Eye On Re-Regulation: Where There's Smoke...

Where There’s Smoke… Notes for the Week Ending Friday, December 12, 2008

Auto Da Fe

You’ve got to be very careful if you don’t know where you’re going, because you might not get there.
- Yogi Berra

The discussion in Washington about the automobile bail-out is a watershed moment in America’s economic discourse. Notably absent from the debate has been the affirmation that Government is inherently wasteful, while private industry is by nature ruthlessly efficient. Rather, we are witnessing the spectacle of Big Government excoriating both Big Business and Big Labor for being inexcusably inefficient. As of this writing, it appears that the Paragon of Government Inefficacy is in league with the Poster Boy for Toxic Industrial Wastefulness – President Bush and GM CEO Wagoner are apparently spending quality time on the phone discussing the details of their forthcoming deal.

Congress has shown itself surprisingly resolute in turning down a request that looked to us all quid and very little quo. It appears that President Bush will issue an eleventh hour and fifty-ninth minute Presidential Pardon to Motown. How will We The People pay for this? Will Ben Bernanke file an extraordinary issue of Fed debt and toss the proceeds to the automotive industry? As hinted at by SEC Chairman Cox (“We Need a Bailout Exit Strategy”, WSJ, December 11), bailing out private industry will require a downstream market for the newly-issued paper. Watch out, China, it looks like we may be getting ready to double park in your spot.

Our story so far: the automotive industry has suffered from a national lack of political will, inability to gauge public sentiment, and an ongoing excess of greed that challenges Wall Street. Its labor-management cabal has viciously and systematically dismembered the Goose the Laid the Golden Egg, all while doggedly refusing to structure their operations to fit reality. We do not weep that they have come awfully close to being collectively thrown under a bus of their own manufacture.

While we wait for the next act, it appears that the argument for Capitalist Efficiency versus Government Waste is dead. The most Businesslike player in this story emerges as Republican Senator Bob Corker, who said: I’ll give you quid, you give me quo. This process, as described by economist Nouriel Roubini, entails combining a Bail-Out (government pushing money in) with a Bail-In (creditors, and stakeholders such as the Union, taking payment in kind), all in the common interest of sustaining this major industry. Can it really be that this deal collapsed because special interests refused to admit that they are no longer so special?

Our Big Question: Why have the shareholders of Ford and GM not already paraded their boards of directors through the public square in an Auto Da Fe – barefoot and in hair shirts, wearing signs on their chests with their sins writ large as they march to the scaffold? Boards of Directors of public companies have an obligation not merely to the shareholders, but to the market. Perhaps the argument should be made from orders of magnitude, and we will not suggest where to draw the line, but clearly the Directors of General Motors exercise a public trust vis-à-vis the marketplace.

Underpinning the self image of American Capitalism is the notion of a Meritocracy. Americans believe that people attain success because they are smarter and more diligent than the rest of us. The Horatio Alger hero remains the paradigm of American success. Falling asleep at the switch is the definition of malfeasance by corporate directors. How can it be that there are not already trillions of dollars of lawsuits filed against these failed protectors of the shareholders?

The Wall Street Journal (Friday, December 12, page A2) reports the Bush Administration has redrafted the Endangered-Species regulations “to reduce the input of federal scientists”. Shades of the Creationist Administrator who prohibited NASA scientists from issuing their research conclusions. With the Bush Administration barring scientists from introducing their findings into the debate surrounding regulation on scientific topics, the current disarray in the TARP and Auto Bailout programs should come as no surprise.

It is easier to live within an income than without one.
- Alfred E. Neuman

The Friday print edition of the Financial Times comes with a fat glossy insert titled “Financial Times – How to Spend It”. The magazine urges us to spend large sums of money on luxury goods, to keep the spending engine primed. The rest of the world may be suffering, but we don’t have to suffer along with them. And if we don’t spend it here, the Chinese will get their hands on it. We are not making this up.

This week’s cover features the Indian Motorcycle Company’s new flagship model, the Indian Chief. We salute the ninja marketer that is promoting the ultimate in Ultimate Road-Driving Freedom Machines at the moment when American road-driving culture is in the process of committing ritual suicide – who says Detroit has learned nothing from the Japanese? This whole publication is an exercise in blatant consumption that is not merely conspicuous, but conspicuously excessive. The Prophet Jeremiah might call this Turning Desperately to Pleasures of the Flesh on the Cusp of Doom. Ayn Rand might call this Those Who Have Owe No Apology to Those Who Have Not – Go And Get Some For Yourself. Thucydides might call this: The Powerful Do What They Will, The Weak Do What They Must.

Our advice: spend recklessly, wisely. Life-styles in the mirror are more costly than they appear.

It is a mistake to think businessmen are more immoral than politicians.
- John Maynard Keynes

It appears that Bernard Madoff, head of the financial firm that bears his name, has spent most of his career producing nothing. Like the Old Testament unfortunate Onan, he threshed within, yet winnowed without, and spilled his seed upon the ground. Alas, the Wicked shall not prosper – Selah!

Our recollection of Bernie is of a middle-aged man – avuncular, yet with an edge. Part of his charm was that Madoff & Co. was a family business. Bernie had one heck of a business model, paying us to execute trades through him. The executing broker got paid, Bernie got paid, we got paid – clearly, Bernie was a genius. And Wall Street loves its geniuses. We can only speculate that Bernie could not countenance no longer seeing himself as a genius. Taking losses is financially costly. Being a Loser is unacceptable.

On Black Thursday – October 24, 1929 – Richard Whitney, Vice President of the New York Stock Exchange, made his famous Walk Across the Floor at 1:30 in the afternoon. The Dow Jones Industrials had tumbled from 305 down to 272, and everyone agreed Something Had To Be Done. Stopping at the post where US Steel traded, Whitney announced in a loud voice, “I bid 205 for 10,000 Steel!” Rejoicing was unrestrained, and floods of buying washed across the Floor – though the reprieve lasted only until Monday, when the market reasserted itself, culminating in Black Tuesday and The Crash of ’29.

At the time that the well-dressed Whitney was buoying the hearts of his comrades, no one knew he was personally on the brink of financial disaster. He was running his own business by illicitly pledging his customers’ shares to secure his personal loans. Because there is no worse fate than seeing oneself as a Loser. It all caught up with Richard Whitney, who ended up in prison. Will Bernard Madoff be the Whitney of our age? Those who do not learn from the lessons of history are doomed to do serious time.

Which brings us back to the debate about Government inefficiency, versus Capitalist efficiency. Governor Rod Blagojevich is accused of trying to peddle a Senate seat for one million dollars. (We note that certain public officials may want to practice a little Auto-Rewind and acknowledge that, in America, Governor Blagojevich is innocent until proven guilty.) Governor Blagojevich is 51 years old and may do serious jail time. Bernie Madoff has admitted to massive financial fraud and may end up sharing an executive suite with the Governor. Madoff, though, is 70 years old and, over the course of the decades during which his admitted fraud was in place, enjoyed the adulation of friends, the admiration of business associates, and the love of family. He also may have run through fifty billion dollars. The Madoff-Blagojevich equation argues that Business appears to be orders of magnitude more efficient after all.

The clear upshot of the Madoff scandal is a high-profile overhaul of the oversight of investment advisors. The news programs are full of references to the “Form ADV” – the document a Registered Investment Advisor files with the SEC. Madoff is an SEC-registered firm, and this failure of oversight is sure to be laid at the doorstep of the regulators. Nonetheless, we suspect that this event makes hedge fund regulation a Done Deal, in yet another observance of the ritual of blaming the Private Sector for the failure of Government. The furor surrounding this debate will make for good media, and the nation will generate both advertising revenues and entertainment. The Congressional pillorying of the existing regulatory structure, combined with the moral preaching surrounding the renewed effort to regulate hedge funds, will generate rivers of both Congressional sweat, and journalistic ink. Taken together with the working out of our nation’s terminal case of Auto-Eroticism, this should keep the American public distracted through much of the first year of the Obama Administration, by which time the American attention span will have suffered Crisis Fatigue that we will be glad to move on to new matters, leaving the current issues unresolved.

As the folks who put out “Financial times – How To Spend It” are aware, we always need something to titillate us. The thrill of spending money that we do not have is far preferable to us Americans to the notion of adjusting our life style to match reality. Or of seeing a regulatory process through to implementation and making sure it works. Witness those whose egos won’t allow them to be seen as Not Wealthy, as they rush out to buy $35,000 motorcycles. Witness the man for whom being Governor of the State of Illinois was not enough. Witness the man for whom being a major force on Wall Street and managing a $50 billion hedge fund were not enough.

America has invented a novel form of ritual suicide. The nation appears determined to spend itself to death. Anyone want to give odds?

Moshe Silver
Director of Compliance
Research Edge LLC

Keith R. McCullough
CEO / Chief Investment Officer

Quote Of The Week: Neel Kashkari ((Director of Treasury's Office of Financial Stability)

"We're not day traders, and we're not looking for a return tomorrow"
-Neel Kashkari (Director of Treasury's Office of Financial Stability)

After losing approximately $9B (as in billion), or 1/3 of the value implied in the so called “preferred investments” Neel and his investment banking mentor Hank Paulson made in structurally impaired banking businesses, we should send this guy back to business school. He wasn’t there very long ago – he’ll be cool with it.

Neel is what the real risk managers in this business call a “theoretical guy.” He has never traded a day in his life, and this is no environment for a rookie to be holding the panic button.

You see, Neel didn’t lose this money in one day – he and Hank “The Market Tank” lost it over the course of a month. Managing risk on a monthly basis is presumably a pragmatic strategy for someone in charge of “directing financial stability”; particularly if your boss is the Goldman guy who oversaw the build out of some of the most levered short term prop trading businesses that the world has ever seen.

Per Wikipedia, you’ll notice that Neel being unaware of how market’s trade really isn’t his fault:
“Prior to joining the Treasury Department, Kashkari was a Vice President at Goldman, Sachs & Co. in San Francisco, where he led Goldman's Information Technology Security Investment Banking practice, advising public and private companies on mergers and acquisitions and financial transactions. Kashkari has a Bachelor's and Master's degree in engineering from the University of Illinois at Urbana-Champaign and an MBA in 2002 from the Wharton School at the University of Pennsylvania.[2][1] Before enrolling in Wharton's MBA program, Kashkari worked for the aerospace firm TRW, where, amongst other projects, he worked on the James Webb Space Telescope.”

Neel has never traded a market with real capital. He has never managed real time risk. He wouldn’t know a trading return if he saw the opportunity to earn one tomorrow anyway. After losing $9B’s, his aforementioned quote is right on the money - I can guarantee you he will never be hired to “trade” anything.

This is all so sad and ridiculous all at once. Unfortunately for Mr. Paulson, American history will record his judgment calls for what they were – wrong. Hiring a junior Goldman banker to be his “yes man” when this country needed both perspective and proactive risk management most is what it is. Shame on you Hank.

We are looking forward to The New Reality; we are looking forward to new leadership at the US Treasury; we, like all Americans, are looking forward to earning a return tomorrow.

Keith R. McCullough
CEO / Chief Investment Officer

Chart Of The Week: "Re-Flate"

Proactively predicting what the US Federal Reserve and US Treasury will do has turned out to be fairly straightforward. The only way out of this financial mess is to either raise rates (which “Heli-Ben” doesn’t do) or let the US Dollar get hammered (which Hank is into these days).

If you want to crush your currency, the first thing you should do to your company or country is lever yourself up. Levering up America’s balance sheet is cool with Paulson. Don’t forget that after the SEC waived their leverage rules in 2004, Paulson signed off on levering up Marcus Goldman’s handshake. It takes a leverage banker with some serious experience to get this kind of stuff done folks!

Will there be consequences beyond John Thain not getting his bonus in 2008? You bet - one of the obvious consequences will be asset based inflation. The world has already learned how this works. Cutting rates to zero, allowed asset bubbles from Icelandic banks to San Diego real estate give a new meaning to the sound of the word “pop.” This time was more like “POP, POP… BANG!”

Never say never. Just when the mass media’s pervasive message is “deflation”, we are setting up to “Re Flate”. Our “Re-Flation” Investment Theme is an intermediate one, and while we think price inflation will appreciate on a far lower scale, what happens on the margin is what matters here. Directionally, this will matter to hard assets like gold just as much as speculative growth stocks on the Nasdaq.

See the chart below. This week we saw the US Dollar get pounded for a -3.7% week over week move, while Gold zoomed higher registering a +9% weekly move.

One week ago today, our accountability sheets showed you we were long gold and short the US$ via the GLD and UUP exchange traded funds.

Hank and “Heli” – thanks for the “Trade.”

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US Market Performance: Week Ended 12/12/08...

Index Performance:

Week Ended 12/12/08:
DJ (0.1%), SP500 (0.4%), Nasdaq +2.1%, Russell2000 +1.6%

DEC08’ To Date:
DJ (2.3%), SP500 (1.8%), Nasdaq +0.3%, Russell2000 (1.0%)

Q408’ To Date:
DJ (20.5%), SP500 (24.6%), Nasdaq (26.4%), Russell2000 (31.1%)

2008 Year To Date:
DJ (34.9%), SP500 (40.1%), Nasdaq (41.9%), Russell2000 (38.9%)

SP500 Levels Into The Close: BUY > 870

When trading action finds itself in a place like it is right here and now, our quant models flash a critical level that we call the Shark Line. This is the breakout/breakdown line where short sellers either get eaten or paid. I am on the bull side of this “Trade” right now. The pain trade is the higher one from here.

See the chart below. I have a major support line that is developing underwater at 836. If confirmed, the SP500 will have successfully made another higher low for this market’s recent trading cycle – that, on the margin, would also be bullish.

Don’t forget that “Heli-Ben” will be dropping free moneys from the skies at next week’s FOMC meeting. FREE money remains a bullish catalyst for any asset class that has the potential to “Re-Flate” – that includes your shorts.

Has American Confidence Bottomed?

On a morning where I woke up to a Wall Street billionaire calling his business a “giant ponzi scheme”, Bank of American cutting 35,000 jobs, and General Motors setting up to go away… other than making them stare at futures traders selling another panic bottom, what else can this brave New Reality throw at the American consumer’s confidence?

This morning’s University of Michigan Consumer confidence number popped out of its darkened hole, coming in at 59 (see charts), after bottoming in early November at 55. My bet here is that confidence continues to make higher lows alongside higher lows in the SP500. We spent the earlier part of this week buying stocks as American consumer confidence in Obama improved (over 70% of adults are either “hopeful, optimistic, or proud” of his becoming President per the Bloomberg/LA Times poll).

Stock markets are leading indicators. They build strength when confidence in them, on the margin, is improving. They break down when that confidence erodes. While there are plenty of reasons to be bearish (read the last year of my investment notes), most of these reasons are no longer a surprise. When the SP500 futures were down 4% pre-open, the stock market had already swan dived for a peak to trough 48% move. Sometimes it’s just priced into the market folks.

Today’s rally has to have the bears dizzied.

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