The Art of Socializing Risk

Finally, the headline we’ve been waiting for:

“Americans cut back sharply on spending,” says the New York Times.

The news is not yet official. Maybe the NYT is jumping the gun. But evidence from chain stores, credit card companies and consumer confidence surveys all points in the same direction – down. “At every level of American society,” says the NYT, “from working class to the wealthy, people are spending less money.”

December was a “blood bath” for retailers, the paper continues, because consumers are worried about a coming recession. They’re afraid to open their wallets, for fear that the few dollars they have left may be hard to replace.

So far, reports show earnings to be holding up, but jobs are disappearing. Even on Wall Street – or maybe, especially on Wall Street – the days of easy employment and easy money seem to be behind us. Citigroup (NYSE:C), for example, says that it will lay off 24,000 workers this year…as it tries to recover from losses (write-offs) of about $24 billion.

Of course, the fall-off in consumer spending looked inevitable to us. When house prices peaked out, we wondered how long consumers could continue spending money they didn’t have on things they didn’t need. The answer: longer than we thought.

But now, the unavoidable seems to be happening: the NYT says so. And if the cut back continues – as also seems inevitable – the result will be an economic slump.

How bad? How long? Those who know the answers to those questions do not write financial opinions. We doubt they breathe.

What we know now is what we have known all along. At the end of the credit expansion – especially one as irrationally exuberant as the one we’ve just lived through – there is Hell to pay. People do not like paying their debts to the devil. Instead, they seek ways to duck and dodge…or lay the cost onto someone else.

Central bankers and politicians, working diligently over the last four decades, have not really mastered the business cycle…nor have they been able to trail rainbows to the pots of gold said to be at their end. Instead, what they have done is elaborated the art of socializing risk. That is, they’ve found new and more socially acceptable ways of taking losses from those who deserve them and passing them along to the general public. This is known popularly as “inflation,” a word that describes the process of jacking up consumer prices without the consumer understanding why. The consumers’ cost of living goes up…but speculators, debtors, investors and leveraged house buyers are able to moderate their losses. For a while, the authorities look like miracle workers. Politicians are re-elected. Central bankers are praised for keeping the economy growing.

Today, we have activist central banks and governments in America and England. (The central bank of Europe is still not sure; it will make up its mind when Spain and Ireland start to howl, we predict.) They are ready to do whatever it takes to avoid a serious slump. In America, they cut rates and inject liquidity. In Britain, they are even willing to nationalize a major bank. The idea everywhere is the same – to disguise losses by sharing them out onto the public.

“Inflation is immoral,” said Congressman Ron Paul when we sat down with him a few months ago.

“It’s immoral in the sense because it steals, it steals value. If you double the money supply and your prices go up twice as much, it’s an invisible hidden tax. But the real immorality here is that some people pay higher prices than others. So if you’re in a middle class or especially in low middle income, your prices might be going up 15% a year…and somebody on Wall Street might be working leverage buyouts and making billions of dollars and they don’t have to worry about the rising costs of living.

“This to me is an immoral act that is prohibited by the constitution and the outcome is always tragic.”

We interviewed Ron Paul for our documentary, I.O.U.S.A., which after close to two years of work, is finally coming to fruition. As many of our dear readers know, we will be premiering the film at the Sundance Film Festival this coming Saturday, January 19. If any of our readers are in the Park City/Salt Lake City area over the next two weeks, please let us know.

Your editor is taking a break from traveling (keep reading today’s issue and you’ll find out why), but Short Fuse and Addison will be there – so drop the Fuse a line at if you plan on coming to Sundance. And for a full list of the movies that will be screening see here:

Sundance Film Festival

Gold, anticipating weaker paper money, shot up over $900 yesterday. The commodity index hit a new all-time high, just shy of 500.

And despite this gush of inflation inspired by the custodians of our money, the number of bonds said to be in distress has risen 800% in the last six months. And Moody’s predicts a default rate this year, five times higher than 2007.

The end of a credit expansion is not nearly as much fun for consumers and investors as the beginning of one. The end of a credit cycle is only fun for people who own gold…people who went short on the excesses of the easy money period…and people write financial commentaries like The Daily Reckoning.

*** And a bit more about our vacation…

In our last installment, we had just spent the day waiting in a desolate stretch of desert. What we were waiting for was never clear. But when we got tired of waiting and drove into the police station, we found ourselves presented with the prospect of waiting some more.

Finally, we gave up waiting and agreed to settle out-of-court and off-record. We would meet in the town square of Cafayate at high noon, two days hence. Your editor would come with 35,000 pesos in his pocket. His adversary would come with the title to his little Volkswagen.

By then, it was about 6 PM on New Year’s Eve.

We loaded into our remaining truck and headed home. But home for us, in Argentina, is a ranch…about two and a half hours up into the mountains.

We set off in high spirits. What could go wrong?

It had not rained at our ranch in nearly two years. Every day, the sun shines hot and the wind blows out of the East like a hair dryer. But it was beginning to look as though nature was toying with us. As we have said, the odds of two automobiles being in exactly the same place at exactly the same time, on that deserted mountain road, were extremely small. The odds of it raining must have been very small too. But still, it rained. And it came down hard.

After a few minutes of driving, we saw automobile taillights ahead. A couple of cars were stopped. We stopped too, got out, and ran up to find out what the problem was.

“The river has flooded out the road. We can’t go on.”

We walked up…sure enough, the riverbed – which had been dry when we crossed earlier in the day – now looked like a dam had broken.

We were set to give up…and return to town for the night…when we noticed that one of the trucks waiting was from a ranch near our own.

“Hola…are you from Colome?” we asked the driver.

“Si…I’m Nestor.”

He turned out to be the fellow in charge of the winery. A cheerful man…he gave us some advice.

“If you have 4-wheel drive, you can go down river a little ways…you can cross there.”

“Are you sure?”


“And are there any more rivers that we have to cross…we don’t want to get stuck on the other side.”

“Yes…there are two more…but you can cross them too. And if you can’t, just come back.”

And so, we set off on what turned out to be a major adventure. In the dark of night, we couldn’t find our way. Henry and Jules got out and scouted ahead, searching for a way through the rocks and trees. Finally, we came to the riverbank. The water was still high…and the current looked dangerously swift.

But Nestor showed up again. He had followed our lights.

“Are you sure we can get across here?” we asked again.

“Yes…I’m sure.”


The boys got back in. We made sure we had the 4-wheel drive engaged. We revved the motor and eased into the water.

The current was strong, but the bottom was solid stone. The water splashed up to the windows and we pitched and lurched from stone to stone. But we made it to the other side and climbed up on the bank.

Then, we looked ahead…and saw only more rocks and trees. We had reached the other side of the river…but where was the road? There was none…

The boys got out again. We moved the car so its lights lit up a path to the right. When that gave out, we edged around, looking for an opening to the left. We were on soft sand. Ahead of us was a pick-up truck with its axel resting on the sand. Could we help get the man out? The two boys and your editor pushed, while the driver spun his wheels.

After a few tries, we judged it impossible to free him. We bid him good luck, got back in our own truck…and followed the track that he had pointed out for us. After a few minutes of twisting between rocks and trees…trying to keep up momentum for fear of getting stuck in the sand…we were able to recover the main road.

All was well again, until we reached another river. This one also had a few cars waiting. But it looked passable. We eased in…and splashed our way to the other side.

It was the third river that stopped us. Arriving at the edge, we saw a truck stuck in the middle. It was almost half submerged…with an entire family sitting on the opposite riverbank while a man and a woman struggled to free it.

“Have you got a line? Can you help pull us out?” the man yelled.


There was nothing we could do for them. We couldn’t reach them…and had no rope to throw them. They would just have to wait for the police and road crews…who probably wouldn’t arrive until morning.

All we could do was head back. Again, we crossed the first river with no problem. The second, though, was a struggle. We had to find the track that led down to the crossing. By this time the boys felt they were accomplished scouts. They got out…looking for tire tracks and hard ground. The scene was confused by several other trucks, trying to find the same passage. Two of them were stuck in different places. One blocked the main track. The other seemed to be in strange position, probably where he ended up by trying to get around the other. Headlights from these two trucks…and our own…criss-crossed in odd patterns. Some areas were in complete darkness. Others were invisible because of the brightness of the headlights in front of them.

“Don’t go that way…go over there…” said a helpful man, whose own truck was going nowhere.


Going over there proved a dead end. In front, were a couple of large boulders.

“You’ve got to go back and go around that way,” Jules pointed to the right. “That’s the way we got through this the first time.”

He was right. The truck that seemed completely out of place was the same one we passed coming from the other direction. We passed it again and saluted its driver.

“No vale la pena…no point in going any further anyway,” we explained. “You can’t get by the second river.”

We meant the third river, but we couldn’t think of the word for ‘third.’

Finally, we were crossed the river again and got back on hard road. Driving all the way back into Cafayate, we went directly to the best hotel in town, the Patios de Cafayate, and asked for rooms. It was almost midnight. Chic guests were dressed in their party clothes…waiting for the fireworks. They looked at us with quizzical expressions; ‘What happened to you?’ they seemed to ask.

We walked by, our blue jeans covered with mud…our shirts soggy with rain…no luggage, not even toothbrushes.

“Would you like champagne?” said a young woman.


The champagne was served out…just as the clock struck midnight…and the fireworks display began.

“Happy New Year,” we said to each other.

“Kaboom…” the sky lit up.

Until tomorrow,

Bill Bonner
The Daily Reckoning
London, England
Tuesday, January 15, 2008

The Daily Reckoning PRESENTS: The Baby Boomers are getting older – and it’s happening faster than our country is prepared for. Chris Mayer points out that the investment ideas that flow from this are many and varied. Older populations have more significant health care needs than younger populations. It’s a simple concept, but also a powerful one – as the best ideas usually are…

by Chris Mayer

Do you know the name Kathleen Casey-Kirschling? Her birth date is the source of her fame. Kathleen Casey-Kirschling was born on Jan. 1, 1946, at 12:00:01 AM. She is widely recognized as the first baby boomer.

In October, she was the first boomer to sign up for Social Security benefits.

Behind her is a bulge, like a giant knot making its way down a garden hose in one of those old Bugs Bunny cartoons. Some 80 million Americans will follow her. All of them born between 1946-1964 – the Baby Boomers.

And they are getting older – fast.

To give some more perspective to these numbers, think about this. The boomers will turn 62 at a rate of about 365 per hour next year.

That kind of rapidly aging population has economists sounding alarms. “This,” says Brian Riedl of the Heritage Foundation, “is the single greatest economic challenge of our era.”

It’s pretty clear that America will add significantly to its older population over the next several years…a trend that will continue for decades. This is not something we can avoid. Demographics never lie.

The investment ideas that flow from this are many and varied. Older populations have more significant health care needs than younger populations. It’s a simple concept, but also a powerful one – as the best ideas usually are.

The usual suspects for investment ideas include managed care facilities, pharmaceutical companies and the like. But I’m not interested in those companies. The actual caregivers have lots of business risks. And the dynamics of the pharmaceutical industry have changed a lot. It takes more and more money to create a drug. The time to approve such drugs is longer than ever. Potential liabilities are huge. Add to that the fact that pharmaceutical companies always seem to fall in the crosshairs of some politician looking to make a mark.

The Wall Street Journal recently ran a front-page story about Big Pharma’s grim prospects. Many blockbuster drugs are coming off patent over the next five years – that’s about $67 billion in sales. As generics eat into that, the drug companies face a lot of pressure to replace those big drugs. The piece also pointed out that the industry brought out 43% fewer chemical-based drugs from 2002-2006 than in the last five years of the 1990s – and that’s despite a doubling of research and development costs.

Other health care-related ideas include a number of biotech companies and whatnot, but it’s incredibly difficult to figure out a drug pipeline and whether or not this or that drug will work out. Too much guesswork for my taste.

So I’ve been looking for something that’s more of a facilitator. Something like a picks-and-shovels idea. I want an enabler, a company that will benefit from increased spending on drugs, but that doesn’t make or administer the drugs.

I think I’ve found one such company…

The business model here is pretty simple. You know how a retail pharmacy works – say, a Walgreen’s or CVS. You walk in, you hand over your prescription and you wait awhile, maybe picking up some toilet paper in aisle five or grabbing some toothpaste. They call your name. You go to the counter, pick up your drugs and pay for everything and off you go.

The company I’m recommending we buy today is a pharmacy, but it’s what’s called an institutional pharmacy. The bulk of its customers are businesses. In this case, 90% of its revenue comes from servicing nursing homes. It’s basically a pharmacy for nursing homes.

The key to the business is to make life easier for the nurses. Logistics are important – getting stuff where it needs to be efficiently. Most people in nursing homes take 10-12 medications per month. So the packaging is important, too. It has to be easy to keep all this stuff straight and save dispensing time for the nurses.

So an institutional pharmacy distributes prescription drugs on a contract basis to businesses, mostly nursing homes.

The good thing about this industry is you don’t need to know what drug people will take. In fact, as investors in this space, we really don’t care what drug company makes it, either. We are interested only in volume. And we want what we invest in to capture a good share of that volume.

We also have to look at the ability of our potential customers to pay. That’s easy. Medicare and Medicaid cover most of this stuff. In fact, Medicare Part D, which took effect in 2006, greatly expanded the number of seniors eligible for government reimbursements. That’s like throwing another log on the fire of drug demand. In fact, if you just look over the institutional pharmacy industry, Medicare made up only about 20 cents out of every dollar of sales as recently as 2005. But today, that number is up to 54 cents, and still growing. If anything, the political trend is to expand drug coverage.

The other thing we have to look at is market share. If this were a crowded field with lots of national players, it would look less attractive. The fact is there are really only two national players.

It’s basically a two-horse race. I’m not betting on Omnicare, which has been around for a while. So that brings me to my recommendation…which is a company that has all of the opportunity in front of it…but it also trades at a deep discount compared with what other recent acquisitions in the institutional pharmacy space suggest it should trade at.

I believe that’s due largely to the dynamics of spinoffs.

A spinoff is what happens when a large company decides to take a business it owns and make it independent. It creates new stock and gives it to existing shareholders. It’s sort of like how a television show made up of a cast of six or seven actors, like Cheers, can then spin off a new, separate show about one of its characters, like Frasier. In the land of spinoffs, most of the time, it’s a big company that spins off a little company.

I love spinoffs. Why? Simply because as a group, they tend to do well. If you fish in waters full of spinoffs, you’re bound to come up with moneymaking ideas. There’s lots of research on this point, but in general, spinoffs outperform the market during the first three years of independence.

Part of this is because spinoffs unlock pent-up entrepreneurial energy. You have a management team that gets to show its stuff. It no longer shares the spotlight with some giant parent. A business buried in a giant can suffer neglect. A business, like a houseplant, needs some care to grow to its potential.

Whatever the reasons, spinoffs tend to do well. They are classic special situations.

The thing is, you can do even better by cherry-picking some of the most promising spinoffs. And then, if you wait a few months, you can usually pick up shares even cheaper. That’s because once a company is free, big institutional holders will often dump it. They want to own the big company – that’s why they own the shares to start with – and to get a few shares of a small spinoff is just a pain in the neck for them. They have to assign an analyst to follow it, and often because the spinoff position is so small, they have little motivation to spend any resources to figure it out. It just doesn’t really matter to the big piles of money. They have bigger fish to fry.

That’s an opportunity for an individual investor. This company separated from its parent in August. So we’ve given it more than enough time for “seasoning.” It so happens that the market has been weak of late, too. All told, the stock has drifted down a good 25% from that initial spinoff price.

Now we’re about to enter that sweet zone where spinoffs start to gain traction.


Chris Mayer
for The Daily Reckoning

P.S. If you look at health care facilities spinoffs in recent years, you’ll find a history of dramatic outperformance. LifePoint Hospitals rose more than 220% after its spinoff. Triad Hospitals rose more than 320%! Both were spun out of HCA.

Could this company enjoy similar results? Over a period of two-three years, I think that’s easily in the realm of possibility.

For all the details on this recommendation – and to learn about the one investment that’s crushed every major index…beaten most major stocks…and doled out 49 times better gains than the S&P 500.

Editor’s Note: Chris Mayer is a veteran of the banking industry, specifically in the area of corporate lending. A financial writer since 1998, Mr. Mayer’s essays have appeared in a wide variety of publications, from the Daily Article series to here in The Daily Reckoning. He is the editor of Mayer’s Special Situations and Capital and Crisis – formerly the Fleet Street Letter.

Mayer’s Special Situations focuses on stocks with tangible assets and no debt. His issues contain recommendations and theories on special situations, such as net tangible asset value, spin-offs, turnarounds, buybacks, etc.

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