November 14, 2008
Obama's Election Strategy in Business Terms
President Elect Obama had a very straight forward election strategy that can be understood in business terms. Obama took two short positions and funded both with lots of cash ($650 million or $1 billion depending on how you count). He went short, with heavy, heavy leverage on two issues: the Iraq war and on the economy. If both come in he wins in a landslide. If either comes in he can win as long as he minimizes the loses on the other. If we lose the Iraq war and the economy stays strong but he can claim it is an illusion (the "poor do not get their fair share" stuff), he wins; if we win the Iraq war but he obscures the victory ("Iraq is not really ready to defend itself and the world hates us for intervening" stuff), and the economy tanks he wins. The later happened and he won. McCain, underleveraged, had to win on long positions on both issues to win the election. Of course, Obama had an advantage that most short sellers do not have -- he is not liable for bear raids under Rule 10b-5 (a prohibition on, among other things, using statements that have material omissions to create market movement); so Obama, for two years is drumming up negatives on both issues, far before any rescission (hard to have confidence in the markets if one listens to him and a loss of consumer confidence is essential to a decline) and far before we even know whether our troops will prevail (moral problems anyone?).
The result? One of his short bets came in big -- late but timely enough to pay off on his leveraged position. Polls showed him behind on September 13. Lehman declared bankruptcy before the markets opening on Monday, September 15, the stock and credit markets go nuts and all the polls flipped, steadily widening in a direct relationship to the falling markets. Exit polls showed that voters believed, in a margin larger than his margin of victory that Obama would better solve our economic problems.
The problem?? As President he is now necessarily long on both the war and the economy. He will have to dance around blaming Bush for residual problems ("Not my fault if war or economy is continuing badly under my watch") while taking efforts to turn around both in time for the next election ("We are winning Afghanistan and fundamentals of economy are strong.") The rhetoric of a short trader in this election will be replace by the rhetoric of a trader who is long on both issues by the next election. Clever indeed.
Suggestion for a New "String" on the Next TARP Authorization: Paulson Goes
Paulson has almost spent his first tranche of cash under the TARP bailout bill. He must go to Congress to get more cash. Congress is making noises about new "strings" for an approval of the next tranche of funds -- strings on executive bonuses and so on. How about this for a "string" -- Congress to President: "Paulson (who did a classic bait and switch on Congress) steps down or no new funds for any additional bailouts."
Bush on Capitalism, Too Little Too Late
President Bush came out defending capitalism yesterday before the G-20. After his remarks the stock market zoomed up 800 points from historic lows. I do not know if his remarks caused the increase but the coincidence is interesting. Where was he defending capitalism when Paulson and Burbank were proposing to "soften" (read dismantle) it?? He will now leave a Democratically controlled Congress and White House in a perfect situation to further "soften" capitalism. An economic crisis and a Republican tradition of bailouts with open-end legislation granting authority to the Secretary of Treasury. His legacy will be a facilitation of the potential dismantling of capitalism.
Damage Control for Treasury
The Treasury has been stung by revelations that a "review panels" mandated in the TARP program have not only not been working they have not been filled. Treasury has released a "Setting the Record Straight" press release that lists what controls have been respected. If you read carefully, you realize that the "Special Inspector General" has yet to be nominated or confirmed and that the "Congressional Oversight Panel" has yet to be established at all. The Treasury's defense -- the "Financial Stability Oversight Board" is up and running. Folks, the Financial Stability Oversight Board is bureaucrats from various agencies. It is not an oversight panel as much as a coordination panel. The true oversight panel -- from Congress -- has not yet been formed. Treasury press release would not meet Rule 10b-5 standards prohibiting material omissions. What a bunch.
November 12, 2008
Investment Banks Use Bailout Money for Executive Pay??
Goldman Sachs will pay $12.4 billion in executive bonuses after receiving $12.5 billion in bailout funds from TARP. Morgan Stanley and Merrill Lynch will pay another $8 billion in bonuses and Citigroup will pay $26 billion. Each bank received $12.5 billion in bailout money. The banks say the bailout money did not go to bonuses because they have "traced" the bailout money, but money is fungible -- funds are funds. Would the banks have paid the bonuses without the equity cushion provided by the bailout money?? One has to wonder. What are they thinking at these banks?? http://blogs.wsj.com/deals/2008/11/12/mean-street-the-painful-path-to-fixing-goldman-sachs/; http://www.dailymail.co.uk/news/worldnews/article-1081624/Goldman-Sachs-ready-hand-7BILLION-salary-bonus-package--6bn-bail-out.html; http://blogs.moneycentral.msn.com/topstocks/archive/2008/10/31/50-billion-of-bailout-going-to-pay-exec-bonuses.aspx; http://www.bloomberg.com/apps/news?pid=20601039&sid=aKAH9t4l3dnw&refer=home
Paulson Should Be Fired
Paulson gives a news conference outlining "changes" in the TARP program and the market drops 350 points on the DJIA. The TARP program, he stated, originally sold by him as a vehicle to purchase Mortgages and Mortgage Backed Securities, will be used now to buy bank stock and stock in other financial institutions. His initial program of buying toxic assets was, as noted here, also ill concieved. The switch is potentially a better progam but still a mess in its implementation -- banks are using the new funds, not to make loans, but to pay executives and to buy other banks.
So, why does the market drop on his announcement? This is his fourth or five public announcement of a change in strategy. The market will not recover until buyers put money into stocks and buyers, given the government's constantly changing strategy, cannot price the effect of government action or non-action on stocks. The government's zig-zag pattern itself makes the markets more risky and disables the market from establishing a clearing price on value. With a new administration we will now have to wait for the new Secretary of Treasury, wait and see what he or she will do, and wait and see if the actions are consistent or constantly changing. It will take the markets until next spring to establish a clearing price. Paulson has been a disaster. From now on, whenever he schedules a press conference, go short in one of the triple-leverged ETFs.
You will also note that in his speech he is beginning to blame others -- Congress -- to cover his a.... He will go down in history as a total failure as Treasury Secretary.
Should you stop paying your mortgage???
The question I get from my middle-class friends (read outside the law school) is "Should I stop paying my mortgage to get a piece of the government relief program?" They have a point. The new program for Fannie Mae and Freddie Mac only applies to those who are three months delinquent on their mortgage. Officials then apply other criteria -- can you pay, and so. But to get to the spinning game, to make your case (complain about your income and the value of your house) you have to be in default. The downside is a hit to your credit rating, but if many are in credit ratings may not matter and if you can repair you rating before you borrow again, credit ratings may be irrelevant. My answer -- I do not know -- but the question is a good one. If people stop paying mortgages in droves -- banks and other financial institutions will be much, much worse off than before. Government intervention alters personal incentives. The details matter.
Auto Bailouts: How?
Amid continuing cries for a bailout of automobile companies by democratic politicians is a dearth of details. The basic question is how does one give money to companies that do not show an operating profit -- that is, its cost of producing its products exceeds the revenue from the sales of the products. The gross margin is negative. There are only three reasons for a cash infusion: Two of which are bad (similar to Woody Hayes view of a pass in football). First, the company must have a product in the pipeline that can show a profit (Chrysler's K car). This is likely to be false. The GM "volt", its heralded electric car, will lose money on each sale. Second, the company must transfer permanently an operating cost to the government. Labor pension plans or health car plans are expensive and the government could pick them up permanently. Third, the company could restructure, changing management (add capital side changes as well --, cashing out shareholders, eliminating debt) and altering its workforce to lower operating costs. The cash would be for re-adjustment expenses. A fourth option, just dump cash in a bottomless pit is not a reason. The third method is the way to go. Congress will push for the fourth option -- there are no hard choices there and give lip service to the first. Eventually Congress may adopt the second. Good grief.
Junk Financial Recommendations: No Details
At some point good financial newspapers should realize that junk financial recommendations help no-one. In today's Wall Street Journal we have James B. Stewart's, "How Obama Can Fix the Economy." Junk. His general suggestions "Shore up banking...[aid] faltering industrial concerns" give no details on how one does such things. Does the government buy stock, offer loans, put companies in conservatorship or receivership, buy toxic assets, take over health care plans?? The devil is in the details. Note the restructuring of the details of the AIG bailout -- it's still no right. Note the struggles of the government to put conditions on the TARP program. Should banks be forced to lend -- should bank boards be changed -- should compensation be capped??? Until folks like Steward offer concrete details they are just taking up space.
November 11, 2008
Fed is Slow on Commerical Paper Purchases
The Fed's program for financing the purchases of commercial paper is not yet off the ground and has been delayed. Other bailout programs have strained staff resources. Two smaller Fed programs have purchased some commercial paper but the main program, the MMIFF, has yet to be started. The program itself has an odd feature. With $540 billion, the Fed will finance a purchasing program run by J.P.Morgan in partnership with money market funds. The program will buy commercial paper issued by 50 financial institutions and held by money market funds. If any any of the institutions fail, each of the money market funds in the program is on the hook for some of the losses, even if the paper was never owned by some of the money market funds (because they bought the better paper). Again, the Fed has put programs that are inferior, or that should never have been started, ahead of the one program that we really need -- a shoring up of the commercial paper market. Again, what a mess.
November 10, 2008
Fannie Mae Loses $29 billion in 3rd Quarter
Fannie Mae reported a 3rd quarter loss of $29 billion. The three month loss was larger than the total profits the company had earned from 2002 to 2006. Under fair value accounting, Fannie Mae has a capital deficit (it is in the red, underwater, bankrupt, kaput) of close to $50 billion and rising. The company whose policies were in large part responsible for irresponsible lending on homes and is now owned by the government, has a balance sheet that would make state owned banks in China look great. There have been no federal prosecutions, no demands that responsible executives or board members give back salary, and no Congressional hearings on who is to blame. One of those board members (the company was a parking lot for Democratic operatives) is now Chief of Staff to Barak Obama. Only a bevy of class action civil suits brought by shareholders are in progress and the bulk of those judgements will be paid by --- the federal government.
Auto Company Bailouts: How??
The big three American automobile companies are showing substantial operating loses. GM is losing $1 billion or more a month. How does a capital injection help? The companies will just burn through the cash (using it to pay labor or pay off debts, old and new, until it is gone). The banks, on the other hand, that are receiving bailout funds have operating profits (they can borrow low and lend high) but suffer from capital requirement issues (which limits what they can lend). A capital infusion helps meet capital requirements, frees up lending and the banks can make a profit. Auto companies are not similar. Unless the auto companies can build and sell a car or truck at a gross profit (a profit neutral of debt service or taxes) it makes no sense to bail them out. They should be liquidated.
The AIG Bailout: A Mess
The AIG bailout is a mess. The government has had to restructure its current outstanding $120 billion loan (extending repayment and lowering the interest rate), to add a $40 billion equity infusion. and to buy around $50 billion of toxic AIG owned or guaranteed assets. The AIG chairman states that the government "will make money" on its investment. Great, if so, why will private investors not step up to "make money?"
My guess: AIG will go bankrupt next year and the government will be a creditor in the bankruptcy.