OK, now that we have the previous two posts out of the way, Monday (03.16.09) we will discuss how the markets and the US Economy are linked but not dependent upon each other.
Essentially, our economy is based upon the number of domestic jobs, the average $/hour/resident of the US and the general mood and optimism of these residents.
The markets, however, are based upon expected earnings after taxes (both domestic and foreign) and the general mood and optimism of investors.
I hope you noticed the domestic and foreign earnings part. Remember, if you are a CEO of an international company (and virtually all listed stocks are international), you are rewarded based upon your consolidated earnings (foreign and domestic) and, consequently, your stock price. There are no rewards for making the US, or US residents, more prosperous.
Globalization is Kryptonite to national economies IF you are a "have" and not a "have not". Globalization levels the playing field. The game is to increase profits, at the expense of the "haves", without destroying them. It is not quite a zero sum game but the US and its residents will think it is.
Think about the higher value (meaning "wage") jobs that have been lost - maybe for a very long time. Unless we replace these jobs with new and equally high value jobs, this means less disposable income, less consumption, less tax revenue for federal, state and local governments. But the countries that landed these jobs improve their standard of living - though their revenue does not go up as much as our revenue goes down.
And that is the trick. Companies seek to globalize to the point where marginal cost equals marginal revenue. This is the old Economics 101 MC=MR graph. At this point, it takes $1 of cost to generate $1 of revenue or a break even. But, right before this $1 came a $1 of revenue that cost just slightly less than $1 to generate - and that is earnings - and that creates value in the share price.
The same is true for the global production/consumption. You globalize right up to this point. It helps you to reduce the costs for your company (even if you eliminate US jobs) just so that you do not kill consumption in the US.
But, as you reduce jobs in the US, the debt stays the same. And here we are...fewer jobs, less income, same debt, more defaults, falling asset prices. We crammed too much debt down the throats of consumers at the same time we cut their jobs and wages.
Finally, just for reference, all of the stimulus the US can throw at our economy won't work because you cannot take from those that have (through taxes, borrowing and inflation) and give it to those that don't and change a thing. And, if you are going to borrow the money, what ever you spend the stimulus on better make money after you build it. But if you REALLY want to muck things up, just print the money. Now you have fewer jobs, less income AND inflation - exactly the definition of stagflation.
And, for the record, stagflation is the mortal enemy of equity markets - IF you use purchasing power as your measure.
We are so screwed...

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Just for everyone's enjoyment, here are the lyrics to "The Wall Street Shuffle"...written nearly 35 years ago! The group was 10cc. What a song! Not much has changed as far as the "Shuffle" goes - just today, it is played with many more zeros and commas - but it is the same old greed game...

Enjoy and go buy a copy of the song...

Do the Wall Street Shuffle
Hear the money rustle
Watch the greenbacks tumble
Feel the sterling crumble
You need a yen to make a mark
If you wanna make money
You need the luck to make a buck
If you wanna be Getty, Rothschild
You've gotta be cool on Wall Street
You've gotta be cool on Wall Street
When your index is low
Dow Jones ain't got time for the bums
They wind up on skid row with holes in their pockets
They plead with you, buddy can you spare the dime
But you ain't got the time
Doin' the....
Doin the....
Oh, Howard Hughes
Did your money make you better?
Are you waiting for the hour
When you can screw me?
`cos you're big enough
To do the Wall Street Shuffle
Let your money hustle
Bet you'd sell your mother
You can buy another
Doin' the....
Doin' the....
You buy and sell
You wheel and deal
But you're living on instinct
You get a tip
You follow it
And you make a big killing
On Wall Street

The war between Russia and South Osseta that continues to expand will likely turn out to be a significant financial story. There is a map of the region for your reference.

Please notice that South Osetta is within 100 miles of Turkey, a NATO ally and a dominant military power. Turkey's southern border is Iraq.

Here is a quote that summarizes the conflict:

Mr. Saakashivili, the Georgian president, said Russia’s oil riches and desire to assert economic leverage over Europe and the West had emboldened Kremlin country to attack. Georgia is a transit country for oil and natural gas exports from the former Soviet Union that threatens Russia’s near monopoly.

“They need control of energy routes,” Mr. Saakashvili said. “They need sea ports. They need transportation infrastructure. And primarily, they want to get rid of us. ”

Finance is not all about stock tips.

Just remember the next time someone tells you about the "BRIC" countries as if they are a homogeneous, ubiquitous "one", ask if Brazil is at war or if India has invaded Pakistan. Just because there has been economic growth in these countries does not mean that there is equal risk.

All the more reason for "Deep Due Diligence". This will be a regular segment on The Wall Street Shuffle. Charts and stock picks only get you so far. Little things like war are also part of the "risk premium" that we all remember from first year finance...the risk free rate (usually a short term treasury) + the rate of inflation (feel free to insert your own calculation here) + market risk premium (THIS is where you might factor in war, pestilence, politics, first strike capabilities, etc.).

This formula has never changed and it never will. And it works for every form of investment. It's just important to remember that "risk" is a much broader word than the financial community would have you believe.

More on this on Monday's show but...

Did you know the FED has about $1T in assets, mostly (90%) in treasuries, at least 8 months ago. They now have less than half that with the balance made up of a collage of CDO's, MBS's and other "difficult" to value collateral. The term "Level 3 Assets" really do not do justice to the nearly impossible to value transfer of bad paper for good (relatively) treasuries.

And, yes, when the FED runs out of treasuries they go right back to the Treasury and ask for more. How does the Treasury fund the FED? They borrow and issue the treasuries to the FED.

And when the Treasury borrows, the US debt increases and the US debt service increases and the US deficit increases and you either owe more or pay more taxes.

No matter how it goes, you pay.

This is really simple stuff when you follow the money.

Since When is "Bankruptcy" a Four Letter Word?

Memo to: Freddie, Fannie, GM, Ford, Chrysler, Ambac, Citi et al.

If it is right to save Fannie and Freddie and other financial institutions from Chapter 11, why isn't it right to save every other company? For that matter, why even bother with bankruptcy laws?

A little short on cash and and a little long on liabilities? Call the FED. Paid your lying, thieving management team big bonuses and stuck "investors" (lol...sorry, this word in this context always makes me laugh) with worthless debt? Call the FED. Too big to fail? Call the FED. Raped and pillaged your pension plan? Call the government.

This is the old saying about telling the same lie often enough it becomes the truth. Tell everyone you are too big to fail...seek the bail.

If we put aside the massive wave of hysteria, talk of financial pandemonium and world economic collapse and every other financial PR hack's message, you still have poorly managed companies that lost billions of dollars and have billions more to loose. Actually, they never really "made" the money in the first place; but that is another story. They lobbied relentlessly for this solution and they won.

Haven't companies entered and emerged from bankruptcy in the past? Sure, the equity is wiped out...AND IT SHOULD BE. If the company is too far gone, then the bond holders are wiped out and the company goes room temp and the last will is read, Chapter 7.

But there is no one to step in and save the equity holders. That is why equity returns a higher amount than debt does...specifically because equity is the first to go in a troubled company and the higher return is the higher reward for the additional risk.

By allowing Fannie and Freddie to continue status quo and for the FED to be allowed to actually buy into the equity is a crime, a felony of the highest magnitude. It is the the theft of tax payer dollars to support the FED (and, yes, this is exactly what it is, no matter what you may hear to the "contrary") to buy equity in bankrupt companies. Absolutely anyone else would have been indicted by now. Add to this the now explicit guarantee of the "full faith and credit" (what is left of it) of the US Government.

Did anybody ever hear of Delta Airlines? 2007? How about the $2.5B in post-bankruptcy financing provided by...wait...JP Morgan, Goldman, Merrill, Lehman, UBS and Barclays. What a cast of characters! Basically the same team borrowing hundreds of billions from the FED right now. THEY apparently heard of post-bankruptcy financing because they would not provide the financing without taking a first priority collateral in the debtor-in-possession facility.

So why exactly are we in such a rush to sweep under the rug bad management, let the equity stand (and, apparently now prosper) and stand behind the debt? Just why couldn't the FED or the US Government take a senior position or own the company? Why provide guarantees and equity?

We are re-writing all of the rules anyway. Why not just write a rule that says that Freddie, Fannie, Sallie, Merrill et al CAN operate with $0 equity AND the backing of the FED or the US Government? Why not replace the management with new management (it is done all of the time)? Why leave the exact same regulators in place and call them something different and give them "expanded" powers? They had all of the power they needed, They just heeded to exercise that power and not bend to the massive lobbying efforts.

When a bank fails, new management is installed by the FDIC over the weekend and the bank re-opens Monday under a new name, government guarantees in place and it is transparent to the depositors. Why can't an investment bank failure work like this?

Where are the consequences for bad performance? You and I face consequences every day for every act and choice we make.

How do you learn a lesson if you can't fail?

Why would you improve?

Why train a dog?

Why no just pass every student?

Why have jails?

Why have immigration laws?

Why wars?

Why have rules?

I guess this is just the ultimate result of a society with an unbridled sense of entitlement and with a complete loss of a moral compass.

This isn't good fiscal governance. This isn't world financial salvation. In our every day lives, this is just a thief and "selective"prosecution.

It makes no sense at all to justify these actions based upon saying "Well, we can't worry about why we got here, we just need to save it." It is precisely this logic that continues to nurture this bad behavior. Politicians, captains of financial industry, indulgent parents, lazy educators all may lay claim to this "cranial-anal inversion" of financial logic.

I just want to say the the next police officer that hands me a speeding ticket "Let's not worry about why we are here. I promise to do better." Let's say to the next murderer on death row Let's forgive and forget. Go home." Tell your children when you find them experimenting with drugs "Don't worry, just don't do it again." Pet your dog when he tears up the house.

Re-elect the same politicians that allow this theft.

Can something be worth less the zero?

I really liked the quote about Merrill Lynch yesterday:

Thain ``is trying to control the mess that he inherited,'' Scott Rothbort, president of Lakeview Asset Management LLC, said in a Bloomberg Television interview. ``I would not rule out at this point their having to write down even more, but you can't write things down beyond zero.''

I beg to differ. You can write ans asset down beyond zero. You buy a gas station, thinking that it is a profit and revenue generating company. Then you find a leaking storage tank. Your business shuts down, the property is now classified by the EPA as a hazardous site any you pay and pay to clean it up. Hence the less than zero valuation.

The same is true for some financial instruments. Let's say you purchased a credit swap derivative. If you bought it for $X, you must think its value is $X+something. You see it become worthless, you write it to zero. But what if the swap goes against you and you cannot hedge effectively due to the markets. You are now exposed to "less than zero" losses and may continue to mount as the underlying security exposes you to increasing losses.

This is a very real possibility so the notion of "you can't write something off below $0" is just no longer true.

We will be discussing exactly that in today's show regarding the great Merrill Lynch Fire Sale of $30B worth of assets at 1/5th their "value".

But did you know that Merrill is financing 75% of the sale? Did you know that a drop of 5% or more in the value exposes Merrill to more risk?

Nothing in the I Bank world is ever quite what it seems. Remember what we said in yesterday's blog, capital is a difficult thing to both create and keep. And, leverage works in both directions.

More on the show today. Join us and call in.

Here is a link to the story:

http://www.bloomberg.com/apps/news?pid=email_en&refer=us&sid=atfHM8sh2xtw