The Voice of Reason Arrives (Finally!)

Today, The New York Times published a well-written and lucid resignation email from Jake DeSantis, Executive Vice President at AIG Financial Products, to AIG’s CEO, Edward Liddy. 

DeSantis’s letter is the cold water of reason that Congress, the White House and the mainstream media should have been pouring on the raging fires of populist anger over the AIG bonus issue, but did not. 

FOLKS, THE BONUS ISSUE IS A DISTRACTION.  GUESS WHAT?

YOU’RE FALLING FOR IT.

The money that made a great big sucking sound as it flew out of collective your 401(k) plans did not turn into bonuses for AIG FP executives.  It actually went into the coffers of a select few hedge funds and other sophisticated traders (the so-called “smart” money) who have played this market so well that if stockpicking were craps, you would swear they were using loaded dice.

The country should be furious about the persistence of naked shorting (technically illegal but not enforced), unchecked insider trading and rumours of market manipulation, among many, many other things.

The rage over the AIG bonus issue has spawned all kinds of stupidity, from the asinine tours of AIG executives’ homes to more pernicious violations of constitutional rights, such as the House’s 90% bonus tax  bill (see for yourself–it violates Article I, Section 9 of the U.S. Constitution). 

Seriously–with just that one bill, the House of Representatives morphed into the Argentine Congress, circa 2001.

This nonsense does accomplish three things–none of which are good for the country:

1.   Focusing collective wrath on a handful of executives shifts blame over the economic crisis away from Congress and, to a lesser extent, the White House to “rich bankers” (whom everyone already hated anyway) and executives (whom everyone hates except when they deify them, a la Jack Welch).  This takes the pressure off the government to effect meaningful reforms.

2.   Public grandstanding and hearings on the bonus issue distract the public from discovering some of the larger systemic issues that are at the root of our problems–for example, as Jon Stewart suggested, that the capital markets as currently played by the “smart” money are a lot like a Madoff-Ponzi scheme (check your 401(k) statements if you doubt me).  This is key because Congress, at least, lacks the political will and intelligence to address the real problems anyway.

3.    Taking action on the bonus issue lets the victims of this crisis vent their anger in a safe way.  Once the bonuses are returned or otherwise neutralized, and the beast of public opinion feels content and appeased, it will return to its lair of ignorance for a nap, when the public should be out rioting in the streets forcing Washington to address the real issues.

Looks like it’s working.

Ballsy! Barron’s Says Markets Near Bottom

As Thomas Paine wrote, these are the times that try men’s souls.  Not to mention their retirement plans.

Over the weekend, Barron’s (subscription required) drew a line in the sand, arguing that U.S. stock prices may be at or very near their bottom:

“Sure, stocks could slide much further — but they probably won’t.  By most measures, they are downright cheap….  [B]arring a global economic and financial meltdown, the Dow should bottom well above 5,000 and the S&P Index well above 500″

On the other side, Bloomberg looked at prices relative to average earnings over the last 10 years and advised investors to hang fire and keep their powder dry:

“Benjamin Graham, the father of value investing and mentor of Warren Buffett, would find most U.S. stocks expensive even after the Standard & Poor’s 500 Index dropped 56 percent in 17 months.”

Here’s the funny thing:  Each article makes well-reasoned and convincing arguments to reach opposite conclusions.  If you’re a small investor, how are you supposed to know what to do if the best financial reporters in the business can’t agree on whether stocks are a bargain or a rip-off?

Some Historical Perspective

At Friday’s close of 683, the S&P 500 was down roughly 57% from its high of 1565 in October 2007.  In the 34-month bear market that followed the Great Crash of 1929 (which I think is the closest historical example to measure the current economic crisis against), the Dow Jones Industrial Average declined nearly 89% from its August 1929 high.

The S&P 500 is now in its 17^th month of decline, which means we could be at the midpoint of our pain, using the Depression-era Dow Jones performance as a guide. 

Both the Barron’s and Bloomberg articles conceded the market could fall another 25% to 27% from its current level, which would suggest a price level of about 499-512.  But if the S&P 500 were to follow the pattern of the Dow Jones from 1929-1932 and bottom out at 86% below its October 2007 high, the price of the benchmark stock index would be about 171.  

Although an S&P 500 below 200 seems almost unfathomable, the experience of the Depression-era market suggests the markets still have a ways to fall.

We have not yet begun to fight this economic crisis and we are only just beginning to see the far-reaching effects of our nation’s (and, in fact, the world’s) corrosive addiction to easy credit.  My sense is that there’s a lot more bad news to come.

In the third year of World War II, the British won a decisive battle against the Germans at El Alamein.  In a speech following the victory, Winston Churchill told Great Britain the win did not mark the end or even the beginning of the end; but perhaps, he said, it was “the end of the beginning.”

If history is any guide, the U.S. stock markets are still waiting for their El Alamein.

Fox News Strategy Room Appearance

I’ll be appearing on FoxNews.com’s Strategy Room next Tuesday, March 10th, from 9:00 – 10:00 a.m.  You can watch the live stream on the web here.

Bobby Jindal Puts the “Recess” into Recession

Watching Louisiana Governor Bobby Jindal rebut President Obama’s speech the other night, I finally understood what Marcel Proust was getting at in his brick-sized Remembrance of Things Past.

From the moment Jindal glided up to the podium and began delivering an oversimplified history lesson on the “redemptive journey” that the President’s speech represented, I had a flashback to 1977.  I was no longer a 37-year old man watching the Republican rebuttal, but a five year old boy watching an episode of Mr. Rogers’ Neighborhood.

Jindal’s lethargic delivery and the patronizing substance of his remarks evoked my favorite children’s television star.  After the first minute, I was wondering whether Jindal was going to put on a pair of slippers and zip up a sweater.

Howdy neighbor!

No disrespect to the late Fred Rogers, but the man’s job was to instruct children on adult concepts in a way they could easily understand.  Perhaps Jindal thinks immigration policy, health care and personal finance are beyond the grasp of ordinary Americans.

How else do you explain something like this:

“[A]ll Americans are moved by the president’s personal story — the son of an American mother and a Kenyan father, who grew up to become leader of the free world.  Like the president’s father, my parents came to this country from a distant land.  When they arrived in Baton Rouge, my mother was already 4½ months pregnant. I was what folks in the insurance industry now call a ‘preexisting condition.’…  Even after landing a job, [my dad] could still not afford to pay for my delivery — so he worked out an installment plan with the doctor.  Fortunately for me, he never missed a payment.  …  [H]e would tell me, ‘Bobby, Americans can do anything.’”

I wondered whether Jindal would tell us a story next.

And then he did.

Leaving the Neighborhood-of-Make-Believe, he set out for greener pastures, regaling his listeners in a folksy voice with the tale of a rural sheriff with a compassionate heart.

Another Proustian episode.  Only now, I was twelve years old and watching re-runs of The Andy Griffith Show.

The lawman he described yelling at someone on the telephone to come and arrest him could have been Barney Fife.  Jindal himself was starting to sound an awful lot like Gomer Pyle.

The rest of the speech was a meandering riff on the “Americans can do anything” nugget his father imparted on him.  Jindal talked about achieving energy independence, greater transparency in government, fiscal responsibility and military strength, but it was meaningless.

How can you take a politician seriously when he talks to the voters as if he were addressing pre-schoolers at recess?

The Republicans should stop trying to prove the GOP is not a party of old, wealthy white men.  Sarah Palin only succeeded in swelling their rolls with lecherous “dudes” who had a Calamity Jane fetish.  In Bobby Jindal, the Republican Party must have been hoping it would find its own Obama.

They came up short.  Instead of trying to find an Obama antidote, they should focus on reconstituting their core values with ones that speak to the needs of average, middle-class Americans.  For that, they need look no further than America’s suddenly all-time favorite president, Abraham Lincoln.

Perhaps the Republicans should start reading Proust-they may realize that the key to their future lies in their past.

Geithner’s Mother-of-All Interventions

Today Treasury Secretary Geithner prescribed tough medicine for restoring confidence in the financial system.  The stock market responded by vomiting up its recent gains.  One could ask why, but one’s time might be more fruitfully spent tackling easier problems, such as rediscovering the lost art of alchemy or devising the Napoleon Dynamite algorithm that wins the Netflix prize.

The fact is nobody really knows the answer.  Chalk it up to the market’s buy-on-the-rumour/sell-on-the-news mentality, low volumes, day traders, short-sellers, profit-taking of recent gains or last night’s full moon.  Each is as reasonably plausible and likely to be right (or wrong) as the other.

But some of it might have been the vague details of Geithner’s ambitious financial stability plan, which consists of three big steps:

(1) Financial Stability Trust:  The Treasury will stress test financial institutions and make direct injections of government capital to insolvent banks; the capital would act as a bridge to private sector investment down the road.

(2) Public-Private Fund:  A public-private partnership to buy between $500 billion and $1 trillion in illiquid assets from financial institutions.

(3) Consumer Lending Facility:  Providing relief to consumers, homeowners and small businesses by getting credit markets to lend again; the government would accomplish this by purchasing $1 trillion of new securitized debt products for auto, student and mortgage loans.

Number (1) basically amounts to a de facto nationalization of weak financial institutions without actually saying so.  Why?  Nationalization is the intervention that dare not speak its name.  But while the measure itself may not be a bad idea, the double-speak and lack of detail have left many scratching their heads as to the real motivations and consequences.  (When, for example, would the government sell off its stakes in these banks?)

Similarly, Number (2) is effectively setting up a “bad” bank without actually saying so.  There are two concerns with a government-run “bad” bank.  The first is that the government runs the risk of over-paying for troubled assets (thus handing banks a windfall at the expense of taxpayers) or under-paying for them (which would require the government to contribute more capital to these institutions down the road, also at taxpayer expense).  The second problem is that the government is not set up to manage the assets it would buy under such a program.

By calling for a public-private partnership, Geithner has answered the second challenge of a “bad” bank initiative–he’ll get the private sector to manage the assets and also buy some of them (though which private sector funds would do so is not clear).  But he hasn’t addressed the valuation problem, which is equally important and more difficult.

So far, somewhat okay.  Many economists believe that some form of nationalization and “bad” bank approach will be needed to make up the approximately $1.5 trillion shortfall U.S. financial institutions currently have.  It’s the third initiative, however, that may be the most ambitious and controversial part of Geithner’s plan.

Banks are so far in the hole they can’t make new loans.  But if they could securitize loans and sell them off to investors (as they did in the good old days of easy credit), they might start lending again.

It’s important to realize here that securitization is not, by itself, a bad thing.  It only becomes troublesome when the loans securitized are worth less than the collective droppings of New York City’s pigeon population.  When that happens, and the entire multi-trillion dollar securitization market collapses, investors understandably become reluctant to buy securitized bonds at any price.

Geithner’s solution would require banks to make only “good” loans, which would be securitized.  Then the U.S. government would buy them all.

In terms of creativity, Geithner gets an A+.  Nothing else would get banks lending faster than the knowledge that they wouldn’t have to hold any of the loans they make.  This would also would be more effective than any stimulus package to get consumers, homeowner and small businesses purchasing and avoiding foreclosure/bankruptcy soon.  But in every other sense, it’s a doozy.

Geithner is proposing nothing less than replacing the global capital markets with… the U.S. government (for a limited time, to be sure–but he’s given no indication of how long that would be).

This is the mother of all interventions.

If you hate big government, it doesn’t get any worse than this.  And he hasn’t told us how he would ensure the banks would make good loans.

To be fair, Geithner is hoping the Consumer Lending Facility, along with the other steps, will restore confidence in the capital markets to invest again in banks and securitized products.  It could just work.  Or it could fail spectacularly.  Geithner hasn’t given us enough details to really know, and that’s one of the big reasons why people don’t like what he’s proposed.

Short of a massive intervention like this, however, it’s not clear how anyone can get the credit markets unglued anytime soon.  Furthermore, both the Great Depression and Japan’s Lost Decade-and-a-Half demonstrate the danger of too little action too late.

Geithner needs to give the country–and, indeed, the world–more details on how he plans to implement these steps.  More importantly, he needs to do so sooner rather than later.  If not, the stock market won’t be the only one vomiting up his medicine.

Bankers’ Bonuses Are a Red Herring

Bloomberg’s David Reilly wrote a very good opinion piece today on the danger of focusing too closely on the investment bankers and their bonuses.

Reilly suggests that the economic crisis is the result of a much larger collective failure by bankers, regulators, legislators, etc. to ensure long-term viability.

He’s right on point.   Blaming the bankers (however well deserved it may be) is a distraction from larger, more fundamental problems.   The biggest danger facing this country–and it is endemic in our society–is the focus on short-term gains to the exclusion of everything else.  Whether it is public education policy or corporate earnings or home equity loans or obesity, our society sacrifices its longevity at the altar of instant gratification every day.

Which brings me to private equity.  As Andrew Barry reported in his excellent cover story for Barron’s last week (subscription required), the next shoe to drop will be the collapse of private equity funds and the bankruptcy of their over-leveraged portfolio companies (like Clear Channel, Minnesota Star-Tribune, Univision, Michael’s Stores, Hilton Hotels, Freescale Semiconductor and many, many others). 

Enabled by cheap credit that was supposed to stimulate an economic recovery after the collapse of the Internet bubble, private equity firms went on a spending spree.  They bought companies, levered them up, took out as much cash as they could get away with, then sold their investment a short while later to the higest bidder (usually another private equity shop). 

The process amounts to little more than sanctioned looting and pillaging.  Repeat the process often enough and any company, no matter how much cash flow it generates, will be crushed by the interest payments. 

Private equity shops never meant to hold these companies indefinitely, just long enought to sell them to the next buyer.  Now the so-called “smart” money is stuck with its portfolio companies because there’s no “stupid” money left to fund that next purchase (sound familiar?).

The problem is that private equity’s expertise is not in running companies (running them into the ground is another matter).  Hence, the wave of anticipated bankruptcies.

Today saw the release of some pretty gruesome unemployment numbers.  They’re going to get worse.

Biden Gets His First Yellow Card

Unsporting behavior.

Less than 24 hours.  That’s how long it took for Joe Biden to stick his foot in his gaffe-prone mouth after becoming Vice President.

Today, while swearing in new members of the White House staff, Biden took a jab at Chief Justice Roberts’ incorrect recitation of the presidential oath at yesterday’s inauguration.

The conservative Chief Justice had decided to recite the oath from memory and, as Dubya would say, “misremembered” the words in the second part of the oath, causing President Obama to inadvertently transpose the word “faithfully.”

An understandable error on Roberts’ part and a lesson, perhaps, on the value of using notes when speaking at momentous occasions.  The embarrassment is humbling enough–Roberts will remember it for the rest of his life.  There’s certainly no need to bludgeon the man over the head with his slip.

Unless you’re Joe Biden.

“My memory is not as good as Chief Justice Roberts,” said Biden with a leering smile, less than a day after Obama called for an end to partisan bickering in his inaugural address.

President Obama was not amused.   Stone faced, he touched Biden’s back in reproach, which led Biden to try and stammer his way out of it.  Or not.  Yellow card for you, Joe.

Look for Biden to take an increasingly less visible role in the Obama administration if he can’t keep his big mouth shut.

Barack’s Inspection

Like a high school teacher on the first day of class, Obama needs to set a tone for the next four years.  He needs to smack people in the head, manage the unreasonable expectations the electorate (and his own campaign) have placed on him and motivate Americans to take ownership of the solutions to the nation’s problems.  

Of all the inaugural addresses the nation has heard its presidents deliver, three stand out.

The first is Abraham Lincoln’s second inaugural address in 1865, just a few months from the end of the Civil War, when he called on the nation to finish the fight and then heal the wounds, with malice toward none, with charity for all.  

The second is Franklin D. Roosevelt’s first inaugural address with the country in the grip of The Great Depression.  Besides imploring that the only thing we had to fear was fear itself, FDR told a scared nation that our true destiny is not to be ministered unto but to minister to ourselves and to our fellow men.

The third is John F. Kennedy’s inaugural address, when he instructed the nation to ask not what your country can do for you, but what you can do for your country.

The unifying thread in all of these speeches is a call to service.  I believe Obama will issue a similar call to service while also telling the nation that it’s time to grow up.

My prediction for what Barack Obama will say to Americans later today in his Inaugural Address:  ”Lift up your pants, tuck in your shirt and pick up a shovel.”

HOW MUCH Is That Gorilla in the Window Gonna Cost?!?

Vincent Rossmeier and Gabriel Winant have a great piece in Salon about the economic havoc George Bush’s presidency will wreak on the U.S. for generations to come.  From GDP to global warming, the red state party’s policies put the country in the red.  A century from now, our great grandchildren will be working just to get the nation out of hock.  

I hesitate to describe the cost as one of “Biblical proportions” and yet, that’s about the size of it.  The amount starts at roughly $200 trillion and goes north from there.  It also doesn’t include fixing the things we don’t yet know will break.  Worth reading if you’re one of those remaining die-hard Republicans who thinks history will remember W as one of our nation’s greatest presidents.

Even the Lawyers Are Getting Killed

Jonathan Glater has a story in today’s NYT Business Section about how large New York law firms are shedding associates and, in some cases, folding.  “It’s bad out there,” says Robin Miller, a principal at New York-based Corrao, Rush Miller & Wiesenthal Legal Search Consultants.

Tell me about it.