subgroup that is growing especially fast: recipients with no cash income.

About six million Americans receiving food stamps report they have no other income, according to an analysis of state data collected by The New York Times. In declarations that states verify and the federal government audits, they described themselves as unemployed and receiving no cash aid — no welfare, no unemployment insurance, and no pensions, child support or disability pay.

Their numbers were rising before the recession as tougher welfare laws made it harder for poor people to get cash aid, but they have soared by about 50 percent over the past two years. About one in 50 Americans now lives in a household with a reported income that consists of nothing but a food-stamp card.

“It’s the one thing I can count on every month — I know the children are going to have food,” Ms. Bermudez, 42, said with the forced good cheer she mastered selling rows of new stucco homes.

Members of this straitened group range from displaced strivers like Ms. Bermudez to weathered men who sleep in shelters and barter cigarettes. Some draw on savings or sporadic under-the-table jobs. Some move in with relatives. Some get noncash help, like subsidized apartments. While some go without cash incomes only briefly before securing jobs or aid, others rely on food stamps alone for many months.

...

A skinny fellow in saggy clothes who spent his childhood in foster care, Rex Britton, 22, hopped a bus from Syracuse two years ago for a job painting parking lots. Now, with unemployment at nearly 14 percent and paving work scarce, he receives $200 a month in food stamps and stays with a girlfriend who survives on a rent subsidy and a government check to help her care for her disabled toddler.

“Without food stamps we’d probably be starving,” Mr. Britton said.

A strapping man who once made a living throwing fastballs, William Trapani, 53, left his dreams on the minor league mound and his front teeth in prison, where he spent nine years for selling cocaine. Now he sleeps at a rescue mission, repairs bicycles for small change, and counts $200 in food stamps as his only secure support.

“I’ve been out looking for work every day — there’s absolutely nothing,” he said.

A grandmother whose voice mail message urges callers to “have a blessed good day,” Wanda Debnam, 53, once drove 18-wheelers and dreamed of selling real estate. But she lost her job at Starbucks this year and moved in with her son in nearby Lehigh Acres. Now she sleeps with her 8-year-old granddaughter under a poster of the Jonas Brothers and uses her food stamps to avoid her daughter-in-law’s cooking.

“I’m climbing the walls,” Ms. Debnam said.

...

But others say the lack of cash support shows the safety net is torn. The main cash welfare program, Temporary Assistance for Needy Families, has scarcely expanded during the recession; the rolls are still down about 75 percent from their 1990s peak. A different program, unemployment insurance, has rapidly grown, but still omits nearly half the unemployed. Food stamps, easier to get, have become the safety net of last resort.

“The food-stamp program is being asked to do too much,” said James Weill, president of the Food Research and Action Center, a Washington advocacy group. “People need income support.”

...

The expansion of the food-stamp program, which will spend more than $60 billion this year, has so far enjoyed bipartisan support. But it does have conservative critics who worry about the costs and the rise in dependency.

“This is craziness,” said Representative John Linder, a Georgia Republican who is the ranking minority member of a House panel on welfare policy. “We’re at risk of creating an entire class of people, a subset of people, just comfortable getting by living off the government.”

Mr. Linder added: “You don’t improve the economy by paying people to sit around and not work. You improve the economy by lowering taxes” so small businesses will create more jobs.

...

Kevin Zirulo and Diane Marshall, brother and sister, have more unlikely stories than a reality television show. With a third sibling paying their rent, they are living on a food-stamp benefit of $300 a month. A gun collector covered in patriotic tattoos, Mr. Zirulo, 31, has sold off two semiautomatic rifles and a revolver. Ms. Marshall, who has a 7-year-old daughter, scavenges discarded furniture to sell on the Internet.

They said they dropped out of community college and diverted student aid to household expenses. They received $150 from the Nielsen Company, which monitors their television. They grew so desperate this month, they put the breeding services of the family Chihuahua up for bid on Craigslist.

“We look at each other all the time and say we don’t know how we get through,” Ms. Marshall said.

...

Ms. Bermudez recently answered the door in her best business clothes and handed a reporter her résumé, which she distributes by the ream. It notes she was once a “million-dollar producer” and “deals well with the unexpected.”

“I went from making $180,000 to relying on food stamps,” she said. “Without that government program, I wouldn’t be able to feed my children.”

Liberty Quote Of The Day: George Bernard Shaw

2010-01-01T15:25:00.004-05:00

We instantly fell in love with this quote, when we heard it released from the lips of Margaret Thatcher, although it originates from George Bernard Shaw. It is so true. Enjoy the bonus Thatcher video below.

"Freedom incurs responsibility; that is why so many men fear it."
- George Bernard Shaw

Tilson's Response To Hovde's Response To Pershing Square's Response To Hovde's Response To Pershing Square's Views On Mall REITS And GGP Specifically

2009-12-30T09:01:00.004-05:00

Whitney Tilson (T2 Partners) re-inserts himself into the Pershing Square vs. Hovde debate on GGP. To be fair, Hovde did take a shot at Tilson's GGP analysis on page 63of its Dec. 29th presentation. For those wondering, T2's analysis is largely a derivation of Pershing Sqaure's, which is not surprising given the two firms' histories of sharing research and investment ideas (and Tilson and Ackman's long friendship).

Tilson emailed the following to his regular distribution list:

Hovde Capital yesterday released its response (link here) to Pershing Square’s rebuttal (link here) (and, to a minor extent, and our rebuttal (link here)) of Hovde’s initial report on GGP (link here).

Our quick take is that it’s more of the same – like Hovde’s first report, there are a few good points (nothing we hadn’t already considered) mixed in with many arguments that are either factually incorrect or misleading, or with which we simply disagree. In short, there’s nothing new that changes our view regarding the attractiveness of GGP (it remains by far our largest position).

Before proceeding, we want to make clear how much we enjoy the debate and think our markets would be much healthier if there were a similarly detailed exchange of viewpoints for EVERY stock!

To some extent, the debate is now about different views of the future: Hovde believes that consumer spending will be terrible for an extended period and that bankruptcies among mall-based retailers will continue or worsen, which will translate into severely declining NOI for GGP over time. Pershing believes that the worst is behind us: that unemployment has peaked, consumer spending has stabilized and may even be picking up a bit, and that retailers are in remarkably good shape in light of what they’ve been through over the past 18 months, all of which will translate into approximately stable NOI. Whether Hovde or Pershing is right about GGP over time will, to some extent, depend on future macro factors, which are obviously impossible to predict with certainty.

That said, good analysis matters and we think Hovde’s is sorely lacking, primarily in the following areas:

1) Hovde’s most serious mistake is misunderstanding (or misrepresenting) what will likely happen to GGP’s unsecured debt. Hovde assumes that it either remains outstanding (throughout its presentation, Hovde calculates GGP’s leverage and interest payments assuming that the debt remains outstanding, which is the main reason its analysis differs from Pershing’s and ours – see page 63, for example) or that it converts to equity, which will result in “significant dilution” (page 72). Hovde makes explicit this assumption when it claims that Pershing “does not use consistent assumptions” regarding what happens to the unsecured debt on page 35 of its report.

Hovde doesn’t appear to understand bankruptcy law and what will likely happen to the unsecured debt. There is almost no chance that it will remain outstanding: it will either be refinanced or, more likely, be converted into equity (this is what Pershing assumes – there is no inconsistency). But here’s the key: it will NOT BE DILUTIVE because it will convert AT FAIR VALUE, as determined by the bankruptcy judge. Of course, if the judge determines that fair value is $1/share, then it would be massively dilutive, but that’s not going to happen. The judge has a great deal of discretion in determining fair value, but will certainly take into consideration the current stock price, comps and the price of any equity offering(s) GGP might do.

For example, as soon as GGP exits bankruptcy and its stock is relisted (it currently trades on the pink sheets, which means most institutional investors can’t own it), it will be a must-own stock for every REIT fund (a big catalyst Hovde misses). To meet this demand and pay down some debt, GGP might issue equity – and the negotiated price at which this stock is sold would likely weigh heavily on the judge’s determination of fair value (and would not be dilutive). Of course, if someone like Simon were to buy GGP at, say, $20, the debt would convert at this price – and again, it wouldn’t be dilutive.

2) Hovde takes seven pages (6-12) arguing for its definition of NOI, but there’s no right answer here. NOI is like free cash flow: different people calculate it in different ways. But however one calculates it, it’s important to be consistent – which Hovde is not. It uses the most conservative assumptions to minimize GGP’s NOI, but then fails to do so for Simon, making its comp analysis deeply flawed.

3) Speaking of comps, Hovde writes: “to suggest GGP should trade at the LOWER cap rate than SPG is LAUGHABLE in our view” (pages 22-23). Hovde can laugh all it wants, but there are very good arguments for why Simon is, in fact, the best comp for GGP. For starter, both have very similar mall portfolios with a national footprint (unlike Macerich, which Hovde cites as a better comp on page 63; MAC also has debt issues that are more significant than what GGP will likely have post-bankruptcy). In addition, GGP will likely have a BETTER liability profile post-bankruptcy, with no maturities until January 2014. Finally and most importantly, GGP is for sale and Simon isn’t, so there should be a premium for GGP reflecting a possible sale of this strategic asset.

4) Hovde’s analysis treats GGP as a collection of assets, but it’s more than that. The fact that GGP is in bankruptcy has put it into play, so there is a once-in- a-lifetime opportunity for Simon, Brookfield or someone else to acquire a national platform, as highlighted in this quote from the WSJ:
The opportunity “is a potentially transformational event that doesn’t come along very often,” says Steve Sakwa, an analyst with International Strategy and Investment Group Inc.

5) Hovde dismisses the likelihood that GGP might be acquired (pages 51-55), focusing only on Simon and not even mentioning Brookfield, which may in fact be the more likely acquirer due to fewer anti-trust concerns and the need for a national platform (which Simon already has). As noted above, Hovde misses the value of GGP as a strategic asset – no doubt, there’s lots of distressed inventory out there, but only one national platform for sale like GGP.

Finally, Hovde finds it “telling” that Simon and Brookfield bought GGP’s unsecured debt, but not the equity, even when the equity was at a much lower price. But it’s not as telling as Hovde thinks for a number of reasons. First, it’s possible that Simon and/or Brookfield do in fact own the equity – if either bought less than 5% of GGP, it wouldn’t have to file (in any case, for anti-trust reasons, they couldn’t acquire more than 7.5%). Also, at the time they bought GGP’s debt it was very cheap and they might have reasonably concluded that it represented a better risk-reward than the equity.

6) Hovde argues that GGP’s rental rates and leasing spreads are very poor and will likely get worse (pages 15-18). They have indeed been under pressure, but Hovde is making the classic investing mistake of projecting the immediate past indefinitely into the future. What Hovde is missing is that GGP over the past year, knowing that it was in a poor negotiating position due to the macro environment and its own bankruptcy, has been renewing leases mainly on a short-term basis. These renewals have indeed been done at low rates, but this isn’t likely to be a permanent state of affairs. The macro environment has at least stabilized and may be improving and GGP will soon either be acquired or exit bankruptcy, so its negotiating position will strengthen and therefore rental rates and leasing spreads will likely improve.

7) On pages 28 and 33, Hovde repeats the charts from its first presentation (pages 33-34), showing that “Commercial Real Estate Prices Have Dropped 43% Since the Peak” and that cap rates are moving higher under the heading: “Despite Speculation to the Contrary, Cap Rates for All Property Types Are Moving Higher, Not Lower. Does Pershing Square Believe These Transactions Did Not Happen?” But the CRE chart doesn’t include mall real estate and the cap rate chart, while showing cap rates for virtually every other type of commercial real estate, is MISSING data for malls! (The cap rate for mall REITs has fallen dramatically from earlier this year.)

8) Hovde paints a very bearish picture of retail sales (page 61), but the latest data contradicts this – for example, an article in the NYT earlier this week www.nytimes.com/2009/12/28/business/28shop.html) noted:
Over all, retail sales from November through Dec. 24 rose 3.6 percent from last year, according to SpendingPulse, an information service of MasterCard Advisors that estimates sales for all forms of payment, including cash, checks and credit cards.
That number — which does not include sales of automobiles and gasoline — was helped this year by an extra shopping day between Thanksgiving and Christmas. Adjusting the results for that extra day cuts the retailing industry’s sales increase to about 1 percent, in line with what many retailing professionals expected.
While the numbers do not suggest a turnaround for the industry, they signal an improvement over last year’s 2.3 percent sales decline…
… “Last year was just a storm and retail was all about dropping prices to get rid of inventory,” said Mr. Katz of AlixPartners. “This year it was much more of a planned strategy: low inventories and tight expenses. And controlled promotions.”
That means most stores did not erode their profit margins the way they did in 2008, though in the days before Christmas, Mr. Katz said, some chains discounted more deeply than they should have.
Perhaps the best news is that the double-digit declines that plagued nearly every retailing category last year are gone.

9) Hovde spends many pages (38-43) questioning whether GGP’s Master Planned Community Segment has any value – but Pershing already assigns no value to it so it’s not clear who Hovde is disagreeing with. Another note: on page 39, Hovde makes this ominous statement: “The heirs of the Hughes estate hold a contingent claim related to the valuation of these assets. If there is significant value in these assets, the resolution of this claim could result in a substantial unfunded liability, which Pershing Square has failed to include in its analysis.” This is a red herring: the only claim by the Hughes estate is for half of any profits. Thus, the only way there could be a claim, leading to a “substantial unfunded liability”, is if there are profits, which would be wonderful for GGP (even if GGP only received half of the profits, this is more than zero, which is what both Hovde and Pershing expect).
This is a great debate and it will be very interesting to see how this plays out.

Happy new year to all!

TILB is on record as saying we love to see the debate. It's healthy for markets and educational.

Hovde's Response To Pershing Square's Response To Hovde's Response To Pershing Square's Views On Mall REITS And GGP Specifically

2009-12-29T10:40:00.004-05:00

Well, Hovde seems to be enjoying the publicity that Bill Ackman's Pershing Square is providing them. They have crafted a response to Ackman's response to Hovde's response to Ackman's views (Ackman's prior response linked here).

Whew.

In any case, we think this is one of the healthier debates that exists. Two thoughtful participants going back and forth in a public forum on their in depth views on a business. We honestly look forward to the next volley in the debate - Pershing Square, it's your turn.

Enjoy. [HatTip: BobBob]

General Growth Properties - 2 - Hovde

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Updated with this Hat Tip video pick from Max Headroom. Cat Fight! Is Hovde the blonde in the pink bra?

Help Solve The Federal Debt - Timothy Geithner Has It Licked

2009-12-29T10:03:00.005-05:00

Good news, the U.S. Treasury has figured out how to solve the problem of runaway deficits (and thus runaway debt and ultimately currency collapse). On the Treasury Direct website, under the FAQ section, you'll find the below gem within the Financing the Debt subheading:

How do you make a contribution to reduce the debt?
Make your check payable to the Bureau of the Public Debt, and in the memo section, notate that it is a Gift to reduce the Debt Held by the Public. Mail your check to:

Attn Dept G
Bureau of the Public Debt
P.O. Box 2188
Parkersburg, WV 26106-2188

We're sure that P.O. Box is an extra large, to handle the volume of inbound mail.

Another gem from the same Financing the Debt subheading is this question:

Why does the debt sometimes decrease?
The Public Debt Outstanding decreases when there are more redemptions of Treasury securities than there are issues.

What we appreciate most about this is that it's so shocking that the U.S. debt might actually decline that it demands a frequently asked question to reassure people that, no, the debt is not actually declining. It's simply a timing issue on when the Treasury issues and redeems notes.

Phew! Glad we don't have to worry about the debt actually decreasing.

Bill Ackman's Pershing Square Rebuts Hovde's Short GGP Thesis

2009-12-22T09:46:00.005-05:00

Many of you know that we are fans of Bill Ackman and his firm Pershing Square. We brought you his prior presentation on the attractive economic merits of mall REITS. In response to that presentation and Ackman's prior discourse on why Pershing Square is long General Growth Properties (GGP), Hovde published a bearish response.

Today, we bring you Pershing Square's dismantling of Hovde's response. Enjoy.

As an aside, this has all the makings of a classic cat fight. Purrrrrrr.

A Detailed Response to Hovde's Short Thesis on GGP (12!22!2009)

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Updated with this Hat Tip from Max Headroom. Cat Fight! Is Hovde the blonde in the pink bra?