Monday, May 11, 2009

Energy Conversion Devices (ENER) Results and "Darker Times for Solar Power Industry"

I have a long (and sordid) past with solar power stocks... since I love high growth sectors I jumped into this theme ahead of the pack in latter 2006. In the interim I've missed a lot of opportunities to the upside and lost a lot of money sticking to stocks that I should not of. This is one sector buying "value" stocks has been incorrect and chasing the top valuation (First Solar) has been the only way to survive any buy and hold strategy. In solar, you can lose money holding stocks for 320 days a year but in 9 day periods every so often you can double your money.

When the stocks were at their peak of fervor in late 2007 I was early calling for a major consolidation to come in this increasingly commoditized business - this was a very unpopular view at the time to the "herd" as solar stocks were money printing machines for investors for much of 2007. [Jan 3, 2008: The Long Term in Solar]

I do have some serious concerns in the 'mid term' (1-4 years)... my thesis is like all mfg goods, especially now heavily based in China, we will have periods of time over the next decade where capacity does not match demand, and even if this holds for a 4-6 quarter period, serious price wars can develop. I outlined this theory in detail in November in [Interesting Survey from Chinese Solar Companies - Price Concerns Already an Issue]

In times like this when speculative juices are flowing in the sector, and even the tiniest of companies get run up 100s of percent it is hard to reconcile these performances with long term logic. The market in the near term is anything but logical. We will have some great shakeouts and many of these no name companies rising 400% I expect to be
delisted, acquired for pennies on the dollar in half a decade or just be gone.

Now as I always repeat in these posts about solar, the counter argument is always, solar is 0.000001% of all energy use and will explode over the coming decades. I don't dispute that. My argument is timing. Timing of supply vs demand. It would only take 4-8 quarters where demand and supply are misaligned (way too much supply vs current demand) and this would crush pricing.... many companies will go from printing money to being major losers.

Not only has that been happening but the credit crunch and drop in oil has caused investors to flee. [Feb 6, 2009: NYT - Dark Days for Green Energy] [Dec 20, 2008: BusinessWeek - Clouds Over the Solar Industry] Frankly my largest mistake here was not listening to my theories and going heavily short the group - but again, if you were a few weeks / months early you could easily lose 100% shorting into a mania that was solar circa late 07.

There are many many many! moving parts in this sector not limited to
  1. Price of polysilicon (major input for most major players)
  2. Government subsidies
  3. Awakening of China / America versus established programs in Japan and Western Europe
  4. Natural gas / coal prices (or "oil" if you want to keep it simple)
  5. Access to credit for large scale installations
  6. Thin film technologies versus polysilicon based
  7. Consumer demand v corporate demand
  8. Massive growth in Taiwanese and Chinese small to large players with cutthroat competition
  9. Ability for many of those players in item 8 to stay solvent
  10. Price points that create equilibrium with conventional energy sources
That's a smattering of issues; there are more - outside of the black boxes of financials, this is probably the most complicated sector I keep an eye on. But for "investing" (speculation) purposes almost all of that is thrown aside and as goes oil, usually goes solar - with some lag. Now, oil has almost nothing to do with solar energy - but in the simplistic mind set of the "market" they seem to have a 1:1 relationship (solar is a competitor with coal and natural gas). Granted HAL9000 of quant fund, program trading fame trades the entire complex (coal, nat gas, oil) as "one" 90% of the time so I guess through osmosis oil = natural gas; at least for stock jocks and their computers. Remember, the stock market likes simple, dramatic easy explained thesis / themes - granularity is not its strength.

It really comes down to a marriage of government incentive introductions / expansions, overlaid with improved technology to drive down break even price points, overlaid with a very dramatic increase in commoditization as barriers to entry are low, overlaid with first mover and / or advantages of size / scale.

In this piece I thought I'd focus on the earnings results from Energy Conversion Devices (ENER) which is a unique niche player in the space - but their commentary speaks to the "moving parts" along with a well timed Wall Street Journal piece further down the page. As I read this, it makes the continued outperformance of First Solar (FSLR) all the more remarkable.

Via Reuters
  • Energy Conversion Devices Inc (ENER) on Monday reported a 81 percent drop in third-quarter profit due to weak demand for solar power in the United States, and the solar company declined to provide outlook for the fourth quarter, citing poor visibility. Net income for the fiscal third quarter ended March 31, 2009 was $1.3 million, or 3 cents per share, compared with $7 million, or 17 cents per share, a year ago.
  • Revenue came in at $66 million, compared to $70 million in the third quarter of fiscal 2008. Gross margins on solar product sales for the latest third quarter was 29.2 percent, down slightly from 30.7 percent a year ago.
  • Skyrocketing demand for solar power was a bright spot in the global economy last year until a pullback in solar subsidies in Spain and frozen credit markets dried up access to project financing and choked off demand.
  • "The global market continues to be difficult, with the biggest challenge being the sufficiency of project financing and our customers' continued access to capital," Chief Executive Mark Morelli said in a statement.
  • On a conference call with analysts, Morelli said the company had lower-than-anticipated product sales and higher-than-expected inventory levels at the end of the quarter. Customer access to project financing remained tight and a number of projects were delayed, Morelli added. (that's like the holy grail of bad news - I am shocked the stock is not up 30% based on what is happening in other sectors)
  • Raymond James analyst Pavel Molchanov said the fact that the company did not offer any guidance suggested visibility remained bad. "Their news last week further adds to the perception that demand is very, very poor," he said, adding that revenue estimates for the June quarter and for fiscal 2010 will need to come down 'quite considerably'. Raymond James' Molchanov said lower selling, general and administrative (SG&A) expenses helped results. (chop chop chop heads... make the number) For the latest third quarter, the company reported SG&A of $12.3 million. For the second quarter ended December 31, 2009, operating, general and administrative expenses came in at $17.2 million.
  • "The reality is that average selling prices are coming down across the board in the industry. So it would be very unlikely for any of these companies or practically anybody in the solar space to see a lot of margin improvement," the analyst said. While ECD declined to disclose its average selling prices, the company said prices came down by low single-digits in the quarter.... it anticipates further declines in ASPs going forward.
So you can see many of the issues we stated above - now let's take a quick look at the Wall Street Journal article for more of a 40,000 foot point of view
  • The global recession and tight credit conditions have cast a chill on the solar-power industry after years of breakneck growth, and could usher in long-term changes in the industry. Banks have curtailed financing for major solar projects, and Spain -- the world's second-largest solar-power market after Germany -- has slashed subsidies for the industry, leading to sharply lower demand for solar cells. Sales of the tiny chips that convert the sun's rays into electricity are expected to drop by at least 20% this year.
  • As a result, solar-cell manufacturers are delaying construction of new factories and sharply cutting prices. Several big solar companies, including Renewable Energy Corp. of Norway and Q-Cells SE of Germany, have scaled back ambitious profit and revenue goals, and are predicting a tough year ahead. Analysts expects solar cells to fetch an average of just $2 per watt this year, down sharply from $3.95 per watt in 2008. (that's a 50% drop, and you can see how sharply input costs have to drop for producers to have any chance of thriving in this sort of environment) "Last year we couldn't make enough solar cells to keep up with our customers' demands," said Anton Milner, chief executive of Q-Cells, the world's biggest solar-cell manufacturer by volume. "Now it's a buyer's market -- customers are coming back to ask if they can buy lower volumes and have lower prices than planned." "I've gone from managing for rapid growth to managing for cost reductions," said Mr. Milner. (commoditization 101)
  • World-wide shipments of solar cells to companies that install rooftop solar-power systems and build fields of solar panels for commercial energy production grew 85% to almost 6,000 megawatts in 2008, according to research firm Collins Stewart LLC. This year shipments are expected to fall to 5,575 megawatts. (so from 85% growth to shrinkage - within 12 months)
Now the great hope is America (Obama) and China (government) will offset any weakness in Japan or Europe. The chart to the right shows you how wide the gulf is between those early adopters and the "Big 2" that future hopes are resting on. But domestically, I just don't see the demand in the consumer space anytime soon with people struggling to stay in homes as first priority (I am excluding the upper 5% of course who would be more able to pay the costs) - so I assume the American push will be driven more by the corporation if and when. As for China, who knows - we see juicy leaks of massive subsidization programs and with the heavy pollution it would behoove them to stoke their in country industry. But that's been a thesis for multiple years now.
  • In environmental terms, there may be a silver lining in the industry's woes. The drop in prices for solar-power gear could make solar energy more competitive with burning fossil fuels to generate electricity, even if oil prices stay at around $50 a barrel. (again, even this writer compares solar to OIL - instead of nat gas or coal) Today, less than 1% of the world's electricity comes from solar power. "The dramatic cost reductions now happening in solar will be good for the industry and the environment in the long term," said Sven M. Hansen, chief investment officer of Good Energies LLC, which invests in renewable energy. "But in the short term, the outlook for solar companies has never looked more difficult."
  • Utilities and other developers are also finding it harder to get loans or raise investment capital for big solar projects. In the first quarter, global financing for renewable-energy projects fell to €11.5 billion from €20.5 billion in the fourth quarter, says London consulting firm New Energy Finance. (talk about dramatic, that's nearly a 50% drop quarter over quarter - certainly some of this was due to the credit crisis)
Now here was the long term issue I really was worried about - solar bulls always come back with "we'll make it up with volume" aka the same thesis I heard with unprofitable internet stocks in the late 90s. Again, it doesn't matter (for stock purposes) what the reality is in the long run - many of those internet stocks created massive wealth as long as you got out at the right time and there is no reason speculative fever can't push solar stocks up 100, 200, 300% at any period of time. But the commoditization issue is a real long term danger, at least from this perch.
  • Some industry watchers think the current downturn is more than a bump in the road. Dan Reis, analyst at investment-research firm Collins Stewart, says falling solar-cell prices could herald an era of lower profits and thinner margins. Sales of solar panels will boom in volume terms, Mr. Reis said, but since prices will be much lower, companies with low costs, such as Chinese manufacturers Trina Solar Ltd. and Yingli Green Energy, will have an advantage.
  • Even so, solar-cell makers may get some relief as countries including the U.S., Japan and China provide more support for renewable energy either as part of their economic-stimulus plans or to combat global warming. But those subsidies are unlikely to translate into an uptick in solar-cell orders until next year at the earliest.
[Mar 16, 2009: Energy Conversion Devices Blows Up]
[Mar 14, 2009: NYT: Europe's Way of Encouraging Solar Power Arrives in U.S.]
[Aug 28, 2008: Energy Conversion Devices Turnaround Story Continues to Have Legs]
[May 8, 2008: Energy Conversion Devices - Is the Turnaround Finally Here?]

No positions

Bookkeeping: Some Purchases

I continue with my strategy of not chasing stocks in the stratosphere, and buying stocks on pullbacks - cognizant that a larger pullback could happen sooner rather than later. This is the antithesis of the current working strategy of buy whats running at 100 mph and sell to the next guy who buys high and sells higher. As I've sold down a lot of stocks that have run, I am simply redeploying that capital in names that are lagging.

I missed Riverbed Technology (RVBD) which I've been stalking for a long time this morning in the mid $16s... it promptly bounced to the low $18s. As always in this market the "theme" of the day switches every few days, what was sold off Thu/Fri was hot today (tech / healthcare) - we're just rotating from one group to another. Today commodities are weak but that means within 2 days every trader will pile back into them if the trend continues.

There is a very obvious gap in the RVBD chart where I have a limit buy order waiting but in case we are heading straight for S&P 1500 I wanted to at least get a position established and the top of that gap is $16.50 where the stock bottomed out the past few days. Missed it today but on my radar.

I added to the following names - not huge positions just incremental 0.5-0.7% stakes to each position
  1. Mosaic (MOS) - the data points seem to be horrid but as long as corn, wheat and the like strengthen (as they have) people seem willing to buy. And the fundamentals as horrid as they are, are far superior to natural gas which "investors" had no problem pushing up 20%+ last week.
  2. O'Reilly Automotive (ORLY) - after a stellar earnings report the stock pulled back as people chased more risky assets.
  3. Smith & Wesson (SWHC) - the company issued a material share offering last Thursday, about a 11% dilution to pay down debt and expand production. Everyone is doing share offerings so why not - unlike banks and REITs this actually hurt the stock price. SWHC does not have the greatest balance sheet so this move helps curtail some risk and the increase in production capability is a good thing, but I hope they don't overdo it unless they have some fixed government contracts coming in. We don't know how long this "guns and butter" theme continues to work - and the stock market is littered with wreckage of companies that overexpanded at the wrong time.
  4. Excel Maritime Carriers (EXM) - continues to be weak off DryShips (DRYS) leadership (down) I consider this a "commodity" play as that's how HAL9000 treats it.
Again - a very incremental approach in a market of hyper emotion. I continue on the thesis that the market was to continue further than people anticipated creating massive anxiety for those who took big losses early in the year and then found themselves underinvested... and then when we pullback it won't be such a neat and pretty convenient "4-7% correction" that allows everyone who missed the run to pile in. Nothing is that easy. The question is where exactly this larger pullback starts from... and when. Without knowing I'm just sticking to names I like on pullbacks... I am hoping to buy - even in these names at lower prices in the future.

I continue to see weakness in consumer discretionary as a lot of names are rolling over, forming tops, or breaking resistance ... hard to act aggressively until / unless the overall market sustains a move downward since they bounce so sharply when the market goes green.

As for today's buys... MOS looks tired to me but I lack commodity exposure so this is just as good as any...

Pull back to 50 day with an initial bounce today in a bad tape - notice big gap at $29 which is plausible on a serious pullback in market

Double top at $7.50 in retrospect, eh? Would love to add to this below $5

Slowly rebuilding this position as a trading stake, below $7 would be a nice place to add

Long all names mentioned ex Riverbed Technology in fund; no personal position (PCLN) Continues to Execute Well

I've never owned (PCLN) but have been admiring the company from afar - in very difficult conditions they seem to constantly execute operationally even if the stock price fluctuates wildly at times. Much like First Solar (FSLR) in their respective base, always seems to trounce the data reported from competition (Expedia - EXPE, Orbitz - OWW). Every quarter I write an entry about how the company does well, and then I never end up buying... will need to get this name into the portfolio sooner or later. I continue to believe its business model works favorably for the weak consumer. At 17x forward estimates it is far cheaper (by half in some cases) than many names people are fleeing into rabidly, and it's actually growing unlike many of those stocks.

Full report here.

AP summary
  • Inc. said Monday that its profit surged 81 percent in the first quarter on improved gross travel bookings. For the period ended March 31, net income available to common stockholders climbed to $25 million, or 53 cents per share. That's up from $13.8 million, or 28 cents per share, a year ago. Excluding depreciation and amortization expense and other items, earnings were $1.09 per share. (I hate always referring to earnings excluding items but this is the Wall Street game)
  • Revenue rose 15 percent to $462.1 million from $403.2 million as both merchant and agency revenue increased. Analysts forecast earnings of 91 cents per share on revenue of $440.8 million, according to a Thomson Reuters survey. Analysts' estimates typically exclude one-time items.
  • Gross travel bookings, or the total amount paid by customers for travel services including fees and taxes, climbed 10.5 percent to $1.9 billion.
  • Gross margin edged up to 45.1% from 44.9%.
  • also said it was able to gain market share during the quarter, despite the recession weakening demand and pricing.
  • But the online travel retailer was hesitant to give a forecast for the rest of the year, saying the recession and the swine flu outbreak are likely to hurt travel demand. (doesn't matter, the market has already spoken - V shaped recovery coming) Still, the company provided guidance for the second quarter. For the second quarter, anticipates adjusted earnings of $1.65 to $1.75 per share. Analysts expect profit of $1.65 per share.
[Feb 19, 2009: Impresses on Earnings]
[Aug 6, 2008: - Down 17% on Good Earnings?]
[May 8, 2008: 2 Earnings Reports of Note: AIG (AIG) and Priceline (PCLN)]

No position

Bookkeeping: Closing Bed Bath & Beyond (BBBY) Short

Bed Bath & Beyond (BBBY) has been a rational chart in a market where almost everything else has been the student body left environment for ages (guess the direction of the market and 90% of the stocks move that way each day)

While I believe the consumer is cooked, and almost all consumer discretionary stocks are massively overstated to the upside as fund managers buy the "playbook" (buy consumer discretionary as its early cycle recovery), I am going to take my wins where I can find them. We have not had more than 2 down days in a row in this entire 2+ month run. So tomorrow we could be back to a +2% day...

Bed Bath & Beyond filled its gap perfectly around $27.70 and that was our goal so I am walking away with a hard fought 10% gain. When people are not being squeezed each morning, it is nice to see good old technical analysis work like it used to. There are a plethora of consumer discretionary stocks at almost double the value of BBBY but they continue to run up day after day as shorts get squeezed out. When the market indeed learns to fall for more than 2 days in a row many of these charts have zero support in them as parabolic moves don't lend to slow drops, but as always if you are a day or two early you can get chopped to pieces. Reading charts has been quite useless in the groups the shorts were betting against due to "fundamental" reasons... once all the underbrush of bears has been cleared out it will be interesting to see who will continue to pile into said stocks at 30, 40, 50x forward earnings - go Whole Foods Market (WFMI)!

As an aside congrats to Capital One Financial (COF) which just dumped shares on the public at the highest price the stock has traded since the beginning of 2009. You can almost here the high 5s happening in Washington D.C. ... as they say "mission accomplished"

Starent Networks (STAR) on "Mad Money

I've noticed the past 2-3 weeks that the "good ole" days are back as mere mentions on TV shows on CNBC evenings now are moving stocks in after hours sharply. Ah yes... "investing" as it should be. Starent Networks (STAR) which we just added Friday morning was one of the "chosen" and made an appearance on Mad Money... of course Friday is the worst day to mentioned because that gives you the entire weekend to think about it, so you can't make "fast money" by flipping stock to over eager retail investors who run in like lemmings as the Pied Piper leads you in. Of course, I say that in a completely long term investment sort of way.

Here is the video, you can skip to the 2:30 minute mark as the first 150 seconds are all about patting oneself on the back for talking up small cap tech stocks that Cramer was able to move like it's 2007 all over again. Boo and Yah.

[Apr 29, 2009: Starent Networks (STAR) 3G Player with 4G Potential]

Long Starent Networks in fund; no personal position

NYT: Rising Credit Card Losses Are Next Challenge for Banks

These type of stories used to matter, but no more - go forward these are simply for entertainment purposes as you take small breaks from buying stocks in egregious amounts. The government has stress tested the banks and rubber stamped approval; more importantly no matter how many losses are to come to the future the US taxpayer will backstop them. Or change accounting rules. Or tax rules. Or let them borrow at nearly 0%. Or backstop their debt offerings. Or... well you know the story by now. Heads we win, tails we win - just like CEO compensation. We cannot let any major bank go out Lehman style. That would be unAmerican; only companies that make minor things - like say cars... can face market forces or have bondholders who actually take a hit. Banks are clothed in bubble wrap and yes, thank you for your support. Again, I ask you to ignore this news or attach phrases such as "if it's in a major newspaper it is already in the stock price and no longer matters" OR "this is backwards looking data, even though it will happen in the future" OR "recession reschmession".

One point I'd like to make before we completely dismiss it and put in new orders to bid credit card companies to 20, 30, 40x 2011 earnings estimates... we brought up in late 2007 and early 2008 the little observed fact that many consumers who have both house and credit cards, have changed their behavior. In the old days they protected their house at all costs - paying the mortgage off each month, and then sacrificing other things. In this era - many have been paying credit cards FIRST rather than their mortgages so the losses thus far are better than usual for credit card companies; this is a new phenomenon seen only in this recession as many people have almost no monetary attachment to their homes due to zero down (or nearly so) mortgages. Hence in times predating "bubble mortgages" people would fail on their cards first and try to save their homes - not in our current (and future based on recent government initiatives) eras. Easy to walk away from 0, 1, 2, 3.5% down - a lot harder when you actually have to act like a homeowner rather than renter and plunk down 10%+.

But feel free to chuckle about that sort of commentary above, and let's present another in a litany of stories that matters not at all... I'll just add it to the list at the bottom of this post.
  • It used to be easy to guess how many Americans would have problems paying their credit card bills. Banks just looked at unemployment: Fewer jobs meant more trouble ahead. The unemployment rate has long mirrored banks’ loss rates on card balances. But Eddie Ward, 32 and jobless, may be one reason that rule of thumb no longer holds. For many lenders, losses are now starting to outpace layoffs.
  • Mr. Ward, of Arkansas, lost his job at a retail warehouse in April and so far has managed to make minimum payments on his credit card debt, which he estimates at $15,000 to $20,000. Asked whether he thinks he will be able to pay off his balance, he said, “Not unless I win the lottery.”
  • Experts predict that millions of Americans will not be able to pay off their debts, leaving a gaping hole at ailing banks still trying to recover from the housing bust. The bank stress test results, released Thursday, suggested that the nation’s 19 biggest banks could expect nearly $82.4 billion in credit card losses by the end of 2010 under what federal regulators called a “worst case” economic situation. (that would be the stress test that banks were able to negotiate) But if unemployment breaches 10 percent, as many economists predict, the rate of uncollectible balances at some banks could far exceed that level. (that would be the unemployment rate, that if measured as it was pre early 1990s is already approaching 13%)
  • Even the government’s grim projections may vastly understate the size of the banks’ credit card troubles. According to estimates by Oliver Wyman, a management consulting firm, card losses at the nation’s biggest banks could reach $141.5 billion by 2010 if the regulators’ loss rate was applied to their entire credit card business. (no problemo - that's where our tireless sucker, errr... hero - comes in, the US taxpayer. Any loss, no matter how immense must be covered. We cannot force losses on bondholders or liquidate very important political donors.... err, banks and sell off their pieces to managers who did not get us to this stage)
  • In the official stress test results, regulators published losses only on credit cards held on bank balance sheets. The $82.4 billion figure did not reflect another element in their analysis: tens of billions of dollars in losses tied to credit card loans that the banks packaged into bonds and held off their balance sheets. (ah, good ole FASB... what allowed Enron to play their little games was off balance sheet accounting. Now, instead of learning from that - we institutionalized it throughout many major banks later in the decade. We have the same level of ill transparency - in fact Paulson wanted to create a SUPER SIV back in late 2007 as the first of his many solutions... when in doubt about off balance sheet accounting - which should not be allowed in the first place - create a super one. Because as we all know, having a parallel balance sheet in some far off universe where things can be hidden... is the right way to run an accounting system. It pretty much sums up a nation in denial)
  • Experts predict that the rate of credit-card losses could eventually surpass the jobless rate because of the compounding effects of the housing crisis and lackluster consumer confidence.
  • Unlike in prior recessions, cardholders who recently lost their jobs are unlikely to be able to extract equity from their homes or draw down retirement accounts to help pay off their debts. That means borrowers who fall behind on their bills are more likely to default, leading to higher losses.
  • For the banks, the economics of the credit card business are increasingly troubling. As the recession has dragged on, cardholders have sharply reduced spending. New customers with strong credit histories are increasingly hard to find.
  • Every major credit card issuer has been approving fewer new applicants, reining in credit lines and canceling unused accounts. And Meredith A. Whitney, a prominent banking analyst, expects credit card lenders to cut the lines of credit they extend to borrowers by a total of $2.7 trillion through 2010. That is equivalent to a 57 percent reduction in the credit they made available two years ago at the height of the boom.
I am sure Citigroup "negotiated" this fact right out of their stress test
  • At Citigroup, executives noted that the company’s 10.2 percent credit card charge-off rate for the first quarter had broken its “historic correlation with unemployment” and showed no sign of letting up.
See what happens when people use government reports that have been skewed to make everything look better? They start noticing "historic correlations" breaking. If it were not so sad, it would be funny. Garbage in, garbage out. [Real April Unemployment Rate Reaches 12.9%]
  • American Express, Bank of America and Capital One Financial showed first-quarter loss rates that hovered around 8.5 percent, roughly tracking the unemployment rate. All three said they expected higher losses in the coming months.
  • Cindy Schneider of Connecticut, 53, is a long way from being confident about her finances. When her credit card company recently raised her interest rates, saying she was three days late with a payment, Ms. Schneider transferred the balance to another card with a lower rate. “We are borrowing from Peter to pay Paul,” she said.
Cindy - really it is not a problem; I wouldn't sweat it. Robbing Peter to pay Paul is how the government has been working for years - and we're going to make the past 50+ years look like amateur hour go forward. Why should the government's citizens not work under the same assumptions? When you run out of Peters to borrow from, just call China or run that printing press under the kitchen sink - and all your problems are solved. Sound preposterous? It's not - this is how the country finances itself. As Dick Cheney said - deficits don't matter.

Worst case scenario - if your printing press runs out of ink, simply walk away and claim the credit card company (or your mortgage servicer) made you buy product (or your home) with a gun to head, and the fine print was confusing. Then, you get a bailout. The other taxpayers who were able to read fine print, and did not see the gun will pay for your debts that the banks are writing off and you keep your merchandise and now keep your house with 1% mortgage rates. We all win here Cindy. Now do your job and shop - see you at Best Buy next weekend!

[Sep 15 '07: Consumer Spending Continues, Where is the Money Coming From? Credit Cards]
[Dec 10, 07 - Consumers Increasingly Turning to Credit Cards]
[Dec 23, 07 - Unpaid Credit Cards Bedevil Americans]
[Jan 10, '08: Credit Card Warnings Here, Credit Card Warnings There]
[Apr 10, '08: Americans Keep Piling on Debt]
[Apr 4, '08: Late Payments on Consumer Loans at 16 Year Highs]
[Jun 3, '08: Credit Card Usage is Surging, Risking Another Debt Crisis]
[Jun 22, '08: Americans Running Out of Places to Hide Debt - Now Credit Cards Go]
[Sep 23, '08: Loan Delinquencies Continue their Path Upward]
[Oct 21, '08: Moody's - Credit Card Chargeoffs Rising Rapidly]
[Dec 15, 2008: Capital One (COF) Updated us on Delinquency Rates]
[Apr 7, 2009: Moody's Credit Card Charge Offs Hit Record; While 8.2% of All Type of Loans are Delinquent or in Default]

Bookkeeping: Weekly Changes to Fund Positions Year 2, Week 40

Year 2, Week 40 Major Position Changes

To see historic weekly fund changes click here OR the label at the bottom of this entry entitled 'fund positions'.

Cash: 34.2% (vs 59.0% last week)
29 long bias: 37.1% (vs 31.4% last week)
10 short bias: 28.7% (vs 9.6% last week)

39 positions (vs 39 last week)

Weekly thoughts
Very little to contribute this week - the market goes up, and that's the only direction it knows. The only period of time I can correlate this to is fall 1999 - the NASDAQ was up 11 weeks in a row. Now the NASDAQ is up 9 weeks in a row and the S&P is 8 of 9, but the only "down" week was a very small loss of around half a percent. Outside of the indexes I don't recall these type of moves happening THIS late into a rally except in the late 90s. We've seen many a sharp rally and many stocks exploding in the first days or even weeks of a rally, but seeing 20, 30% daily moves in huge market cap stocks in week 9 - that's just rare.

This coming week will now be the 4th week I sit here thinking to myself, the moment I throw in the towel and get aggressive long will be the week the market posts a sharp correction. And for 3 weeks that has been dead wrong. Whatever the case from here - if proven wrong or right in the coming weeks, a monster opportunity cost was just let go... the type of money one can make in this frame on the long side in such a short amount of time does not happen too often. So for that missed opportunity, it really is not fun. With that said, I entered last week 3:1 long to short but yet again suffered going nowhere - obviously shorting a stock that was up 80% in 1 week (COF) was not the right idea; that's one for the record books. It appears only Doug Kass and I are foolish enough to have shorts on at this moment; especially those of the financial kind.

Obviously I am more hedged now as we enter this week but if we begin putting +2% days, day after day again I will have to cry uncle. The market has wanted me to for weeks, and as the contrary indicator of the past month, the moment I do we'll reverse. I see China approaching 30x earnings, and Europe at 4 year highs on valuations - but people keep piling in. I bought Atwood Oceanics (ATW) and the next day I'm up 8.5%. The student body left trading stampedes that now are a year+ in duration continue. The market direction determines 90% of your brilliance.

What is funny about this is a decade ago I would of minted huge amounts of money with the way I traded (ahem, "invested"). I was young, dumb, and risk control was not even a concept that registered. In return for those attributes: I made oodles of money. You could buy any good internet stock or tech stock in fact and after they ran 20%, you just kept buying. Yes every so often they'd drop 10% in 3 hours but that was just a buying opportunity. I see the same behavior now, and suddenly I feel like I'm in my late 70s chiding folks for chasing these things. But that's what is working, so the chasers are right, and I am wrong.

I sort of chuckled to myself when a reader posted 2 months ago we had a chance to hit the 200 day moving average on the S&P 500. I mean we were 40% away! Well, the 200 day is now down to 970 - that's only 4.3% away and since we rally 2% a day, 3 out of 5 days a week - this is easily in reach this week alone. Crossing north of that would cause the last remaining 4 bears to give up.... and in normal times I'd say the market would be ready to reverse once every bear gave up. But I've been saying that for a few weeks now, and it has been wrong. I thought we'd get to S&P 870-875... but take much longer to get there. That was blown through - and fast. So was S&P 900 (big round numbers being key resistance? hah)

Valuation? I thought we had a good chance of $40-$50 type of earnings on the S&P for 2009. Bulls say $60ish... I don't think it matters either. 15x, 20x, 25x forward earnings - just buy. You're supposed to get trough multiples in bear markets but with paper printing prosperity there are fiat paper dollars for everyone so bid it up. People want to buy at any price, the more expensive the better. The only divergence I see is late in the week NASDAQ - which has been the leader for this move - took a back seat as people ran into the bank + commodity trade. The NASDAQ rose right to its 200 day moving average Thursday and then was rejected - but I suppose if the S&P makes its march to 970, the NASDAQ will be pulled along as well. I continue to watch this S&P futures situation that I watch each night - its uncanny how night after night you can buy futures at midnight and "by magic" they surge higher by 7 AM to 9 AM - almost the entire past 2 months. Almost as if orchestrated.... maybe when that stops working at a 80% clip the rally ends. I'll have to ask Goldman Sachs where the ultimate level they will let us rest at is.... (only 8 trading days negative in all of Q1, I am sure Q2 is shaping up just as well for the 4th branch of government)

Other than that I have little to offer - I'll be searching for companies posting big losses with massive debt and up 20% a day, so I can buy them and unload it to some sucker up 20% the next day (not really, but I'll be living through those that do). As the artist formerly known as Prince says, Party like its 1999.

Timmy G reports on how the stress tests worked...

Updated Position Sheet

Cash: 34.2% (v 59.0% last week)
Long: 37.1% (v 31.4%)
Short: 28.7% (v 9.6%)

This data is updated weekly and can be found on 'Performance/Portfolio' menu tab on the website. As always the total gain/loss (both dollars and percentages) only apply to the open portion of the position; it is does not apply to portions of the position sold earlier.

(click to enlarge)

Sunday, May 10, 2009

NYT: Shift to Savings May Be Downturn's Lasting Impact

This piece from the New York Times reinforces my thesis on spending v saving. The American consumer still wants to spend and return to old behavior. However, he/she won't be able to. To survive in the coming era he will be/she will be "forced" so save. Although the government is doing everything in their power to not have this happen with our easy money policies that grow in furor with each iteration. I outlined in this piece what happens if we simply return to our old ways [Dec 29, 2008: What Happens if America Returns to a Historical Savings Rate?] - people incorrectly believe that by returning to normal we'd return to 1-4% savings rate. No, that is not our historical long term normal - that is simply the easy money normal we now believe has been long lasting. We used to be a savings culture, before we focused so much of our economy on "shopping" and all its related activities.

In the 1960s, Americans typically saved in the 7.5% to 10% range. A bit below where Germany has been the past 15 years.
In the 1970s, Americans typically saved in the 8.0% to 12% range. A bit below where France has been the past 15 years.

Then something changed in the mid 1980s - call it culture, call it entitlement, call it lack of financial literacy - call it what you may. The reasons are immaterial for our purposes - we just care about the raw numbers. After being over 8% for just about all of the 1960s and 1970s, the savings rate has never hit that level since 1987.

Between 1987 and 1993, Americans typically saved in the 6% to 8% range.
Between 1994 and 2000, Americans typically saved in the 4% to 6% range.

So essentially if we go back to the a national 8% savings rate, we'd lop off anywhere from $800B to $1 Trillion from our $13-$14T economy. Which would require the same government intervention (i.e. stimulus) we just passed, about $800B... each and every year. Or we could have a more rational economy. Nah... let us stay at 1-2% savings rates and paper printing to make up the difference....

Right now the stock market disagrees with my thesis and this story, as we're heading back to good ole days of spending based on which stocks are surging and the valuations they are now receiving. Again, I will stress I don't believe people will save willingly - we are now conditioned to this "I deserve everything" lifestyle... I believe they will have no choice. [May 2, 2009: WSJ - Debit Card Use Overtakes Credit] My way is actually much more healthy for the long term of the country but would cause a 1x wave of pain. We can't handle pain - that's how you lose elections, so the government is here to "save the day" and stop market forces from adjusting back to historical trends.

Again, many of my views are based on this new normal - at SOME point the world must demand higher rates for us to spend as drunken sailors and this game of low interest rates to create false demand ends. Maybe 5 years, maybe 15... I don't know. Eventually the market will win out.

Via New York Times
  • The economic downturn is forcing a return to a culture of thrift that many economists say could last well beyond the inevitable recovery. This is not because Americans have suddenly become more financially virtuous or have learned the error of their free-spending ways. Instead, these experts say, Americans may have no choice but to continue pinching pennies.
  • This shift back to thrift may seem to be a healthy change for a consumer class known for spending more than it earns, but there is a downside: American businesses have become so dependent on consumer spending that any pullback sends ripples through the economy.
  • In the last year, the savings rate — the percentage of after-tax income that people do not spend — has risen to above 4 percent, from virtually zero. (note: I disagree with this number - but let's go with it for purposes of the story) This happens in nearly every recession, and the effect is usually fleeting. Once the economy recovers, Americans revert to more spending and less saving. Over the last 30 years, the savings rate has fluctuated from over 14 percent in the 1970s to negative 2.7 percent in 2005, meaning Americans were spending more than they made.
  • This time is expected to be different, because the forces that enabled and even egged on consumers to save less and spend more — easy credit and skyrocketing asset values — could be permanently altered by the financial crisis that spun the economy into recession. (note, we had what was called a shadow banking system - where the risks were created and spun off throughout the globe. That was a huge parallel system sitting alongside our normal financial industry. Now that shadow banking system has been pummeled; in it's place we've introduced the Federal Reserve, with the taxpayer as the ultimate bearer of the risks)
The shadow banking system consists of non-bank financial institutions that, like banks, borrow short, and in liquid forms, and lend or invest long in less liquid assets. The system includes SIVs, conduits, money funds, monolines, investment banks, hedge funds and other non-bank financial institutions. (and now the Federal Reserve) These institutions are subject to market risk, credit risk and especially liquidity risk, since their liabilities are short-term while their assets are more long term and illiquid.

  • Sustained increases in household saving would cause a difficult period of restructuring for the American economy, which has become increasingly driven by consumer spending. Such spending makes up about 70 percent of the nation’s gross domestic product.
Shop shop - til you drop. Shop shop - never stop. -Def Leppard
  • Add the decline in consumer spending to the planned expiration of government stimulus spending, and a painful readjustment in demand for goods and services could occur, economists say. The effect would be felt here and abroad, as many developing economies also depend on America’s big-spending ways. (wait, government spending fixed all these problems - see overseas stock markets. Decoupling was exposed as a fraud spring 2008, but it's back baby... it's back.)
  • If Americans cut back, as they almost have to do, what will replace that source of demand?” asked William G. Gale, director of the economic studies program at the Brookings Institution, a liberal-centrist policy research group. “The easy answer is the Chinese consumer,” he said, but unlike their more prodigal American counterparts, the Chinese save about a quarter of what they earn. “We may cut back faster than they expand into that space, so there might be a lull.” (it all comes back to the Chinese, all the world's hopes are based on their government spending and then like magic a populace that has historically saved massive amounts of their income.... will turn American-like. Yep... the pundits said so, so must happen. It's such a cool and easy to explain thesis, you can almost see the stock jocks falling over themselves into this one.)
What's one way the government can help us shop again? Oh, I don't know - maybe help prop the stock market up... umm, sorry, did I say prop? That word has multiple meanings...
  • Consumers have lost a huge chunk of their net worth, in the housing bust and the stock market, and to resuscitate their retirement accounts or children’s college funds they will have to channel more of their paychecks toward saving — unless those asset markets soar again. [Feb 4, 2009: Americans Lost $10.2 Trillion in 2008]
This next reason I had to LAUGH at after we exposed what the FHA is now doing last week
  • Forms of easy credit that were once prevalent, like mortgages with no down payments, also may not return, either because the government regulates them out of existence or because banks dare not venture back into such risky lending. That means if Americans want to buy a house, they will have to save more and borrow less.
Share a laugh with me as you read what I highlighted above and then see these stories - nope dear writer, American have no need to save more or borrow less to buy a home; the government is working overtime to make sure the same policies we had mid decade are back [May 8: Minyanville - Subprime Lending is Back with a Vengeance] [May 6: WSJ - FHA Loans: The Next Housing Bust]
  • “People are realizing they can’t accumulate everything they want anymore, and they’ll have to prioritize more,” he said. “That may be hard for a lot of brands — figuring out not only how to get considered by consumers, but put at the top of their list.”
Thankfully in the stock market, mutual fund managers know the playbook - buy consumer discretionary ahead of the rebound - don't read Gallup polls. We're going right back to 2005-2006 per the stock action. Shop shop - til you drop. Shop shop - never stop.
  • A recent Gallup poll found that most Americans who have recently increased their savings believe their budget adjustments represent a “new, normal pattern for years ahead.”
Again, in the long run a savings rate would actually be quite a nice thing for the country... but since we don't want to take the 1x time hit, we'll avoid that.
  • Despite the immediate jolt to the economy, more personal saving would be a positive step in the long run, analysts say. More saving leads to more investment, which promotes economic growth, which leads to better living standards.
Enjoy the paper printing prosperity - it's less SPOOKY.

Saturday, May 9, 2009

The Curse of the Class of 2009 - Lower Wages for Up to a Decade

An interesting piece in the Wall Street Journal ... as a horde of US college graduates enter the workforce, we eagerly await them with jobs as census takers and/or in the "birth / death" model as they disappear into the ether and not show up as unemployed...

The data in this study is quite fascinating; amazing how much the random luck of what year you were born or graduate from college affect your earnings capacity. Oh well, Obama promised the stimulus would create (OR save) 2.5M... err 3M... err 3.5M... and did we end at 4M jobs? Or was it 3.5M that the dart hit? Whatever the case we have 1.5 million census jobs coming online... and the state of the economy is good and getting better. Listen to the soothing whispers of the stock market; she knows far more than this alarmist piece of doom and gloom.
  • The bad news for this spring's college graduates is that they're entering the toughest labor market in at least 25 years. The worse news: Even those who land jobs will likely suffer lower wages for a decade or more compared to those lucky enough to graduate in better times, studies show.
  • (college grad Friedson) To save money, he's living with his parents. ... If asked a year ago whether he'd be tutoring now, Mr. Friedson says, "I would have laughed in your face."
  • Trading down to a lower-skilled job isn't just a hit to Mr. Friedson's ego. It could also hurt his bank account for years to come. Economic research shows that the consequences of graduating in a downturn are long-lasting. They include lower earnings, a slower climb up the occupational ladder and a widening gap between the least- and most-successful grads. In short, luck matters. The damage can linger up to 15 years, says Lisa Kahn, a Yale School of Management economist. She used the National Longitudinal Survey of Youth, a government data base, to track wages of white men who graduated before, during and after the deep 1980s recession.
  • Ms. Kahn found that for each percentage-point increase in the unemployment rate, those with the misfortune to graduate during the recession earned 7% to 8% less in their first year out than comparable workers who graduated in better times. (sounds bad but you'd think this would be corrected once we got back to our normal bubble of the half decade economy) The effect persisted over many years, with recession-era grads earning 4% to 5% less by their 12th year out of college, and 2% less by their 18th year out. (not so much it appears - I'd assume this is because most wage gains outside of promotions or job changes are the usual 2-3% type; so if your original base is low, you're indexed to that base in many cases)
  • For example, a man who graduated in December 1982 when unemployment was at 10.8% made, on average, 23% less his first year out of college and 6.6% less 18 years out than one who graduated in May 1981 when the unemployment rate was 7.5%. For a typical worker, that would mean earning $100,000 less over the 18-year period. (that is truly amazing, an 18 month difference in graduation date means the typical worker earned 6.6% less nearly 2 decades later)
  • One reason behind declining wage potential, economists say: The caliber of jobs available in a recession, and their accompanying wages, tend to suffer. High-end firms hire fewer people and drive down salaries because jobs are in such demand.
  • That means many graduates end up with lower-wage, lower-skill jobs at less-prestigious firms or in firms outside their field of interest. Once the economy picks up and they try for better jobs, these workers have to learn skills they should have been developing immediately out of college. In the meantime, colleagues who graduated in a better economy have already developed these skills and progressed much further.
  • This year, employers say they'll hire 22% fewer college graduates than last year, according to the National Association of Colleges and Employers, an organization of career counselors. At the same time, colleges are expected to see the highest number of graduates in a decade. (most of these kids will "find work" in the birth / death model - creating a multitude of jobs in companies the size of 1-5 people... per Washington D.C. metrics... no unemployment here, move along)
Now this next piece is the structural change I've talked about since blog inception and been observing in data during this decade as people became wealthier during the 2000s off "asset inflation" rather than "earnings growth". [Dec 8, 2007: Do the Bottom 80% of Americans Stand a Chance?] When you realize your standard of living is slowly dropping for some strange reason - just hit that house ATM! Rinse. Wash. Repeat. I continue to believe there is a great chance that when we look back in 10 - 20 years this will be the first generation who did not do better (on average) than their parents. Especially if the US actually tries to pay back the huge amounts of debt it is incurring by the minute. Try to imagine how this economy, so weaned on easy credit would ever survive if our creditors ever demanded a return to 8%+ type of interest rates. Every solution the past two decades has been to slash rates, and each iteration is working less and less - much like a drug loses its effectiveness. Now we're too the point we simply bypass the banks themselves and the government is offering 3.5% down loans, with sub 5% interest rates - all the way down to 620 FICO scores and with the $8000 tax "credit" the states now have engineered a way for you to use that as your down payment / closing cost. Magic! No savings needed in this country. Maybe in the 2020s the Federal Reserve will pay us interest to buy homes and just allow ever American a $50,000 credit (not rebate, just a hand out) at birth to go towards a new shiny home - gotta keep people employed in construction trades. It's just fiat money anyhow - and the world loves ours.
  • ...a college degree isn't an automatic ticket to upward mobility, either. Even before the recession began, graduates were seeing their wages shrink. Between 2002 and 2007, according to government data, the inflation-adjusted hourly wage for men ages 25 to 35 with bachelor's degrees (and no graduate degrees) fell 4.5%. For the typical woman, inflation-adjusted wages fell 4.8%. (and as long time readers know - we discussed often in 2007 and first half 2008 how the inflation reports are ANOTHER government report that has been "adjusted" over the past few decades so it doesn't show the same levels of inflation it did as measured in the 70s, 80s - so I'd once more say the data above is a lot worse than presented because inflation is understated by government decree)
I will say it again - the flatter world will continue to pressure the wage in high cost of living countries - mostly in the private sector. Much of it is not something that can be "fixed"; it is inevitable. The latest iteration of this trend that has been growing slowly but surely the past 15+ years ,was when IBM told workers they can keep their jobs if they move to low cost countries, but they would have to take the local wage. So I advise you to urge your children to strive for the ultimate goal: government work, especially of the federal kind because these jobs exist in a bubble that feels no pressure. The taxpayers pockets are limitless; benefits continue to grow nicely and wages as well. Or work in farming or other commodity based industries as China and India's sheer magnitude of growth creates persistent demand on all the Earth's resources. Or become a banker but only at the largest of firms (preferably in NYC) and only in the top 2-3 levels of management.

Here are some examples of recent grads - alarmist of course as the Wall Street Journal clearly went out of its ways to find atypical situations. Granted, these folks are still earnings degrees that are better suited to the 70s and 80s, rather than jobs that are better suited for the 00s, i.e. anything that gets you a government job. Keep in mind many of these kids, due to the ever increasing inflation at colleges (another parallel universe that only now feels the slightest of pressure) are graduating with $10, $15, $20K of debt... just for undergrad. [Dec 5, 2008: NYT - College May Become Unaffordable for Most in US]
  • Plenty of recent graduates are making far less than the average. Between her business marketing degree and numerous New York City contacts, Nicole Buckley, 21, figured she would find a marketing job after graduating. She didn't expect to be working the jobs she has now, five months after graduation: As a full-time receptionist with a part-time gig as a model, promoting Bacardi rum and Grey Goose vodka to patrons at bars. But after doing two interviews a day and applying to more than 50 jobs, she had to do something to pay the bills. "I don't think anyone went to college and said, 'I want to graduate and make $25,000 a year,' " says Ms. Buckley. She estimates her earnings at a little less than $30,000 between the two jobs. (welcome to the most dynamic economy on Earth Ms. Buckley)
  • Diane Hempe, 24, planned to be a teacher. But after graduating from the University of Maryland last year with an elementary education degree, she failed to find a job at a school. So she settled for working at a day-care center, where the $12 an hour she brought in felt like an affront. (and just imagine, eduction is one of the "high growth" areas of our economy the past few years)
  • Sarah Veilleux, 22, one of Ms. Buckley's two roommates in a $1,125-a-month Brooklyn apartment, graduated in May 2008 from the University of New Hampshire with a communications degree. For a few months, she worked selling band merchandise at a music venue. Then she found her ideal job: doing promotions for Sirius Satellite Radio. But they need her only 20 hours a week. "As soon as I saw the offer for Sirius," she says, "it didn't matter how many hours a week." She spends the other half of her week doing administrative tasks for a staffing company, earning $1,500 a month -- $18,000 a year -- between the two jobs. (check out Sirius' stock price to see how "healthy" of a company it is)
  • Still, Ms. Veilleux probably will be better off than those who take low-wage jobs outside their fields, says Till Marco von Wachter, a Columbia University economist (now that's a kicker)
Here is a key point as we continue to churn out bushels of humanities degrees - rather than areas we should be focusing on to compete globally (on this I agree with Obama; sciences and math). But why bother to compete when you can get government work [Mar 13, 2009: USA Today - Police Agencies Buried with Resumes]...
  • People who majored in fields that lead to high-paying jobs, such as chemistry, biology, physics and engineering, tended to catch up to other graduates more quickly, primarily by switching jobs during the economic recovery and landing at better firms. In contrast, says Mr. von Wachter, the wages of humanities majors at less prestigious schools were less likely to catch up to the wages of their peers who graduated in healthier times.
If you can afford it there does appear one last way to get around this; since graduating at the wrong time can really set you back for a decade or two - just keep going to school.
  • Another alternative to unemployment or a low-paying job: Stay in school. Graduate applications for 2007-2008 were up 8% nationwide compared to the year before, according to the most recent numbers from the Council of Graduate Schools. Schools such as Northwestern University and Harvard are already tracking double-digit increases this year. College grads who went to graduate school instead of the job market during the early '80s recession didn't suffer the same wage losses, says Ms. Kahn, the Yale economist.
  • That's the approach John Bence is taking. A 2008 graduate of Kenyon College in Ohio, the history major worked with a temp agency and did a six-month stint at an international consulting company. After repeatedly losing out on jobs -- at museums, universities, consulting firms -- to more-qualified candidates with master's degrees, he'll head to New York University to get a master's degree in history, specializing in archival management. "I wasn't surprised I didn't get those jobs in, like, museums," Mr. Bence says. "But I was surprised that no one was willing to hire me to do anything."
I posted this trailer in 2008, and outside of the recession on Main Street it speaks to longer term trends; part of what the issue is, is many kids are simply majoring in things that have less application in the much more competitive world to come down the pike. [Feb 23, 2008: Two Million Minutes - a Global Examination]

WSJ: Banks Won Concessions on Tests

As I stated in my previous piece, only in America do you get to negotiate with your regulator... on a test that "everyone passes" no less. "Look regulator, I don't believe you got it right - here is how we can make it better". It just seems to thrive in this market you have to close your eyes and live in a parallel universe of make believe.

I think when the books are written about this entire era in 4-5 years you will see so much dirt exposed, but by then the "solution" of pumping up every asset class via magic hand waving and disingenuous information (leaked of course) will have "succeeded". And we'll all just chuckle as we look back - Banana Republic style. There are so many earlier injustices that have long been forgotten - such as destroying Chrysler bondholders but never once asking anything of bank bondholders. Such as paying AIG's derivative partners 100 cents on the dollar when in normal bankruptcy like procedures (which AIG would be if not for the US taxpayer) [Oct 17, 2008: Your Tax Money Paid to Investment Banks and Hedge Funds via AIG] - they'd be happy with 20, 30, 40 cents. Such as the tax loophole Hank Paulson threw into TARP at the last minute to allow banks that buy other banks massive windfalls. [Nov 13, 2008: Washington Post - A Quiet Windfall for US Banks] Such as.... ugh... it's all good. The FDIC Troubled Bank List might plummet to zero next quarter... all for a measly $75 billion. Easy as that.

p.s. did anyone in mass financial media even talk about Fannie Mae getting in line for another $19B bailout? We don't even talk about these things anymore.
  • The Federal Reserve significantly scaled back the size of the capital hole facing some of the nation's biggest banks shortly before concluding its stress tests, following two weeks of intense bargaining. In addition, according to bank and government officials, the Fed used a different measurement of bank-capital levels than analysts and investors had been expecting, resulting in much smaller capital deficits. Government officials defended their handling of the stress tests, saying they were responsive to industry feedback while maintaining the tests' rigor.
  • When the Fed last month informed banks of its preliminary stress-test findings, executives at corporations including Bank of America Corp., Citigroup Inc. and Wells Fargo & Co. were furious with what they viewed as the Fed's exaggerated capital holes. A senior executive at one bank fumed that the Fed's initial estimate was "mind-numbingly" large. Bank of America was "shocked" when it saw its initial figure, which was more than $50 billion, according to a person familiar with the negotiations.
  • At least half of the banks pushed back, according to people with direct knowledge of the process. Some argued the Fed was underestimating the banks' ability to cover anticipated losses with revenue growth and aggressive cost-cutting. Others urged regulators to give them more credit for pending transactions that would thicken their capital cushions.
  • At times, frustrations boiled over. Negotiations with Wells Fargo, where Chairman Richard Kovacevich had publicly derided the stress tests as "asinine," were particularly heated, according to people familiar with the matter. Government officials worried San Francisco-based Wells might file a lawsuit contesting the Fed's findings. "In the end we agreed with the number. We didn't necessarily like the number," said Wells Fargo Chief Financial Officer Howard Atkins.
  • The Fed ultimately accepted some of the banks' pleas, but rejected others. Shortly before the test results were unveiled Thursday, the capital shortfalls at some banks shrank, in some cases dramatically, according to people familiar with the matter. (magic!)
  • Citigroup's capital shortfall was initially pegged at roughly $35 billion, according to people familiar with the matter. The ultimate number was $5.5 billion. (lol - best negotiators on the Street; huge kudos to the lobbyist and law team at Citi; I expect multi hundred million bonuses paid out to these teams at Citi, of course using our tax money - err, not our tax money since it cannot be proven it's our tax money)
And this just sums it up... as a regulator you DO NOT want to risk angering the firms you are REGULATING. Not in America - home of "free market" capitalism and socialism for the corporation.
  • With the stress tests, government officials were walking a fine line. If the regulators were too tough on banks, they risked angering their constituents and spooking markets.
Whatever you do, do NOT spook the markets - that would be wrong and take away from the whole point of a "test". The market is a very fragile beast that we do not want to "spook" - we need it to go up, so it "tells" people everything is right in the world. Because the market tells us all we need to know - even if bad tests would "spook it". It now has telegraphed the correct message... good job market. And "regulators".
  • On Friday, some analysts questioned the yardstick, known as Tier 1 common capital, that regulators chose to assess capital levels. Many experts had assumed the Fed would use a better-known metric called tangible common equity.
  • According to Gerard Cassidy, an analyst with RBC Capital Markets, the 19 banks' cumulative shortfall would have been more than $68 billion deeper if the government had used the latter metric, which accounts for unrealized losses.
Mr. Cassidy, put a sock in it... that info is more SPOOKY. We don't do SPOOKY - we do reassuring.

William Black on Yahoo TechTicker

Let me reiterate that I have zero belief in "market efficiency" - we can see that over the past 18 months, as we switch from panic to euphoria back to panic back to euphoria. Markets at all time highs in Fall 2007 clearly forecasting what was to come "in 4-6 months". In the near term, stock movements have a lot more to do with psychology and herd behavior than any fundamentals. 2.5 months ago I was posting "happy" videos because the mood was so dour, and I felt like I was piling on with my "fact" based entries.... Now? If I post anything negative I feel like the snitchy neighbor trying to call the cops on the raging keg party. What kind of sour puss would do that.

I did watch in awe Friday as Wells Fargo (WFC) priced nearly $9B shares at $22, opened at $24 and closed at $28. It is clear people want in, at any price. The government has laid out the gauntlet that we will be Japan - no matter what is inside these major banks they will live, and be subsidized. While I talk about the rising yields on long term bonds potentially causing harm to the house ATM rebirth plan, it will only increase the magnificent profits banks can make on current loans. The fact Bernanke is "ok" with this when his original intent was to drive rates down as low as possible so people could refinance everything in sight, makes me wonder if what they see inside the banks is so poor that they think the better battle plan is to make this yield curve as wide as possible so the banks can "earn" their way out of their losses. The same plan as Japan two decades ago. I don't know ... despite intellectually knowing the (not so) Invisible Hand is everywhere it is hard to throw away year upon year of experience using sign posts and adjusting to the new normal. So I guess, go forward, all these non market comments will just be intellectual exercise with very little grounding in terms of "market" based decisions.

As people with integrity have given up - such as Charles Bowsher who resigned when he could not sign off on the "new normal" [Apr 6: William Black on Charlie Rose, Charles Bowsher Resigns] - and others who were there in our last financial disaster, when much harder lines were drawn on the banking system (pre financial oligarch era) - I guess we can only sit and listen to their words and ... well, just listen. Nothing will come of it.

William Black was on Yahoo's Tech Ticker with a series of videos... one of them had to do with PPIP; it is funny ... that seems like something proposed 18 programs ago, and with the government rubber stamping "all is fine" with just another $75 billion needed, the PPIP seems like a prop from another era. Just imagine, $75 billion to fix the entire banking system - that's just two AIG bailouts. Easy as that.... the crisis is over. (I'd also like to ask in what other country on Earth do financial institutions get to "negotiate" with their regulator over the results ... some of these things would not even make it into a fiction book as they would be deemed absurd. But this is our reality - truth stranger than fiction)

As a reminder William Black was the senior regulator who was cracking down on the S&Ls during the crisis of the late 80s / early 90s.... aka someone not to be listened to inside the halls of power, as we rely on the architects of deregulation such as Larry Summers & captive to the bank folk such as Timmy G - he who oversaw all the NYC powerhouse banks as their main regulator at the NY Fed.

Again, this is only for humoring yourself if you are intellectually curious. Do not let it cloud your decisions regarding purchasing stocks ...

The Big Lie: Stress Test Optimism Just Wall Street Propoganda, Former Bank Regulator Says

Results of the stress test brought a collective sigh of relief from Washington D.C. to Wall Street Friday, and stocks were rallying again on a growing sense the financial crisis has past.

Don't you believe it, says William Black, an Associate Professor of Economics and Law at the University of Missouri - Kansas City.

"It's in the interest of the financial community to send this propaganda out," Black says. "It's remarkable not that they do it but that it still works."

In other words, this isn't the first time we've been told "the crisis is over" and that "banks are well capitalized" - and probably won't be the last.

The professor and former financial regulator foresees another wave of foreclosures and future bank losses of more than $2.5 trillion vs. the government's $599 billion estimate.

Simply put, the stress tests weren't strong enough to be considered "wimpy," Black says. Furthermore, Fannie Mae, Freddie Mac, AIG and IndyMac were deemed to have "passed" much more stringent government stress tests before their respective failures, he notes, recalling the grim history:

  • Fannie and Freddie: In July 2008, Treasury Secretary Paulson testified that Fannie and Freddie were "adequately capitalized" under the test. In August 2008: "even in [Freddie's] most severe stress tests, [show] losses ... less than $5 billion." Actual losses: 20 to 40 times greater.
  • AIG: "It is hard for us, without being flippant, to even see a scenario within any kind of realm of reason that would see us losing one dollar in any of those [CDS] transactions." AIG claimed in 2008 "Using a severe stress test ... losses could go as high as $900 million."
 Actual losses: 200 times greater.

  • IndyMac: Sold over $200 billion of "liar's loans." Actual losses: 160 times greater than its tests.
  • Rating Agencies: Their stress tests gave AAA ratings to toxic waste. Actual losses: more than an order of magnitude greater.

"The examinations and stress tests are shams -- always precise, always farblondget," Black claims.

So while others are celebrating the end of the crisis, ask yourself this: If the government sees up to $599 billion in additional bank losses, why are they requiring banks "only" raise $75 billion? That suggests the government thinks the banking sector is overcapitalized by $525 billion.

"Once people learn they're being lied to, they react very badly," Black says. "And of course this is not the first lie."

Maybe you really can fool some of the people all of the time.

Beware Crisis' Next Wave: Option ARM Foreclosures, More Debt Defaults

Along with the reaction to the stress tests, the upbeat response to Friday's jobs report is evidence of our collective "disaster fatigue," says William Black, an Associate Professor of Economics and Law at the University of Missouri - Kansas City. "Every day is bringing a disaster. [539,000] jobs lost is a catastrophe but now we think ‘that's not so bad.'"

An optimist would say Black is missing the improving trend in the labor market: Although the unemployment rate rose to 8.9%, its highest level since 1983, April's 539,000 job loss was the smallest since October and compares favorably to March's decline of 699,000, February's 681,000 (both revised) and January's 741,000.

But Black's point is the improvements are, if not illusory, then certainly transitory. He foresees bad loan "shoes yet to drop" that will be like "Imelda Marcos' closet in an earthquake":

  • Commercial Real Estate: This is already on Wall Street's radar screen but future losses could account for a big chunk of the government's stress test estimate of $599 billion of future bank losses.
  • Option ARMs: These "pick-a-payment" mortgages will lead to "waves of foreclosures" starting next year in the "hundreds of billions of dollars," he predicts.
  • Credit Card Debt: With unemployment rising and home equity loans unavailable to most Americans, this is a "major problem that's going to take down major lenders," he says.
The Greatest Boondoggle in History; Banks Buoyed at Taxpayers' Expense

Bank stocks soared Friday, including Wells Fargo and Morgan Stanley, which sold shares a discounts of more than 10% below Thursday's close.

The ability of banks to raise capital is certainly positive but the idea of shares rallying amid the capital raising and dilution is "counterintuitive," Bank of America CEO Ken Lewis said on CNBC this morning.

BofA shares were also rallying even as the government said it needs to raise an industry-leading $33.9 billion. Citigroup stock was also a big winner after the government's curious declaration that it "only" needs to raise $5 billion.

While much of the focus is on the stress tests and banks' efforts to raise cash, the real story is Geithner's Public-Private Investment Program (PPIP), says William Black, an Associate Professor of Economics and Law at the University of Missouri - Kansas City.

The PPIP is the "greatest boondoggle in the history of the world," says Black, a former bank regulator who was counsel to the Federal Home Loan Bank Board during the S&L crisis. As occurred during the S&L era, Black says the PPIP will allow banks to exchange "trash for cash" and turn "real losses into faulty gains."

If the goal of Tim Geithner and other regulators was "to rip off the American taxpayer for the benefit of the least-deserving wealthiest people you can imagine, well - mission accomplished," Black says.

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