The Golden Value of Reliable Numbskulls
We take a brief pause from our usual format. For the next two days we will surrender the floor to our friend and colleague Dan Denning, substituting our usual guest essay for a few more notes and insights. Read on…
*** Helicopter Ben and Bazooka Hank…Fire at will…
*** Buying common for less than intrinsic…and more!
Greetings from the Lucky Country. We are hard at work where the rubber meets the road in the China-resource boom (the coal/iron ore/gold/bauxite/vanadium/molybdenum rich Aussie outback).
Along with you, we wish the U.S. crew and Bill best of luck in releasing I.O.U.S.A. into the wild today. It’s a timely movie on an important subject. And Addison has much better hair than Al Gore.
In the meantime, the markets are in full swing. And since the sun never sets on The Daily Reckoning Empire, allow us to take a look at the scene and tell you what we see: a gunfight.
First, it looks obvious now that Henry Paulson is outgunned. Remember in July the U.S. Treasury Secretary said that if it was clear to the market that the Treasury COULD buy convertible preferred shares in the GSEs, it would probably restore order and prevent any more naked short selling and the total collapse of the U.S. housing market. Taxpayer money would not have to recapitalize Fannie and Freddie.
Paulson told Congress that a new regulatory arsenal for Treasury and ‘Helicopter Ben’ at the Fed would be enough to turn the psychological tide (ignoring the fact that it was solvency problem, not simply a poor frame of financial mind).
“If you have a squirt gun in your pocket,” Paulson told the Hill, “you may have to take it out. If you have a bazooka in your pocket, and people know you have a bazooka, you may never have to take it out.”
In the meantime, to paraphrase Jim Malone (Sean Connery’s Irish Cop in The Untouchables), never bring a squirt gun to a gunfight, Mr. Paulson. What the market really wants to know is what the Treasury is prepared to do. And so the market has called Paulson’s bluff. “What are you prepared to do,” it asks?
*** Shares of Fannie Mae fell 26% yesterday, while cousin Freddie was off 22%. The death/nationalization watch for the GSEs is now on round the clock. But what does it mean for U.S. investors? And what happens next?
As the Barron’s story pointed out this weekend, both companies are effectively insolvent. But the charade that everything’s just fine continues. One reality check may come soon. Fannie has nearly US$120 billion in debt that matures by the end of September. Freddie has US$103 billion in debt.
Can the GSEs roll it over? Who’s going to buy it? The Russians? Central banks? Private equity? Bueller? Anyone?
If the GSEs can’t fund their operations or roll over their debt, what point is there in having a government sponsored mortgage lender that cannot provide liquidity in the secondary mortgage market? We shudder at what this means for the U.S. housing market…but the phrase ‘lower prices’ comes to mind.
Facta, non verba. Deeds, not words.
Paulson hoped that by publicizing the fact that the Treasury could buy equity in the GSEs and recapitalize them, it wouldn’t actually have to do anything. He wanted all of the benefits without any of the risks and actions. That pretty much sounds like the ethos of America’s financial economy in the early 21st century.
Harry Callahan had a .44 Magnum, the most powerful handgun in the world. And the punk he was chasing down didn’t know if Dirty Harry had fired five shots or six. It was a gamble the punk didn’t take because the magnitude of an imprecise calculation would result in a large hole in his head.
The difference here is the market knows that without direct nationalization, the GSEs won’t last the month, and perhaps not the week. Common equity shareholders (those that are left) are headed for the gallows. This particular verbal weapon: “Hey if we really need to, we’ll buy $25 billion in preferred convertible” – ended up firing blanks.
*** But what happens if the Treasury steps in now? We don’t know yet. We don’t know if it will restore any stability to the mortgage market. We’re pretty sure it won’t arrest the fall in U.S. home values. It may even precipitate a blow out in the spreads on GSE debt versus Treasuries, forcing the Feds to bring GSE-guaranteed debt onto the taxpayer balance sheet.
About the only thing you can be reasonably certain of this week is that the direct assumption of GSE liabilities should be a negative for the U.S. dollar. Even if the Feds reorganize the company, liquidate the riskiest assets, and refloat it as a public company…there’s a lot of uncertainty for two of the largest financial institutions in the country. Markets don’t like that.
On the other hand, there is always the remote possibility that the appearance of a resolution to the decline and fall of the GSEs will give the stock market a shot in the arm. Irrational rallies are frequent when you are in a permanent state of crisis, as the financial markets now seem to be.
But it all seems to be reaching a crescendo this week, doesn’t it? In the bigger picture, that crescendo sounds like this: debt-financed consumption is not a long-term strategy for economic success.
A minor, but building theme, might be this: buying common stock for less than underlying value (intrinsic value, net tangible value, or earnings power) is a sensible investment strategy.
Translation: keep your eyes on the resource prize. All stocks (commodity stocks included) are in for some volatility as the financial markets wait to see which dominoes fall next. But the selling in equity markets simply makes some resource shares a lot more attractive. This is assuming, as we do, that the trends of urbanization and industrialization and rising per capita incomes in the emerging world will not be derailed by the collapse of America’s Ponzi finance).
*** One interesting question: High in their bazooka-armed helicopter, do Paulson and Bernanke have quick enough trigger fingers to prevent deflation in financial assets from precipitating more selling in stocks and more failed small and regional banks (as the assets on those balances are market to market and liquidated)?
Our guess, although it is not a happy one, is that they do. The Fed is becoming a buyer AND a lender of last resort. It will manage the great collateral laundering in the financial markets, exchanging Treasuries for mortgage-backed securities and other dodgy debt. It can do this by expanding its balance sheet as much as it needs to in order to accomplish the task, something it has not yet begun to do
“I have not yet begun to defile myself,” as Doc Holliday says in Tombstone.
*** Meanwhile, we don’t reckon there’s any real need to worry about “pushing on a string.” That phrase refers to the inability of Fed policy makers to get money into the system by lowering rates.
The futility suggested by that metaphor is based on the presumption that a middle-man, the bank, is necessary to get credit and new cash into the hands of people who will use and abuse it. If the banks won’t pass the Fed’s easy credit on to consumers and corporations, then interest rates as a tool for deflating away debts aren’t effective. So the theory goes.
But the stimulus package from last year showed that the government is more than willing to bypass the banks entirely if it needs to. Treasury can simply write checks to Americans, or, through the wonders of the Internet, make direct deposits into your bank account. That’s how our stimulus check arrived this year…although that probably means the money can be taken away just as quickly and easily as it was given, can’t it?
Drug dealers always give away free samples to get users hooked. After that, it’s easy. Debt is addictive and destructive. That’s what makes the behavior of our money pushers so revolting and morally reprehensible. They’re a bunch of pushers in suits.
Mailing checks to Americans is a direct stimulus. But it’s a desperate measure. When you are that transparent about so-called “wealth creation” and “economic growth,” the nature of the system is exposed for anyone who cares to see it. Markets care.
That means it probably can’t go on for long until people begin to lose confidence (which happens when you lose purchasing power quickly). Dollar-denominated assets should fall as Bazooka Hank fires away. So should the dollar. Gold and silver, we reckon, have taken plenty of heavy fire in the last month, but will come out of all this looking like they always d shiny, durable, and like real money.
But even then, there will be another wave of fiat fraud. Public spending can be ramped up indirectly with an increase in the kind of massive public works that FDR pursued in the 1930s. President Obama/McCain better start working on some new agency acronyms.
National Rail System (NRS)? Check! New Manhattan Project For Oil Shale (NMPFOS)? Check! A War To Rebuild America’s Infrastructure (WTRAI)? Check!
The checks are in the mail America! Spend all you want. We’ll make more!
The GSE nationalization may be a kind of starter’s pistol which causes the Fed and Treasury to roll out all their inflationary guns…and fire at will. Stocks appear to be caught in the crossfire. They’re falling as financial assets deflate. But some stocks have tangible assets. What does that mean for resource stocks? More on that tomorrow.
The Daily Reckoning
August 21, 2008
Dan Denning is the editor of The Daily Reckoning Australia. He’s also the author of 2005’s best-selling The Bull Hunter (John Wiley & Sons), and spent five years as editor of Strategic Investment, one of the most respected “big-picture” investment newsletters on the market. A former specialist in small-cap stocks, Dan draws on his network of global contacts from his new base in Melbourne, Australia.
What’s going to happen to the mortgage twins – Fannie and Freddie? Yesterday, investors got nervous. They wanted to know. Would the feds officially nationalize them? No one believes the two will disappear. But no one knows on what terms they will be saved either. Both stocks sold off yesterday – with Fannie taking a 27% whack…and Freddie getting hit for a 22% loss.
The feds let it be known that they stood behind the two back in 1968 – when they were set up in their present form. They were no longer on the government’s financial books, but every lender knew they wouldn’t be allowed to go broke. So far, Treasury Secretary Hank Paulson has counted on that implicit guarantee – along with a long line of credit – to keep the two going. But now that investors are selling off the stock, he may have to come up with some real cash to put on the equity side too.
As reported here – we still have trouble believing it – Fannie and Freddie are each in the red by about $50 billion. They’re about $100 billion short, in other words. And judging by yesterday’s trading, private investors are in no mood to ante up. Which leaves good ol’ Uncle Sam. He’s not very bright; but at least he has very deep pockets…and a printing press in the basement.
But that still leaves an open question: the feds may be forced to take back Fannie and Freddie (they were publicly owned prior to ’68), but at what price? At $10 a share? Or $2 a share?
Apart from Fannie and Freddie, stocks generally rallied yesterday. The Dow rose 69 points.
Oil rose to $116. Gold rose too – to $822.
Gold is down nearly 3% for the year. But our Trade of the Decade is still, technically, up – since stocks are off 14%.
Gold is the “the epitome of human stupidity,” said an opinion in the Telegraph newspaper. “A metal that is dug out of the ground at great cost to be reinterred in bank vaults as a protection against the same stupidity as caused it to be dug up in the first place.”
The writer is right. Gold is useful because humans are stupid. That’s why it is always useful; because humans are reliably numbskulls. And it is particularly useful when humans are particularly stupid. Remember, a correction is equal and opposite to the deception that preceded it. When people have deceived themselves in an especially monumental way, the following correction is a doozy. And that’s when you want to have some kruggerands in your pockets and a little bolt-hole in South America.
We never know what will happen, but we’ll stick with our Trade of the Decade a while longer – just to see how it turns out.
*** What else happened yesterday?
Word came that more students are choosing community colleges; analysts believe it is because they are cheaper.
GM is said to be giving up its sponsorship of the Oscars for obvious reasons – it’s running out of money. And shopping malls are finding it harder to bring in customers – partly because people are not shopping as much as they used to and partly because they’re not driving as much as they used to.
Of course, there’s a long list of things that aren’t what they used to be – house prices, stocks, emerging markets, consumer spending, bank lending, Wall Street bonuses…and so forth. Our guess is that the list is going to continue to stretch.
With that, we say goodbye for today…we’ve got to get ready for the big party – at which, your author gets to make a fool of himself twice. First, when he gives a short welcome speech, in French…and again when he performs a few songs with the band. He is a terrible musician under any circumstances, but in front of a crowd, after a few drinks, he is pathetic.
Your editor has only two good qualities. As you know, he is extremely humble…even if he is insincere about it. More importantly, he also doesn’t embarrass easily.
The Daily Reckoning
P.S. In lieu of a Guest Essay today, we hand the reins over to Dan Denning reporting from Melbourn, Australia for some additional notes from Down Under.