Monthly Archives: January 2008

Its The Consumer?

This data from the fed makes me wonder what is going on with all the headlines suggesting that the economic slowdown is coming from hurting consumers.

January 10th Consumer Credit data

Sure, I get the logic: I am levered, I can’t afford my ARM, I can’t afford higher CC rates, so I can’t spend more.

But what does this rapid increase in revolving credit mean? I mean it popped 10% in November which is the most recent data available. Is this all increasing balances? It seems like it has to be the “Christmas shopping” season, which seems relatively strong at least in the sense that the consumer credit market remains open in a way that subprime lending is no longer available…

So does that mean that savings are tapped out and now people are just at the end of their rope?

Whatever it means, it sure doesn’t look pretty for the balance sheets of households across the country, but it sure does seem that people are willing to keep flashing the plastic to get some bling.

Any thoughts are appreciated on this one.

Birds And Glass Doors

Have you ever seen a bird flying into its own reflection? For whatever reason, the impact of skull on glass does not seem to teach these otherwise brilliant (read: they can fly!) creatures not to keep doing the same thing over and over again.

Although Alan Greenspan has reluctantly admitted that perhaps he should have seen some of the potential impact of the excesses created in the real estate house of cards, those outside the Federal Reserve to seem to almost unanimously agree that it was Al’s wall street-friendly interest rate policy that allowed so many borrowers, from private equity firms to subprime home owners, to spend too much for assets over the last five years, leading to the repricing which is at the root of the current credit debacle.

So as the global equity markets started to recognize the gravity of the challenges facing our economy over the weekend, and it looked like the most sophisticated investors in the world – U.S. equity markets investors – were starting to follow suit with the S&P500 trading down over 4% in the futures market this morning, what did the Fed do?

What else but slam its head into the glass door of loosey-goosey lending (yes that is a technical term) by cutting the federal funds rate 75bps before the market opened this morning?

Like Bush’s proposed “bailout”, this was a move to change the psychology of the market, and perhaps it had its intended impact as the market avoided major losses with the major indices ending the day virtually flat.

However, this does not change the basic reality that we live in a world where asset prices have been overly inflated by excess liquidity and as the reality of the obligations that people have incurred comes to roost ugly things will continue to happen.

Just today the SF Chronicle reported on a dramatic 421.2 percent increase in foreclosures in Cali for the fourth quarter of 2007.

I don’t know about you, but I have become almost numb to the bad news coming out about the housing sector and not just because I have been paying attention for a long time. It has become as commonplace as the murder in the inner city, and it is not going away until we go through the healing process necessary to overcome the hangovers caused by the excesses of the recent past.

One of the greatest lessons that a parent can give a child in my opinion is to allow her to suffer the consequences for her actions, because someday in the real world, she will have to stand on her own two feet. For some reason, our Federal Reserve feels like it needs to baby those who made poor decisions in deploying capital over this last cycle with a bottomless basket of puts…but anyone who looks will see the glass door that we are banging our collective head into once again. Who knows, maybe if we close our eyes it will go away or better yet, maybe like the monster in Will Smith’s recent flick Legend if we bang our head hard enough the glass will break.

The Fan

As the world markets plummet on MLK day here in the States, the worst-case scenario that I have worried about for a few years now seems like it may be starting to unfold.

For those who haven’t spoken to me on the topic, the basic idea goes like this:

When people enter CDS contracts, most of the time they don’t do much work on their counter-parties in terms of evaluating their credit. In other words, much like when you or I get flood insurance for our homes we don’t ask our insurance company for its financial statements to make sure they will have the cash if we need to draw on it, people who bought default protection in the CDS market often did not evaluate the credit-worthiness of their counterparties.

Some suggested to me over the last few years that this was not necessary because the entities they were trading with were AAA rated, or that they were AAA rated subsidiaries of other entities.

As it turns out, there was counterparty credit risk in these contracts, and it is starting to materialize…and the repercussions may be massive as the counterparty is unable to make good on his side of the insurance contract (for more on CDS, see my earlier post here: Crazy Derivatives Stuff).

Doomsday happens if banks have to step in and make these contracts whole because they were market-makers in facilitating the trades. Haven’t seen this piece of the pie emerge yet, so I am hopeful it does not. But being forthright about exposures has not been high on the list of qualities of U.S. financial institutions of late.

It appears that one institution alone, discussed here by Bloomberg, has more than $60B in CDS exposure that it just “can’t pay”. In other words, it is like you paid your insurance premiums on your flood insurance and then Katrina hit and Bam – they didn’t pay…and not because it was “wind” damage ;-) .

ACA Customers Allow More Time to Unwind Default Swaps

The problem with this is that we are only the the beginning of the default cycle and if there are already these kinds of issues, this may set off a waterfall effect as commercial real estate, credit card and autoloan ABS, and corporate loan defaults start ticking up.

In other words: we ain’t seen nothin’ yet.

Who Needs A Put, We Get Bail Outs!

It seems like the twilight zone when stepping back and surmising the last year from 50,000 feet.

Last spring was one of the strongest bull markets in recent history, and the economy (and real estate market) was humming along with seemingly unbreakable speed.

Although the writing was on the wall for many of us, bringing profits in being ahead of the curve in shorting some of the worst offenders of the subprime crisis, most people thought we were doomsdayers and brushed us aside.

I remember vividly a number of conversations with friends who graduated from HBS in the Spring, which consisted of me trying to explain to them that we were headed into a seriously challenging economic situation and them nodding while their eyes said: “sure buddy…I’m off to my sweet consulting gig…you stay here and come up with more conspiracies”.

Now, just 8 months later, the fact that we are heading into an economic downspiral is of such consensus that Bush and Pelosi are having friendly jabber about it.

What started as a “put” through continued rate cuts has now become a full on economic bailout as the President and the Congress are working hand in hand to come up with what they are terming an “economic stimulus” package.

It is discussed further in this article: Bush Nears Plan That Economists Say May Boost Growth

The punch line is this: we are going to try to deficit spend just a little more to somehow buy our way out of a leverage-induced economic cyclical downturn.

My take: this is election year politics at its finest. $150B is peanuts to this economy in the first place, not to mention the fact that at a fundamental level this is perpetuating the kind of overly-leveraged fiscal policy at the household and country level that got us into this mess.

We borrowed too much, can’t pay our mortgages (and soon auto-loans, credit cards, commercial real estate loans, corporate loans, etc), so how do we fix this problem? Borrow more.

Unfortunately, I think something like this might be needed for psychological reasons (and on the campaign trail) if nothing else – we need to trick at least some people out there into thinking that things are going to be OK in the short run, as most of us are so myopic that long-run payoffs don’t register.

For those of us paying attention, as I mentioned in my last post, there are starting to be some opportunities to invest in strong companies for the rebound. Not to mention all of the super-sweet stuff happening in the world of technology.

There is hope on the horizon…but in the foreground let’s face the fact that there is more carnage to come.

Happy 2008!!!

Been awhile since my last post as I have been out of the country in Australia after a brief stop in Texas for the holidays.

Of course you all have noticed that the carnage has continued unabated and even those idiots who didn’t want to admit that the problems in the credit market would spread beyond “subprime mortgages” have now had to face the hard truth that we are in for a challenging environment in the credit markets and capital markets in general for some time to come.

I must admit, though, that the pessimism in the equity markets over the first couple of weeks in the year has had the bullish side of my psyche drumming its fingers and looking for cheap buying opportunities. Even financial stocks like CFC’s knight in shining armor BAC are starting to look somewhat interesting, as BAC is trading at over a 6% dividend yield right now and has just guaranteed itself the position of leading mortgage originator in the first half of the 21st century.

WAG has gotten so punished that it is trading at a reasonable ebitda multiple of just over 8x, and especially if you believe that our drug-addicted culture is going to produce fatter margins for complementary products sold in drug stores, as this dominant american franchise continues to have the prospect to enjoy the benefits one might start to take a closer look. I know I am.

Even the king of fake revenues through 0% financing and other shenanigans, GM, is so beat up that if one can get comfortable that GMAC is no worse than a zero (i.e. there is no liability there…I wish I knew more about this issue, but unfortunately, I don’t) there might be something there. We have to believe that the largest auto manufacuturer in the U.S. can somehow benefit from a weak dollar. At least to the tune of greater than a $32B enterprise value. Remember. GM’s revenues are over $180B. It should be able to convert SOME of that into profit. Assume 2% operating margins and you are less than 9x. Juice it up to 5% and you are less than 4x EV/EBITDA…Maybe I am just patriotic, but I am optimistic that in the long run, somehow, some way, american auto manufacturers will make money selling cars.

These are just a few of the nuggets that are starting to glisten in the duststorm of the markets out there. Tough to say that any of these have found a bottom yet, but at a certain price, even mud is worth buying if you think people will someday need bricks.

Enough optimism. There are sure clouds on the horizon. More on that later.