Pillow Talk

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Milan Kundera

Ever heard of Czech modern? Communist lounge?
Well there's one guy in Dumbo doing it.
Can we corner the market in Hungarian... or after the currency peg collapses, Romanian modern..? Yes, we can.

Lube in Contango

After the gold rush...

On Fri, Dec 5, 2008 at 9:45 AM, michael vanreusel wrote:
Matt,
Did you see the employment report? Looks like we are entering great depression part 2.
Michael

Dear Michael,
Lets look at this in prospectis:

Base metals:
With the exception of Tin, which I believe is still in a bull market, the majority of base metals (zinc and lead particularly) are essentially at their 20th-century lows, inflation adjusted, of 1919 and 1930. So essentially any positive growth would be inflationary for these metals. In precious metals, the gold to silver ratio is extremely high, suggesting that if we end up in a highly inflationary environment, silver should out-perform. Rhodium was $11,000 and now is around $1000. This should do well long term if we get fair weather or stagflation.

Agriculture:
Our stocks of wheat are at their lowest in decades yet the price (inflation adjusted) is at its lowest ever excepting the range from 1995-2005. Broad agriculture exposure to the physical commodities from ETNs like RJA or the DJAIG indexes is desirable. A small equity exposure to producers of fertilizer and genetically modified seed could be applied as a kicker.

Bonds:
Brazilian 10-year government bonds (at 17%) and 10-year TIPS (at a negative 1% yield) looks like bargains. A mixture of investment grade and junk bonds looks attractive, as the junk bonds are pricing in a 50% default rate (about a 20% yield) and investment quality corporates are yielding 7-9%. (The default rate on junk bonds was 30% at the height of the Depression) If you’re feeling a little footloose, Tata Motors just got permission to take deposits and has set up savings accounts in rupees paying 11%.

Shipping:
The thing with the most to gain (besides physically holding rhodium for a long, long time) is Paragon Shipping. [Nasdaq:PRGN] Paragon Shipping (with 12 dry goods ships in three different sizes) has a current liability to current asset ratio of 50%, and just announced share buybacks. Long term liabilities to assets are at 58%. Its trading at $3.85 and had earnings per share of ~$2.48 in the third quarter. Their earnings will obviously be terrible in Q4. It has mostly 1-2 year staggered time charters and a few ships on spot. The chart looks extremely good as long as the Baltic Dry index of spot shipping rates (which has plummeted 93%) doesn’t vanish from the face of the earth and the world economy collapse entirely. I would like to think that a majority of the pressures on the Baltic Dry are due to problems obtaining letters of credit. If so, this sector should lead any recovery in the markets overall. Furthermore, banks will forgo their traditional role as buglers for the bull recovery due to increased regulatory pressures. As such, shipping companies provide a unique transmission channel to gain exposure to a recovery in the commercial paper and asset-backed markets without exposure to toxic assets.

Art:
Mark Rothko is off 25% this year and he’s swell. I think late 1970s through early 1990s Sam Francis and David Hockney prints are exceptionally cheap right now. I’m trying to get Damien Hirst to make a pencil with a gold center for me.

I think artprice.com [Euronext:PRC] (down 75%) is a great “what the hell” kind of play. It revenues are growing every year (and profits falling) and it has virtually no analyst coverage in the US. I find the site extremely useful. Its trading at $5 dollars vs. its IPO two years ago around $20.

Equities (Macro):
Starting in the spring, with a super long term macro view, I would buy the stocks of companies in India, Brazil, and Finland.
One: because they all make beautiful music.
Two: because their women are incredibly attractive.
And three: because their educational rankings are good on average.

I also believe these three together, comprise a very balanced ex-US equity portfolio: Brazil and India are two emerging markets with two completely different economies. Brazil exports commodities and India imports them, exporting services instead. Finland is a highly developed economy with good social services (reducing cost to businesses) and a cultural memory of design and innovation.

I believe someone who desires additional equity exposure, could further diversify with a Pan-Sub-Saharan Africa ETF. After my recent visit to Buffalo, NY where people were not overly concerned about the economic collapse and where real estate just rose 3% year on year, I have become convinced that the optimism and trust engendered and inculcated by shared sacrifice is an essential component to equity portfolios in a time where most of the developed world is frozen in indecision fomented by distrust and fear.

Real Estate:
I would definitely buy a craftsman house in Vallejo, CA immediately. And real estate in New York within 18-36 months. Probably sooner for distressed bargains in the high-end market, and later for bargains in the middle and lower-end.

Oil:
This is obviously a big story in the medium long term but its extreme price ranges over the last 40 years makes me totally unable to predict its path in the near term. That being said, it is at the same price as in its peaks in 1990 and 2000 (inflation adjusted). This should provide strong price resistance given the large amount of demand which came online in the past 20 years and the current production declines from existing oil fields. I would hedge oil exposure with stockpiles of kerosene and AK-47s in case of a true deflationary meltdown. I really like your black swan style-call option-bird flu-stockpile idea.

Sport:
Finally, I've got 20 bucks riding on Manny Pacquiao in the Oscar de la Hoya fight, because of his trainer Freddie Roach and for the reasons listed in these two LA Times articles:

http://www.latimes.com/sports/printedition/la-sp-dwyre6-2008dec06,0,4193360.column
http://www.latimes.com/sports/printedition/la-sp-dwyre3-2008dec03,0,1834058.column

I'm gonna post this on my blog today, and try to upload some pictures of the charts in the next few days. Check it out next week.

Take care,
Matty Talty Colvard

We teach what we cannot learn.

A "friendly experiencer" in the markets, makes his decisions amidst the deluge of sights, soundbits, and combating opinions from other experiencers market-wide. Often times our convictions are proved wrong, and when we get burned, we learn not to touch the fire. But if we're all future-blind, how are we to know the incendiary agent? We may prepare ourselves against fire, only to be scalded by a bursting steampipe. Worse, in our blindness, we may mistake the scald for a burn and learn nothing.

And so we often learn the wrong lessons, mistaking causality or blaming our own tactics. But the most malicious lesson, is the one we make when we have been burned so many times that our nerves have been seared off. We cease to be able to feel. In our numbness, we abdicate our responsibility to prepare for the next conflagration.

Today the stock market fell back 11 years in time, briefly touching a number near which Alan Greenspan gave his infamous "irrational exuberance" speech. In 1997, Greenspan was worried about the excessive valuations in the stock market. He decided to raise interest rates. The market fell 7% and then roared back. Greenspan writes, "It recouped all of its losses and gained 10 percent more, so that by mid-June, it was nearing 7,800. In effect, investors were teaching the Fed a lesson. Bob Rubin was right: you can't tell when a market is overvalued, and you can't fight market forces."

This was precisely the wrong lesson to learn. Lets review what Greenspan said in his infamous speech:

"As we move into the 21st century... one factor will continue to complicate [the] task of pinning down the notion of what constitutes a stable general price level... Where do we draw the line on what prices matter? Certainly prices of goods and services now being produced - our basic measure of inflation - matter. But what about futures prices? Or more importantly, prices of claims on future goods and services, like equities, real estate, or other earning assets? Is stability of these prices essential to the stability of the economy... How do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions... and how do we factor that assessment into monetary policy?... We should not underestimate, or become complacent about, the complexity of the interactions of asset markets and the economy."

And so after Greenspan's puny stand against asset prices (he raised interest rates 0.25%) he threw his hands in the air and abdicated all responsibility for counter-cyclical tightening, with grave consequences for us and the stability of the world economy.

He will be remembered for illustrating what he could not perform.

And for teaching what he could not learn.

Make-A-Wish Foundation Rings Opening Bell, Tanks Stocks. Seismic Collapse in Bond Market Yields Benefits Non-Profits Everywhere. Quantitative Easing!

The Make-A-Wish foundation destroyed the stock market today. Charity is even more out of style than clowns and Kiss.

This is ironic because a properly run foundation should have the majority of their investments in bonds. Well lets hope they do because the entire yield curve collapsed to below the rates where the Treasury has ever issued bonds. Assuming Make-A-Wish is properly run, they racked up massive gains today as the collapse in Treasury rates make their bond holdings extremely profitable.

As the market moves to price in quantitative easing, banks are aggressively hedging their exposure to the bond swap market, in which they have guaranteed long term rates for borrowers. This has kept swap rates below the bonds they're linked to... previously considered to be a mathematical impossibility. This is because banks normally charge a premium over the market rate on bonds to compensate them for the long term risk they're taking on.

Let's review the Bernanke playbook for conducting monetary policy in a zero Federal Funds rate environment which we spoke about a week and a half ago.

1) Take the Federal Funds rate to zero. Check.

2) Lower the rates on long term (5-30 year) bonds, by either promising to keep short term rates low for a number of years or commit to make unlimited purchases of long term bonds until their interest rate falls. Check.

3) Push down interest rates on private securities by buying them as well. Check for Commercial Paper (short term debt) Not much impact on long term corporate bonds, unfortunately.

4) Intervene in the Foreign Exchange market to weaken the dollar and raise the price of imports. No action yet.

5) Coordinated easing of both monetary and fiscal policy, for example tax cuts financed by issuing money so there is no increase in government debt. Check, sort of.

So it appears the majority of their gunpowder remains only in Foreign Exchange intervention. This is an extremely politically sensitive measure and is unlikely to be implemented except as a last resort.

But what is truly shocking about this whole thing is that the Fed has not come out to announce these courses of action. Very strange for a Fed that prides themselves on transparency.

Opening Bell

Last Friday, clowns from the "Big Apple Circus" rang the opening bell. The Dow fell 403 points.

Today, Gene "The Street Giveth, and the Street Taketh Away" Simmons rang the opening bell. The Dow fell 517 points.

Tomorrow, the Make-A-Wish foundation will ring the bell. Frankly, this is getting a bit ridiculous.

Oddly disconcerting clips:
Clowns

Kiss

The (un)Thinkable is happening. Panic now. Thankfully we have the Bernanke Experimental Economics Playbook

Vol. 1: "Soft Landings..."

Dr. Ben Bernanke, in a speech on November 21, 2002 laid out a playbook of options for the Federal Reserve to run should it ever lose control of monetary policy in the face of massive deflation. Intended primarily as a thought experiment, this graph shows the Fed losing control as we speak. Witness the (relative) stability of the federal funds rate until the bankruptcy of Lehman Brothers and the reverse take-under of A.I.G.. Up until today, the effective federal funds rate has never approached its zero limit... never-ever.

We are truly balancing on the edge of economic science and there is no chart for where we are going. This is a Ph.d level, alchemy lab improvisation called "Quantitative Easing." The Federal Reserve is synthesizing a powerful medicine, but they don't know if they're missing an ingredient, and they have no idea what size dose to give. To much and the patient will OD chasing the inflation dragon. To little and he'll go into cardiac arrest.














Click here to understand what I'm talking about.

And here to read "The Unthinkable Has Happened" by Tracy Alloway, Ftalphaville.ft.com

And here to read "Obama Can Be a Roosevelt, Not a Carter" by David Blake, Ft.com

Go Long, Karl Popper

Reading a biography of Karl Popper today I was struck by this quote:

"Popper regarded democracy as the only political system capable of institutionalizing knowledge and freedom, and since he regarded the latter as a condition for the former, it may be said - though he might not say it - that history had proved him right. The fallibility of the democracies had turned out to be a strength; the infallibility of dictators had revealed their weakness. Totalitarian systems created an illusion of frictionless cohesion and inflexible unanimity, but - by damning all dissent as treachery - such regimes lost any prospect of improvement or self-correction through constructive criticism."

Applying this concept to the stock market, I think this is the strongest argument in favor of allowing short selling I've ever heard.

The Gaussian Fallacy and Other Epistomological Failings in the Age of the (Aging) Bullshit Baby-Boomer

I've typically been skeptical of adherents to Nassim Taleb's "Black Swan" club. The events that have unfolded since the collapse of the Chrysler deal in late July 2007, are not black swan outcomes. [No one posited the existence of black swans. All swans were white, until they weren't.]

These outcomes are the wholly predictable results (in framework, if not in detail) of the moral bankruptcy of the Baby-Boomers and Generation X coupled with an unsustainable and untenable financial system. I believe there were extremely few people in the world who believed we could save nothing and borrow money at 0% forever without the bill ever coming due.

However, I think that this very lucid post on Ultimi Barbarorum (a Spinozist blog about finance) is an excellent summary of the ways in which financial innovation abetted the stability of the system for the first half of this decade until it didn't.

The only thing I would add, is that retail investors were also tricked by a Gaussian Fallacy. They were told that stock returns followed a Gaussian distribution... as long as you diversified, never paniced, and invested in low cost stock index funds, you could expect 10% a year and retire happy. This shiny ordure was sold to our parents by men under fifty who had begun their careers after 1980 and had never seen anything but a stock bull market. The ideological laziness and lack of intellectual curiosity on the part of our parents and their financial advisers is inexcusable. The "this time its different" argument, used to explain why it is not important to study the past, is the direct consequence of the self-indulgence, egoism, and narcissism of the Baby-Boomers and Generation X, both of whom were raised or came to believe that they were "special" and somehow their history would be as well.

With compassion for their sins, I nevertheless look forward to the rottenness being purged from the system. As a child I used to think a good name for my generation would be "Generation Why" but more and more as I become an adult I believe in Generation MGMT.

Synopsis:

"Banks would normally be wary of lending to someone whose liabilities were 50 times their net assets, but they happily lent to each other on that basis - until, one day, they stopped. If you want a one sentence explanation of the present crisis, that is it.

In business, capital is the stuff you have - to protect yourself, your customers and your creditors - when things go wrong. In good times, you may feel you do not need it and may resent paying for it. In bad times, you can never have enough. If you do not have it already you will find it very expensive or impossible to obtain. You may then go broke. If you want a one paragraph explanation of the capitalist system, that is it."
- John Kay, FT

Distressed Assets

I just bought the book, "Distressed Debt Analysis: Strategies for Speculative Investors" for 10 cents on the dollar. The person coding the bar code scanner must of labeled it wrong, but there was no way for the salesperson to verify it since the was no price on the book, only a bar code. Based on this transaction, I may not read the book, since I think I just mastered the material.

Quote of the Century

“…public credit depends on public confidence…The financial crisis in America is really a moral crisis, caused by the series of proofs …that the leading financiers who control banks, trust companies and industrial corporations are often imprudent, and not seldom dishonest. They have mismanaged…funds and used them freely for speculative purposes. Hence the alarm of depositors and a general collapse of credit…”
-The Economist, November 2, 1907

Quote of the Day

"Markets remain gloomy. They are waiting anxiously for “the shoes to fall”, except it seems that the shoes are from Imelda Marcos’ collection."

-Satyajit Das, author of the brilliant and funny, "Traders, Guns, and Money: Knowns and Unknowns in the Dazzling World of Derivatives"

Quote of Yesteryear:
Me (in the business section of B&N): "I'm looking for a book by Das."
Hipster Clerk: "Ram Das?"
Me: "No, not frigging 'Be Here Now', its a book on derivatives. You should read it, we're all about to be nowhere."

The Long View... 1885-2008

Click to enlarge:


As you can see from the chart above, the Dow Jones Industrial Average (inflation adjusted) peaked at ~5000 in 1929 and ~7000 in 1966. Which makes last week's trading range between 8000-9000 either the most tremendous buying opportunity in the last 15 years or a terrifying look into the ravages of deflation. You will also notice that it takes on average 14 years for these massive troughs in the cycle to right themselves again. The DJIA often stays flat for around 28 years (for example see 1890-1911, 1900-26, 1926–56 and 1966-96). I figure we are about halfway through the current cycle.

I believe in human progress, and the science of economic theory and crisis management has evolved quite a bit in the last hundred years. The key question however is this: Which expertise has evolved farther, our ability to solve economic crisis, or our ability to create them?

Living in Clip

Imagine credit is the world's largest, loudest, most awesome guitar amplifier and we've just blown almost all of the speakers. When you overdrive an amplifier it heats up and this heat makes it more difficult for the amplifier to handle a large burst of energy (Think of the bankrupcy of Lehman Brothers.) When this happens, the amplifier cannot reproduce the signal and clips, sending the burst of energy to the speaker which blows up the speaker coil.

The repo market is living in clip right now. In this tightly coupled market of lending between institutions, one failed trade can cascade through the system causing massive counterparty failures. On Tuesday a record 2.290 trillion dollars worth of trades failed. Borrowing rates on loans backed by U.S. Treasuries are stuck near zero percent, suggesting that despite the offer of free money, no bank is willing to part with their holdings of government debt which is crucially necessary for them to hold as collateral to ensure their solvency. The Ted spread, a measure of the difference in borrowing costs between interbank loans and loans directly from the government is stuck at historic highs, as banks hoard capital and refuse to lend for more than an extremely short duration.

As this clip ripples through the system it is rapidly destroying crucial cogs in the machine. This more than any other factor is what has contributed to the massive collapse in paper and tangible assets as fears of deflation lead to widespread discounting in the prices of all assets. Despite an easing in the credit default swap market on the risk premium for financial companies, we can not even hope for a bear market rally until some semblance of trust is restored.

Farmer's Almanac: 2009

Low-quality Robusta coffee prices have tumbled as exporters struggle to obtain financing. At these prices ($o.06/lb in Indonesia - $0.93/lb in London) millions of farmers are suffering and have begun to remove their product from the market rather than face steep losses. Exporters are halting shipments until prices recover. "We are effectively slitting our throat at these prices," said Hasan Widjaja, chairman of the Indonesian Coffee Exporters Association.

Farmers, burdened by heavy debt they incurred during last spring's highly inflated fertilizer purchases will go bust. Failures in agriculture may lead to an explosion of inflation next year.

In 1929 the Dow Peaked at 4893

(Inflation Adjusted)

1966

So, regarding the very real, but still unlikely prospect that the Dow could fall back to the year 1966, (it peaked then at 6900 points versus 9400 today)... how good of an economic indicator is the stock market? Has there been any real and inalienable increase in wealth since 1966?

["Wealth is the number of days you could sustain your lifestyle if you were to stop working today"- Buckminster Fuller]

Or is the stock market only an indicator of credit availability, that is, leverage and a unassailable trust in future wealth creation?

Rally like its 1999...

Some quick back of the envelope calculations... If you took out a CD yesterday at 3.5% and invested an equal amount of money in the stock market at the same time... your losses today in stocks equal all of the interest you could hope to accrue in the next year from your "safe" certificate of deposit.

Touching 9300, a level its not seen since 1996, 1997, 2001, or 2003, the stock market is now ready to rally like its 1999.

(Unless it hits 7000 in which case we're back to 1966)

Why?...

I am beginning to feel pessimistic for the first time since Bear Sterns was rescued. Judging by the capitulation factor, this means I am wrong, since I am the most pessimistic guy out there. I was amongst the first to feel worried back when the Chrysler deal collapsed in the last week of July, 2007. But, I've been optimistic ever since Bernanke began to bend the rules this last March. . .If I am capitulating than we must have reached the bottom.

However the volume, the amount of trades done in a given day, has been extremely low ("dull"). This make me nervous.

Normally in a bear market, the situation is as Joseph Granville (see footnote) describes it, "Volume will be light on the early stage of the decline because the public believes that the decline is nothing more than one of the usual previous dips in the bull market and the result they expect will be another buying opportunity. The early selling is therefore done by the professionals. When the decline does not stop, the public becomes concerned and starts to sell stocks and the volume gradually rises on the accelerating decline.

As the decline becomes more rapid, the public gets more and more frightened and now stock are being dumped. This sends the volume still higher and a 'selling climax' results.

Recognizing this climax as a sign for a technical rebound in the market, the professionals start buying and the market goes into a technical rebound.

If the fundamental business background is showing some signs of weakening at this juncture, then such a rebound in the market would probably be considered as a selling opportunity, further declines are yet to come. This pattern can be summarized as: First phase of the decline on light volume- professionals are selling, and the public remains confident. Second phase of decline on heavier volume- professionals are selling, public disbelief over the decline causes them to lighten up. Third phase of decline on still heavier volume, leading to a selling climax- professionals finish their selling, and public confidence, now shaken, bring in a deluge of stocks. Fourth phase of decline- temporary technical rebound on professional short covering and general professional buying while the public continues to sell."

But I believe these rebounds have already happened in September 2007, April/May, and July/August of 2008.

"H.M. Gartley was a great technician in the 1930s. He did more work on volume than any other man. In 1933, he wrote:

'Bear market cycles begin on reduced volume. As the major (downward) phase develops, volume increases and this phase ends in a selling climax on heavy volume [March 18th 2008, July 15th 2008] The ensuing rally (corrective phase) is accomplished by declining volume, which dwindles until the rally loses momentum completely, and the major trend is resumed in a new bear cycle... Bear market rallies start out of active selling climaxes.'

Note that the first six bear market rallies, following the 1929 top, came out of heavy trading. But the rally in July 1932 came out of extreme dullness, indicative of a major reversal (a new bull market began on July 8, 1932 [granted it was down 90% from its peak]). The rationale behind the diminishing volume in bear markets is simply that the public loses interest as it loses money. Also, they have less capital to trade with, owing to those losses."
-Harry D. Schultz, "Bear Market Investing Strategies" 1968, revised 2002.

I think the difference between a crash today, or the crash of 1929 is the the government is coping with rather than exacerbating the crisis. So perhaps we will not have six bear market rallies, but more likely 4 or 5. We already had one in September 2007, April/May 2008, and August/September 2008, so maybe one more rally now and another in 9 months or so.

Or we will have six or more rallies but they will be not from declines like 1929-1932 but more like the gradual troughs of the 1970s. Basically the picture I see in my mind is the Federal Reserve, like a machine, trying to damp the vibrations of a violently oscillating string. In this picture the each fall and rally gets less dramatic as the crisis is solved.

Here is the reason why the crisis is not solved... Consumption is 70% of our 13 trillion GDP, about 9 trillion dollars. When a store takes on inventory, or in the service sector, borrows to meet its payroll in advance of its receipts, the store borrows in the commercial paper market. Doing an extremely crude back-of-the-envelope calculation, lets say half of that 9 trillion dollars needs to be borrowed every year to finance the goods we consume.

If this is averaged over 12 months, 375 billion dollars needs to be borrowed by companies, short term, every month. Right now this market is entirely shut down. (Quick check of the facts, the commercial paper market is actually 1.6 trillion dollars per week, because corporation evidently borrow more than I thought possible and it also includes bank's short term financing requirements, which I did not consider.)

"The Federal Reserve is working with the US Treasury on plans for a dramatic move into unsecured lending in the hope that this extreme step could help bring credit markets back to life.

As well as unsecured lending to banks, this could lead to the Fed directly purchasing commercial paper or funding a special purpose vehicle set up to do this.

Any unsecured lending would be a radical departure for the Fed. Central banks almost never make unsecured loans, and the Fed has never done so in its history...

It would allow the Fed to address two key problems in the financial system directly: the freezing of the term interbank money market, which covers all but overnight borrowing, and the rapid contraction of the commercial paper market...

The core of the problem in the interbank market is the lack of availability of term unsecured loans. Banks can get some term funding, but only on a collateralised basis, which helps explain the extreme demand for Treasury securities used for collateral purposes. Unsecured borrowing rates for any significant period of time - such as the three-month Libor (London interbank offered rate) - are sky high. In practice, most financial institutions are now unable to get term loans without collateral, and are funding themselves heavily in the overnight market." -Ft.com

"This hurts banks. Most [bonds/revolving lines of credit] are three- to five-year deals, agreed pre-crunch, at rates - typically Libor [pre-crisis, LIBOR was Prime minus 3%] plus six to 10 basis points for an investment-grade credit - that now seem extraordinary. Back then, these were barely break-even deals for the banks: they'd use them as a ticket to an M&A mandate or a big interest rate swaps programme. Now banks are funding themselves at much wider spreads. Whether they recover the notional amount is almost irrelevant - a drawn-down revolver means net interest margins are shot to pieces." -Ft.com

"This reliance on overnight money is dangerous for the financial system. It makes banks vulnerable to short-term market dislocations or loss of confidence, increasing the likelihood of failures and firesales of assets.

The core of the problem in the interbank market is the lack of availability of term unsecured loans. Banks can get some term funding, but only on a collateralised basis, which helps explain the extreme demand for Treasury securities used for collateral purposes. Unsecured borrowing rates for any significant period of time - such as the three-month Libor (London interbank offered rate) - are sky high. In practice, most financial institutions are now unable to get term loans without collateral, and are funding themselves heavily in the overnight market.

There are two reasons why banks cannot obtain term unsecured loans from the private market. There is a classic financial-crisis coordination problem, characterized as: "I won't lend you money for a month if I think that everyone else will only lend you money for a day, allowing them to pull out tomorrow and leave me stranded." This "roll-over" risk is a form of liquidity risk. The second reason is the credit risk of lending to banks, which has been elevated by the financial and economic turmoil.

The Fed's existing liquidity operations - ramped up again yesterday - reduce liquidity risk by providing a large backstop source of funds. But they are imperfect substitutes for unsecured borrowing, as they are only available on a secured basis. Unsecured term loans - for instance at 100 or 150 basis points over the federal funds rate for three-month money - would provide a near-perfect substitute.

The unsecured Fed term loan rate would act as a ceiling for Libor. Banks would be able to use these loans to reduce their reliance on overnight borrowing, making the system more stable.

Moreover, banks would in theory become more willing to lend spare funds to each other, reviving the private interbank market, since the borrower or lender could turn to the Fed for unsecured loans if it suddenly needed additional liquidity."-Ft.com

It is extremely dangerous to call market bottoms, but this unprecedented move by the Federal Reserve is almost the last trick in their hat. They have also announced they will start paying interest on overnight bank deposits with the Federal Government. This (which the European Central Bank already does) will allow the Fed to much more closely manage overnight borrowing rates. If this doesn't work, nothing else will. I suggest putting half of your money in the mattress and buying stocks with the other half.

For the folly of calling market tops, see the footnote on Joseph Granville below...


[Granville is probably best known for his bearish market calls during the 1970s, 1980s, and 1990s, when he claimed that the stock market was headed for imminent collapse. His overall track record, according to the Hulbert Financial Digest, is very poor.

The Granville Market Letter "is at the bottom of the Hulbert Financial Digest's rankings for performance over the past 25 years - having produced average losses of more than 20 percent per year on an annualized basis." ^[3]

Nevertheless Granville was known as a great showman ^[4] who would emerge from a coffin at an investment conference, or appear to walk across water (at a swimming pool) when meeting clients. According to Robert Shiller in his book Irrational Exuberance^[5]

His investment seminars were bizarre extravaganzas, sometimes featuring a trained chimpanzee would could play Granville's theme song "The Bagholder's Blues," on piano. He once showed up at an investment seminar dressed as Moses, wearing a crown and carrying tablets. Granville made extravagant claims about his forecasting ability. He said he could predict earthquakes and once claimed to have predicted six of the past seven major world quakes. He was quoted by TIME Magazine as saying "I don't think that I will ever make a serious mistake in the stock market for the rest of my life," and he predicted that he would win the Nobel Prize in economics. -Wikipedia]

Bullish...

The New York Times reported in the Sunday Times this weekend that a bull escaped from its pen and ran wild through the streets of Queens. While there is not much precedent to give this event credence as a contrarian indicator, it is worth examining some of the factors that may result in a stock rally for the next few months. No less an authority than Marc Faber, a fund manager so bearish that he is often referred to by his nickname, Dr. Doom, thinks a rally is imminent. He writes,

"What is important to understand is that equity markets have become extremely oversold, that sentiment is very negative - almost a panic - and that equity markets usually bottom out from a seasonal point of view between the end of September and early November. Markets may have put in a low yesterday and could rally into March of next year. But such a rally will not be the beginning of a new bull market but a bear market rally, which will be followed by further price declines - certainly in real terms - as the global economy contracts and as corporate profits disappoint badly. The credit bubble has burst for good and central banks' easy money policies and large fiscal deficits will be unable to re-ignite credit and economic growth. Between 2001 and 2007 we had a global synchronized economic boom and a bubble in all asset classes including real estate, equities, commodities, art, worthless collectibles, and even bond prices. Now a global bust will follow with all asset prices deflating one after another like a falling domino."

I would add to this four things. Baron Rothschild once extolled the virtue of buying when there is "blood on the streets." In the last week I have heard everyone from the extremely rich parents of a friend of mine, to my union colleagues at the Metropolitan Opera house wondering if it is finally time to give up on equities. Secondly, yesterday I overheard a shopkeeper in Brooklyn worrying about deflation; highly unusual considering his costumers' complaints about high prices all year. Thirdly, since 1888 the Dow Jones Industrial Average has risen 4.34% on average from October through December in a presidential election year. This has occurred in 21 of the 30 election years. And finally, the Dow failed to break 10,000; a very important psychological level not just for stock investors but for the American public at large.

While none of these musings is remotely scientific, I would like to mention that the stock market appears to be the only market in the world where people typically buy when prices are high and sell when prices are low. It makes no sense to wait until some Abbie Hoffman-esque character releases a bull in lower Manhattan for more of a signal to begin bargain hunting.

Oh no...

Ebay Whip Inflation Now intervention fails! Dow rises 600 points!

Ketchup Soup

1.2 Trillion Dollars vanished from our imagination here in the United States, and we moved four years back in time. The S&P 500 had the biggest percentage loss since October 1987. The Vix (Fear Gauge) hit a level that has only been seen in 1987, the Russian Default of 1998, and the aftermath of the 9/11 attacks.

Campbell Soup was the only stock in the S&P 500 which gained today. But, if we are really in the worst crisis since the Great Depression, shouldn't this be the worst performer?

This is deeply disturbing. Either everything is going to be okay, or we should all go out and enter a spread: shorting Campbell soup and buying some second-tier ketchup like Hunts.

By the way, the Ebay Whip-Inflation-Now Indicator is flashing high alert as it hit 100% unconcerned about the prospects for inflation. At zero bids, Ebay W.I.N. Indicator is signalling crisis level fears of imminent depression. I may have to intervene in the market.

Reflections on Today, from Henry Clews, 1908.

"The action of commerce, like the motion of the sea or the atmosphere, follows an undulatory line. First comes an ascending wave of activity and rising prices; next, when prices have risen to a point that checks demand, comes a period of hesitation and caution; then, care among lenders and discounters [or not -ed.]; then comes the descending movement, in which holders simultaneously endeavor to realize, thereby accelerating a general fall in prices. Credit then becomes more sensitive and is contracted; transactions are diminished; losses are incurred through the depreciation of property, and finally the ordeal becomes so severe to the debtor class that forcible liquidation has to be adopted , and insolvent firms and institutions must be wound up. This process is a periodical experience in every country; and the extent of the destructiveness of the crisis that attends it depends chiefly on the steadiness and conservatism of the business methods in each particular community affected. In addition to this ordinary and, I would even say, natural liability to commercial crises with a greater or lesser degree of panic, we, in the United States, have to stand the far more violent oscillations so inseparable from our great mass of new and immature undertakings.

In times of crisis, the obligations issued against such enterprises suffer instantly from the uncertainty about their intrinsic value. Holders are anxious to get rid of them; banks which have advanced money on them, call in their advances; and they became virtually unavailable assets...

In view of the facts, what is the use of discussing the possibility of averting our periodic panics? Risks and panics are inseparable from out vast pioneering enterprise; and all we can hope is, that they may diminish in severity in proportion as our older and more consolidated interests afford an increasing power of resistance to their operation. I am disposed to think that, in the future, the counteraction from this source will be much more effective than it has been in the past...

But, whilst maintaining that panics cannot be avoided in a country situated as ours is in its present incomplete development, I cannot avoid expressing the opinion that conditions are permitted to exist which needlessly aggravate the perils of these upheavals when they do occur. In every panic much depends upon the prudence and self-control of the money lenders. If they lose their heads and indiscriminately refuse to lend, or lend to only the few unquestionably strong borrowers, the worst forms of panic ensue; if they accommodate to their fullest ability the larger and reasonably safe class of borrowers, the latter may be relied on to protect that whom the banks reject, and thus the mischief may be kept with in legitimate bounds. Everything depends upon rashness being held in check by an assurance that deserving debtors will be protected. This is tantamount to saying that all depends on the calmness and wisdom of the banks...

These periods of the breaking-down of unsound enterprises and of the weeding out of insolvent debtors and of liquidation of bad debts can never be wholly averted; nor is it desirable that they should, for they are essential to the maintenance of a sound and wholesome condition of business; but it is a grave reproach to our legislators if, when the day of purgation comes, the law treats the deserving and the undeserving with equal severity."

-"Fifty Years in Wall Street," Chapter 10 PANICS-THEIR CAUSES-HOW FAR PREVENTABLE, Henry Clews, 1908

One way bets... Vallejo, CA

Amidst a financial crisis of the worst kind, let's put things in perspective. For at least a decade, my fiancee's grandfather, Grampa Moe, was convinced that the "bad times" were coming. He prepared for one scenario, a repeat of the Great Depression. This required land, a house, several watercraft, 30 pressure cookers and ample stockpiles of gold and silver. In light of recent events, this seems extraordinarily prescient. If he were alive today (he got tired and frustrated waiting so long for it to happen) he would tremendously enjoy his vindication and his transformation in his family's eyes from eccentric to genius.

But history will not repeat the past because we have in our employ Chairman Ben Bernanke, the foremost scholar on the Great Depression, and possibly the most creative, trenchant, and able authority to sit on the Reserve Board since Marriner S. Eccles presided over the New Deal.

Grampa Moe prepared for the crisis in broad strokes. But eight years into a recession which has now reached its crisis phase, it is time to make some refinements to his strategy.

The gold and silver he stockpiled has trebled in value. The pressure cookers are most likely rusted. And while the house has fallen in price, its value is unchanged. If five years from now when the crisis abates and life returns to some semblance of normality, the gold and silver will fall and the value of the home will rise again.

In this situation then it seems prudent to sell the metals now while they are extremely valuable, in the hopes that everything will eventually be okay. Under no circumstances could it possibly make sense to sell the home at its extremely distressed price, because after all this is Monterey, California.

In the Dust Bowl where did everyone go? California. California, the most fertile state in our nation, the epicenter of our innovation, is gift from God which appeared to its immigrants literally on a golden platter.

With that in mind lets turn our attention to the focus of this installment of "One way bets..." Vallejo, California.

Vallejo sits at the mouth of the Sacramento river, on the border of Napa County, in the North of San Francisco Bay. It is a 45 minute ferry ride to the Ferry Building in San Francisco, surely the most pleasant commute in the entire Bay Area. It is filled with charming Craftsman-era bungalows and is a short 10 minutes away from the new 300 million dollar cancer research facility at Turou University.

It is currently in the embroiled in the largest city bankruptcy in California history and is one of the largest casualties of the sub-prime collapse with thousands of foreclosures citywide. Houses are down in many cases 70% from their peak in early 2006. With all of the foreclosures, rental rates have gone through the roof as people struggle to find adequate housing. In this climate, it is easy to find a bungalow for a hundred thousand dollars which, at a 6% rate, require monthly payments of $600. With rents averaging $750-1000, this is a steal even if you assume the house sits vacant for a few months every now and then.

Prepare to kick yourself in 15, in 30 and again in 45 years if you miss this opportunity now.

Whip Inflation Now!

Despite my feeling that the reprise of the Resolution Trust Corp. will be inflationary, the Ebay Whip Inflation Now indicator is not flashing red. The "Ebay Whip Inflation Now" Indicator you may ask? Actually, it's my own invention.
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Since January, every time inflation has surfaced as the predominant worry in the economy, the price of Ford-era Whip Inflation Now buttons has surged. Today the price action appears calm. Perhaps this bailout will actually accomplish its goal of preventing deflation while not proving too inflationary. But more likely with today's $25 surge in oil or the $180 leap in gold over this week people are more worried about the future than feeling ironically nostalgic about the past. The next button goes on sale in six days. We'll know soon enough.

When one door closes...

The upcoming reprise of the Resolution Trust Corp., will weigh on the dollar in the near term and the implications of this course of action are a little hard to suss out. One one hand it will strengthen the dollar if the U.S. finance industry and by extension the economy is put on decent footing. On the other hand, it will massively increase the Federal Budget leading to a surplus of Treasury bonds. Since the government is in effect setting a floor under mortgaged backed securities, it is in effect inflating away the value of the debt in order to prevent a deflationary unwind.

While I have worried quite a bit recently about the potential for a deflationary outcome to the turmoil, it is instructive to remember that Bernanke is the country's foremost scholar on the Great Depression and determined to prevent deflation at all costs. Much of my concern was caused by the fact that I could not foresee further mechanisms for addressing the deflationary spiral. This new gambit by Paulson & C0. allays those fears.

The dollar will not collapse. Much as we have seen the correlation between the direction of the Euro and the direction of commodity prices breakdown over the past three weeks, we may be in for a period where inflation accelerates while the dollar's relative strength against its trading partners continues. If you just went, "Huh?!" I empathize. I am not sure that this is even possible according to the laws of economics, but this is one of the reasons I'm writing on this website. If you have any ideas on this unorthodox notion, please let me know.

One way bets... Charles Rangel

Do you think Charles Rangel will be forced out as chairman of the Way and Means committee by Dec. 31st 2008? The odds are good and the spread is better. On the Intrade Prediction Markets, you can speculate on anything from Barack Obama becoming President, to Israel attacking Iran before the end of 2009, to the likelihood of mad cow disease emerging in the American herd. When forced to put their money on the line, the wisdom of the crowds always trumps simple opinion polls.

It works so well that the CIA briefly considered setting up a market along the lines of Intrade.com in order to ask people to speculate on where the next terrorism attack would occur. Unfortunately, the project was shelved because the administration deemed it too insensitive.

The accuracy of Intrade is well documented, accurately predicting all of the Senate election outcomes in 2006. Betting sites are great for determining how in-step your opinion is with general reckoning and the direction to which they're out of alignment. You can bet for or against yourself, depending on where you see the equilibrium. With 2:1 odds on Rangel being removed, I think the price is way out of alignment. According to the NY Post, Pelosi's spokesman denies that Pelosi will insist on Rangel stepping down. But with the current price, you'll see 100% gain if you believe Pelosi will do the right thing.

Crisis averted for now...

So as I wrote last night, the relative stability in the Yen proved to be a good indicator for the fact that the markets would pull through. This does not mean that the crisis is over, but stocks should rally for the next month or so. The next shoe to drop will be defaults in the corporate bond sector, which will prove that the chaos in the markets over the last 14 months has spread to the real economy. But given the extremely weak covenants in the bond market in the second half of 2006 and the first half of 2007, these defaults will take place later in the cycle then normal. That being said, almost two years out from the period of lax underwriting the defaults can't be too long now. So don't you be to long either. Sell into the rally.

Harry Reid Says Congress Won't Act on Markets

Because quote, "NO ONE KNOWS WHAT TO DO."
At least they're being honest. I was aghast during the Bernanke's testimony before congress in July 2007 when no one addressed the looming crisis in the credit default swap market and I realized that I, with no formal economic training, knew more than members of congress did. That being said, I think that these days we're getting more or less equal.

The Fear Gauge

Today was the most fearful day in the markets that probably anyone living can recall. Gold surged 11%. Banks essentially stopped loaning money to each other. At one point banks were so scared that they were willing to invest in 3 month U.S. government debt (which they can use as collateral in case of disaster) for 0.03%, essentially for free. This was the lowest rate anyone has seen since the Second World War. The Vix, a measure of the amount of volatility traders expect over the next thirty days, reached its highest point since the crisis began last July. Since its inception it has only been this high twice, once during Russia's default on its debt in 1998 which caused the largest hedge fund collapse up until that time, and once during 2002. At its current level the Vix indicates that the S&P 500 will move up or down by 10.4% over the next 30 days. My personal feeling is that this is either the end of things as we know it or the worst its gonna get, staring into the precipice wise. Since I've been expecting Armageddon for since 2006 the fact that it hasn't happened yet is encouraging. Also despite the extreme stress in almost all markets, the Japanese yen which has typically surged during times of crisis has remained steady over the past 2 days. Finally, for the past 14 months it has been profitable to bet on volatility declining every time the Vix has broken 30 on an intra-day basis. I believe it is extremely unlikely that the Vix will break 40. That said, I have no idea what other policy initiatives the central banks of the world will pull out of their pockets. They can't just make bad loans good, and despite the massive injections of liquidity into the markets, there is no way that temporary liquidity can solve credit problems. Oh and by the way, the Federal Reserve has run out of money and has asked the Treasury to begin borrowing money on its behalf so that it can continue to function

Europe's Enthusiasm May Accidentally Defeat Obama

Since 1976, in every presidential election year when gasoline prices were lower than they were in the previous presidential election year, the party in the White House remained in the White House. While the prospect of prices declining to their 2004 level is extremely unlikely in the next 8 weeks, their recent pullback will have a large psychological impact on the public. Therefore it is ironic to note the supporting role Obama played in their rapid decline.

The Euro/US Dollar exchange rate is primarily driven by economic factors, but sentiment also plays an enormous role. The recent astounding crash in the Russian Rouble immediately upon their engagement with Georgian forces comes to mind. Therefore I find it extremely interesting that while the economic news about Europe deteriorated precipitously in the months leading up to July, the actual breakdown in the Euro began within days of Obama's speech to ecstatic crowds in Berlin. This rise in the dollar in turn reduced inflationary pressures making oil and other commodities less attractive investments. While Europe remains enthusiastic about an Obama presidency, their trader's vote of confidence may have unintended consequences.

The Architecture of Washington Mutual

The saddest thing about the demise of Washington Mutual is the loss of the one true champion of architecture in corporate America. Never has a financial firm embraced architecture as an expression of their role in the genesis of personal wealth with such a radical and catholic program.

The Palm Springs Branch:


Sunset and Vine, allegedly (I thought this was on Wilshire:)


Sunset and Vine, Mosaic Detail:


Oakland (I think:)



Early 20th Century Sketch of a Branch:


Somewhere in the San Fernando Valley:


This Spanish Colonial Ranch empathizes with the aspirations of elderly tract home mortgage applicants in the greater Orlando area.

The Carpets are Falling

Back in January I thought I had a foolproof plan to survive the turmoil. I assumed the recession would be inflationary. (to comfort my fiancee I assured her it would be just like the most glamorous moments of the 70's) The only way I could imagine the debtors in this country getting out of trouble was for inflation to take off in such a way that everyone's debts would shrink as they paid them back with inflated dollars.

I had long planned for the two possible recession scenarios. If it was inflationary, I would move into hard assets like real estate and art. If it was deflationary, well I would hide under the mattress with my cash.

I thought I had a foolproof plan, I would buy vintage keyboards, oriental rugs, and some chinese vases. Keyboards to sell to aging yuppies or trust fund hipsters, rugs because they're pretty, and Chinese pottery because at some point the Chinese will want their heritage back (unless they get really good at counterfeiting that too).

I also had a tube of that poisoned Chinese toothpaste which I'd bought in a dollar store in Manhattan and held onto after it made me really sick because I figured lawsuits are good for income in any type of recession.

I was also aware that the Fed was taking an enormous gamble, hoping to create inflation so fast that commodities too became a speculative bubble primed to burst leaving the stimulative effects of easy money without the troubling result of embedded structural inflation.

But now that this gamble paid off better (it seems) than I could have possibly imagined I am faced with a troubling prospect. No one seems to have any money to purchase keyboards.

The prospect of carpet prices falling terrifies me much more than any sort of stock price declines, because if we have truly entered into a deflationary phase, nothing will be glamorous and our debts will become increasingly onerous as we pay them back with our stagnant wages.

The only bright side I can see is that this scenario will keep the bond holders happy which will continue to enable our government to do what it does best, spend its way out of trouble.

Robinson Crusoe and the Subjectivity of Desire

“Price is what you pay. Value is what you get.” -Warren Buffett

What matters to us and what price? Until the 1860’s, economists such as Adam Smith and Karl Marx struggled to develop a compelling theory to explain how humans qualify value and quantify price. Smith thought that the value of a good was a gestalt of the various costs required in its manufacture. Marx sort-of believed that a good’s value was determined by the amount of the labor required put the good together. The Austrian economist, Carl Menger, was the first to articulate in a brilliant and compelling fashion, how humans value goods and derive their price at the market.

Menger uses the example of Robinson Crusoe shipwrecked on his island. Let’s assume Crusoe has 100 cups of water at his disposal each day. Crusoe determines that he requires 10 cups of water in order to feel healthy and hydrated. He also needs 50 cups of water to irrigate his crops. He uses 25 cups for washing his clothes and dishes, and he uses the remaining 25 cups to water flowers in his garden. He has no further need for any more water.

What is the value of one additional cup of water: the 101^st cup? Zero. It has no value because Crusoe has no use for it. The 101^st cup, Menger terms “non-economic.” Looking at this metaphor from the other extreme, if Crusoe’s spring dries up and he is left with only one cup of water, the value of this one cup is priceless. It means the difference between life and death.

Menger posits that all human interactions in the marketplace are composed of sliding valuations, valuations bordered at their extremes by the non-economic and the priceless goods. Menger, therefore, strikes directly at the subjectivity implicit in the vast majority of these pricing decisions: the subjectivity of desire.

Absent the terrible coercion of poverty, we predicate our decisions of whether to buy or sell purely within the framework of our own sense of justice. In the vast majority of our purchases and sales, we only ask, “What is the value of this good to me, and is the price a fair representation of its value?”

Money provides a handy calculus for this determination. By referencing all goods with respect to their price in dollars, we manage to shackle our subjective musings under a link of objectivism. Our ration of water, to extend the Crusoe metaphor, is our weekly paycheck; and after accounting for the basic needs of our survival, we can begin to attend to our wants.

It is for this reason that inflation fills us with dread. The rising cost of bread breeds anxiety because it sows doubt in our minds about our ability to pay for our needs. But more subtle, sinister, and insidious is the inchoate notion deep in the back of our minds that the markings on our yardstick are in flux; that money, the arbiter of all goods, is no longer predictable, discernible, or just.