Is Government Intervention Working?

[Prieur du Plessis of Minyanville, commenting on the credit crisis:]
"The TED spread (i.e. 3-month dollar LIBOR less three-month Treasury Bills) is a measure of perceived credit risk in the economy. This is because T-bills are considered risk-free while LIBOR reflects the credit risk of lending to commercial banks. An increase in the TED spread is a sign that lenders believe the risk of default on interbank loans (also known as counterparty risk) is increasing. On the other hand, when the risk of bank defaults is considered to be decreasing, the TED spread narrows. Since the TED spread’s peak of 4.65% on October 10, the measure eased to 1.75%, but has since worsened to 2.10%.... In summary, although some progress has been made as a result of central banks’ liquidity facilities and capital injections, the credit markets are not yet thawing."

Obama Sees What Works, Sticks With It

The best thing George W. Bush ever did as President was to fire his Defense Secretary, Donald Rumsfeld, and to replace him with Robert Gates (above). This is, of course, faint praise, as it simultaneously brings to mind the worst thing that he ever did, which was to hire Rumsfeld in the first place. Dubya compounded that error by sticking with Rumsfeld for the first six years of his Presidency, making it impossible to recover during the last two.

Yet Gates did almost exactly that. Now expected to continue at Defense during the early months of the Obama Administration, Gates is a pragmatist who reminds us how capable and well-trained the American foreign-policy establishment really is. Our diplomats and strategists work best when not bound by an ideology that simplistically maps the world into good vs. evil. "Success," Gates offered in his famous "Soft Power" speech at K-State a year ago, "will be less a matter of imposing one's will and more a function of shaping behavior--of friends, adversaries, and most importantly, the people in between."

It could be that the Gates appointment was not actually Bush's idea, that he was grafted onto the Administration at the behest of a wise old guard of policymakers who simply could no longer abide rampant incompetence. Dubya has since demonstrated that he still capable of stifling reasoned debate and nuanced judgment; witness the resignation last spring of Admiral William Fallon as the head of U.S. Central Command in the Middle East. Fallon, incidentally, states in a recent Boston Globe interview that the war in Iraq is "essentially over." Perhaps Gates was able to clean up Rumsfeld's mess after all.

Jobs are Going, Going...GONE!

Unemployment is in the eye of the beholder. This chart depicts three views of the unemployment rate in the U.S. over the past fifteen years. The rosiest scenario, naturally, is the line in red (so-called U3), which shows unemployment currently running at a little over 6%. U3, however, does not count workers laid off in the past year who have become too discouraged to look for a new job. Add those workers into the mix, and you get the U-6 calculation (in gray) of almost 12%.

Now, there is another segment of the labor pool, those discouraged workers who have been jobless for more than one year. These the Labor Department simply ignores. Youz guys don't exist. Add them back in, and now you're talking 16% unemployment (blue). With this figure likely surpassing 20% in 2009, get ready for more talk about the Next Depression.

In the River Valley, baseline unemployment has climbed past 8%, and the news is getting worse. The region's biggest employer, the NewPage coated-paper mill in Rumford, has just announced nearly a month of downtime for its #15 machine. Beginning December 8, at least 250 workers will be temporarily laid off--nearly one-fourth of the mill's workforce.

[update, December 5:]
This morning brought the Labor Department's monthly employment report, and the numbers are abysmal. 533,000 jobs were lost in November, the largest monthly slide since 1974; the loss in October was revised from 240,000 to 320,000. The total for 2008 now stands at 1.9 million jobs lost. The "official" unemployment rate (for what it's worth) ticked up from 6.5% in October to 6.7% last month.

Falling off a Cliff

Copyright 2008 The Boston Globe

2008 AL MVP

Red Sox 2B Dustin Pedroia

Hall of Shame

The Magnificent Seven, Wallywood-style. Combined, these CEOs pocketed nearly $1.5 billion over a five-year period while steering their companies to tens of billions in losses and, in some cases, to oblivion. Tens of thousands of employees have lost their jobs. However we revamp our tax code, the rewards to companies should be for jobs created, not for jobs destroyed. Such concentration of wealth as displayed above has throughout human history been a portent of societal stress, often to the breaking point.

When Charts Go Parabolic, Change Is Imminent

The Federal Reserve's balance sheet has more than doubled in the past six weeks, from less than $1 trillion to almost two. Richard Fisher, the president of the Dallas Fed district bank, predicted this morning that another trillion will be added before year's end as the U.S. Treasury cranks out government bonds to pay for the bailout of Wall Street banks. The Fed, in turn, has been swapping Treasuries for mortgage-backed securities and other tainted collateral to try to thaw credit markets.

So let's get this straight. We, the taxpayers, are borrowing money that does not exist to liquefy banks that should be allowed to fail. We pay interest over a long period of time to provide this service. If we try to retire the debt early, we will be paid back in toxic securities. The fallout from all this financial legerdemain will be a devalued dollar, which rewards borrowers and punishes savers. (Watch the price of gold for hints about future inflation.)

Thanks, Congress.

Here Comes the Cavalry

Your paycheck is in the mail, thanks to Monday's roll-out by the Federal Reserve Bank of short-term financing to some of the nation's biggest businesses. The Fed's intervention is illustrated by the spike in the chart above. The issuance of 90-day commercial paper surged ten-fold, with the Fed committing over $60 billion in a single day. The money will help companies meet payrolls and replenish inventories.

"Of all the things the Fed has tried this year," writes Minyanville's Charles Payne, "I believe this is the smartest. Payrolls have to be met, and cash has to flow into coffers if businesses are to forge ahead in a tight credit environment."

Which Is the Party of Big Government?

Copyright 2008 The Boston Globe

Dear Senator Collins

Message just e-mailed to Senator Susan Collins (R-ME):

Please vote AGAINST the bailout bill to be voted on by the Senate this evening. The TARP will add to the mountain of debt being prepared for our kids and grandkids. It will protect entities that deserve to fail. It will saddle the taxpayer with assets that cannot be valued and may be essentially worthless. It will accelerate the process by which the national debt will be monetized, penalizing savers and crushing folks on fixed incomes. The debt needs to be destroyed instead.

Purveyors of panic insist that a bill is necessary to avoid financial armageddon. For the average American, the worst thing that will happen with no TARP is that he will lose his credit card. The other bad outcomes--loss of jobs, mortgage defaults--are baked in already. The bill cannot stop these.

A vote FOR the bill condones a radical power grab by the moneyed elite and condemns the middle class to indentured servitude for generations to come.

TARP in Trouble

Our Salesman-in-Chief is pushing this latest bailout plan hard, but Congressional leaders may not be able to bring along the rank-and-file, who are getting bombarded with messages of outrage from constituents. With the general election just five weeks away, congressmen running for re-election are going to have a hard time ignoring those messages. Voters have short memories, but not that short.

The proposed "Emergency Economic Stabilization Act of 2008" will require an initial outlay of $250 billion (with another $100 billion at the President's immediate disposal) to fund a Troubled Asset Relief Program (TARP). Once the Treasury Secretary burns through that, he has access to another $350 billion unless Congress votes to withhold it. TARP funds will be used to buy impaired securities for future resale, hopefully at higher prices. Only when TARP has sold all its inventory will taxpayers know the true cost of the program.

It's not like Congress actually has the money. One provision of the new bill is to raise the Statutory Limit on the Public Debt (the so-called debt ceiling) to $11.315 trillion. This will make it legal for us to borrow and spend even more. And it's not like the $700 billion of borrowed money is going to be enough, either, with tens of trillions of dollars worth of illiquid assets looking for a home. So what's the point?

According to erstwhile presidential candidate Ron Paul, the mission is "to prevent the liquidation of bad debt and worthless assets at market prices, and instead [to] try to prop up those markets and keep those assets trading at prices far in excess of what any buyer would be willing to pay." In other words, government will be in the price-fixing business, last attempted with little success during the Nixon Administration. Distressed securities for which there are no bids will be marked to maturity. (I call it marked-to-mandate.) Recent regulations requiring mark-to-market accounting by investment firms may be rolled back: "The Securities and Exchange Commission shall have the authority under the securities laws...to suspend, by rule, regulation, or order, the application of Statement Number 157 of the Financial Accounting Standards Board."

Recalcitrant lawmakers on Capitol Hill have formed a "Skeptics Caucus" out of concern that the government will overpay for troubled assets. Convening the caucus a week ago, Rep. Brad Sherman (D-Calif.) proclaimed, “this is greatest shift of power to the imperial presidency and the greatest shift of wealth to a still wealthy Wall Street that anyone could imagine.” The Skeptics cannot be reassured by the present bill, which leaves it to Treasury Secretary Hank Paulson to develop TARP guidelines, including "methods for pricing and valuing troubled assets" and "criteria for identifying troubled assets for purchase." The Secretary is furthermore authorized to make "direct purchases" of assets where "use of a market mechanism...is not feasible or appropriate."

The Secretary's new job, thus, is to create a market where none exists and a price structure that fortifies financial-sector balance sheets under severe pressure since marking to Merrill. And he needs to broadcast the results with all the gusto of a carnival barker. "To facilitate market transparency," the bill reads, "the Secretary shall make available to the public, in electronic form, a description, amounts, and pricing of assets acquired under this Act, within 2 business days of purchase, trade, or other disposition." The goal is to alter perception in the marketplace, to entice private bidders back into the pool.

If private capital remains on the sidelines, the Paulson Plan will go up in smoke.

Merrill, Lehman Are Goners

While most of us got to watch football this weekend, government officials and bank executives had to work overtime in the Big Apple to address the ongoing, ongrowing credit crisis. For those folks, seven-day work weeks are now the norm. Their task is to shuffle assets in a way that will assure investors that (a) they know what they're doing and (b) what they're doing will work. If the answer to either question is "no," financial markets will crash.

Last week came the announcement that Fannie Mae and Freddie Mac will be bailed out by U.S. taxpayers. The news this morning is that Merrill Lynch and Lehman Brothers will cease to exist: Merrill is being taken over by Bank of America, while Lehman is filing for Chapter 11 bankruptcy protection to allow more time for liquidating assets. Treasury Secretary Hank Paulson, apparently of the opinion that taxpayers have done their part, is holding firm for a private-sector workout. Meanwhile, the Federal Reserve (privately capitalized, remember) stands ready to lend funds to other troubled firms (think AIG). Trouble is, the Fed's firepower has already been cut in half year-to-date.

Merrill's demise is no surprise, as vultures have been circling since February. What is a surprise is the price that Bank of America is paying: $29 a share, or 70% higher than Merrill's stock price at the close of Friday's trading. (Too high, traders are saying this morning, as BAC is down five in the pre-market.) In a similar move last March, JPMorgan Chase got Bear Stearns at a substantial discount. So why the premium now for Merrill? In all likelihood, the Fed forced the deal. It remains to be seen whether BAC shareholders can be forced to approve the deal.

A stock-market rout is a distinct possibility today, but it is the price that must be paid for future economic recovery. The bad actors in the false prosperity of the past decade must be allowed to fail. Unfortunately, we will all share the pain in the years ahead. As market strategist Mike O'Rourke observes, "The problems will be the reverberation throughout the economy as access to capital becomes even tighter than it already is. It appears that the amount of de-levering the market is about to encounter in coming months will likely outweigh the benefits of last week's GSE program."

[update, Sept. 17--]
With Merrill Lynch saved from bankruptcy, will the firm satisfy Maine's claim to funds invested last year in MainSail II? A check of the Maine Treasurer's website reveals that the issue was resolved three weeks ago. Merrill has agreed to pay back the $20 million.

Latest on Lehman

After yesterday's bloodbath, in which the common stock of Lehman Brothers declined in value by 45% in a single day, company executives feverishly accelerated their quarterly report by a week. Originally scheduled for next Wednesday, third-quarter earnings were released this morning instead. The news was worse than expected: a loss of nearly $4 billion and a mark-to-Merrill write-down of twice that on its inventory of mortgage-backed securities.

Lehman announced several steps to repair its balance sheet. It cut its quarterly dividend from 68 cents to a nickel (should have been done a year ago) and disclosed plans to sell a majority stake in its investment-management business (good luck--the Koreans just walked away from a possible deal). There was also talk of spinning off its commercial real-estate portfolio into a separate, publicly traded company, but that's just a shell game, no value added. All this is to "reposition" the firm, according to the CEO, who must not be comfortable with the current position of prostrate and tire-marked.

The hastily arranged conference call was meant to prop up the stock price, which briefly exceeded $9 a share in the pre-market as short sellers cashed in. An hour into the regular trading session, the stock has settled back to 8, down 85% in the past year. If the Mac'n'Mae takeover by the U.S. Treasury earlier this week is any indication, the shares are on their way to zero. Another bad omen: the yield on Lehman's two-year paper is going through the roof. The firm will be unable to roll over its debt as a stand-alone entity.

[update, Sept. 11, 8:15 a.m.--]
LEH is getting crushed in today's pre-market, trading near 5.

[update, 15 minutes later--]
Make that 4. Sounds like a launch-pad countdown!

[update, Sept. 12, 8:15 a.m.--]
Now trading with a 3 handle.

[update, Sept. 15, 7:00 a.m.--]
Now less than a buck, as the company files for Chapter 11 bankruptcy protection.

A U.K.-based newspaper, The Observer, reported yesterday that Richard Fuld, CEO at Lehman Brothers Holding Inc., is slowly but surely being relieved of his duties. "His credibility is shot," a senior source within Lehman is quoted as saying. I suggested back in March that Dick should have his parachute ready. Fuld bought time in June by allowing his Chief Financial Officer and Chief Operating Officer to be sacked, but that is all it is, a matter of time.

[update, August 29--]
The Wall Street Journal is reporting that Lehman will lay off between 1,000 and 1,500 employees, or about 6% of its workforce. Other than that, business is good.

Back from Baxter S.P.

If I am alone in the woods, do I hear the trees falling on Wall Street? The quick answer is "hell, no"--which is precisely the point of our annual pilgrimage to South Branch Pond Campground. No TV or radio, no e-mail, no phone calls. Just roll out of our sleeping bags at dawn and climb above treeline in the crisp morning air, far from the madding crowd. Saunter back to the campground in the late afternoon and slow-fry some quesadillas. Maybe go for a paddle after supper to check out the loons at the far end of the pond. Life is simple and sweet.

Still, I know the trees are falling. They were falling before we left and are not yet done falling. While we were gone, Lehman Bros. tried to sell itself to the Asians, who are holding out for a better price. They just might get it. Meanwhile Merrill Lynch, Goldman Sachs, and Deutsche Bank became the latest investment firms to fess up to government regulators. They agreed to buy back auction-rate securities that had been improperly peddled to clients earlier this year. The industry-wide tally has reached $50 billion in buybacks and over half a billion in fines. Finally, Fannie and Freddie came ever closer to issuing super-senior debt to taxpayers like you and me. Even though we don't want it.

From the top of Bald Mountain (there is no trail, so we had to bushwhack) could be seen the winding course of the East Branch of the Penobscot, the riverbanks finely tinged with crimson in an otherwise broad green expanse, the first faint traces of autumn. Much wider and deeper runs the red ink on Wall Street.

Updates: Following the Money

The window is closing on Seth Carey's casino. This morning's Boston Globe is reporting that two North Shore racetracks, Suffolk Downs and Wonderland Greyhound Park, are combining operations, perhaps with the goal of launching "a premium resort-style casino." This is bad news for Rumford lawyer Carey and his envisioned Evergreen Mountain Four Season Resort & Casino in Oxford County. With gaming revenues stalling nationwide, Carey's only chance for a viable enterprise rests on further delay in Massachusetts, where Governor Deval Patrick supports the idea of casino development. Mainers are still waiting for details from the Evergreen campaign regarding exact location and investor support.

Wall Street banks raise money any way they can. Desperate for cash, Merrill Lynch is expected to cut its dividend to shareholders by at least half. This long overdue step would be a first (Merrill has never cut its dividend since it became a public company in 1971) and follows the company's announcement two weeks ago that it sold a tranche of mortgage-backed securities at a huge discount to face value. Meanwhile, Lehman Brothers is selling off a third of its commercial real-estate assets, three-quarters of which are mortgages sure to be be discounted.

But the money keeps going out faster than it comes in. Last week Citigroup and UBS joined Merrill in agreeing to buy back auction-rate securities sold to retail clients earlier this year. Combined price tag: $40 billion (and climbing, as JPMorgan Chase and Morgan Stanley have just settled). For pushing ARS, several of these firms have been fined by government regulators to the total tune of $200 million. And the write-downs for mortgage-backed securities are never-ending. J.P. Morgan revealed in a 10-Q filed Monday with the SEC that its collateralized debt lost $1.5 billion in value just in the past month. That's 75% of the firm's second-quarter profit--gone.

MDOT puts pavings projects on ice. Apparently $105 million does not go as far as it used to. The Maine Department of Transportation originally planned to pave 825 miles of the state's roads in 2008. But with the price of liquid asphalt jumping 150% since January, the Department is going to come up 85 miles short for the money budgeted.

The news has Peru residents patting themselves on the back. In 2007 the Town voted to borrow $400,000 to address a backlog of local road projects. At the time there was no competition for contractors from the state, which had placed a moratorium on paving projects pending the results of a bond referendum. Peru's timing looks even better now that paving costs have skyrocketed, easily justifying the borrowing costs of the ten-year loan from the Maine Bond Bank.

Living to Tell the Tale

Taking the time to refresh a blog becomes a challenge when the outdoors beckon. August in Maine is about as good as it gets, and the blueberries this year on Whitecap are just plain ridiculous. Yesterday my wife and I were scooting up the mountain yet again when we met an elderly gentleman descending, in one hand a trekking staff and, in the other, a four-quart basket filled right to the top with plump blueberries.

This was David Worcester of Hanover, and we got to chatting. David told quite a story of a tragic incident on Whitecap 49 years earlier, when a party of berry-pickers, himself included, got zapped by lightning near the summit. All were stunned; one was killed. Photos of the expedition are posted at David's website.

What Merrill Means for MaineFail

When a shaky investment falls in value while no one's looking, does it still make a sound? Answer: only when it's time to sell. Earlier this week investment bankers up and down Wall Street began complaining about some serious ear-ringing at the exact moment that Merrill Lynch announced an impending sale of impaired assets at 22 cents on the dollar.

The mortgage-backed securities on Merrill's balance sheet are on everyone else's, too. Ever since the credit crisis began last August, there has been a tacit code of silence among the players: whatever you do, don't let on as to what these securities are really worth. Write these down gradually, a few billion this quarter, a few more the next. What we need is time to wriggle our asses, sorry, assets out of this mess.

Merrill has broken that code. (You may now cue up the Chambers Brothers' "Time Has Come Today--TIME!") Thanks to Merrill, there is now a market to which these assets can be marked, triggering massive write-downs throughout the industry. "Merrill Lynch converted its mark-to-market losses into permanent ones," noted investment strategist Ed Yardeni in an e-mail to clients Tuesday. "This is bad news for other investment banks and commercial banks trying to get rid of loans and securities in a market flooded with distressed assets."

Which brings us to Maine's failed investment in MainSail II. Yesterday Maine's Treasurer, David Lemoine, posted an update on the State's cash pool. Because accounting rules required a "valuation snapshot" of the MainSail investment on June 30, or fiscal year's end, consultants used their magic dartboard to come up with 33 cents on the dollar. That meant that Maine's cash pool was showing an unrealized loss of almost $13.3 million on that investment. But that was then. If we mark to Merrill, not to magic, we are looking at a paper loss in excess of $15.5 million on an initial investment of $19.9 million.

Let's keep going. Remember that Merrill accepted only 25% down on the sale of the CDOs, or 5.5 cents on the dollar. The loan of the other 75% is secured only by the CDOs themselves, which means that Merrill will get them back if they decline in value by another 25% from here. If you use the down payment as the real market value of such securities, then MaineFail's loss balloons to $18.8 million. Why does it suddenly sound so loud in here?

Lemoine's capsule summary is as good as any. "The market estimate confirms that the U.S. housing market and the worldwide credit markets continue to suffer, and that investors continue to shy away from mortgage-backed investments regardless of their underlying value. The arrival of a bear market on the equities exchanges, ongoing huge bank write-downs, relentless energy prices and inflation fears have stifled investor appetite for fixed-income instruments such as Mainsail II."

Will Merrill's Bungee Break?

Shell-shocked shareholders got more bad news from Merrill Lynch last night when the company announced the sale of new common stock in a desperate attempt to stay afloat. The number of shares outstanding will increase by one-third, a painful dilution that compounds the injury of depreciation. Merrill's stock price has declined by three-fourths in the last eighteen months (and is still over-priced, according to Oppenheimer's Meredith Whitney).

This latest stock offering is supposed to raise $8.5 billion, but don't count on shareholder equity increasing by that much. Merrill will turn around and give $2.5 billion of that to its largest investor, a Singapore-owned sovereign fund, as compensation for losses suffered on an earlier stock purchase. Merrill now expects a third-quarter write-down of nearly $6 billion. So the "new" $8.5 billion is basically gone before it even comes through the door.

CEO John Thain, who has been on the job for less than a year, inherited this mess and so can be spared much of the blame. Still, he has been slow in gauging the depth of the doo-doo. In April he remarked that "we have plenty of capital going forward and we don't need to come back into the equity market," and less than two weeks ago he reiterated that "we are in a very comfortable spot in terms of our capital." Further damaging Merrill's credibility is the liquidation, also announced last night, of over $30 billion worth of collateralized debt obligations at a discount of nearly 80%, a markdown that should have been booked long before now. "Why these assets are written down when you're selling them and weren't written down in your earnings is a question," observed one research analyst.

How toxic are these CDOs? Merrill was forced to finance 75% of the sale price--i.e. they practically gave 'em away. Since the financing is secured only by the assets sold, Merrill will be on the hook if the CDOs decline in value by another 25% or more. The firm had tried to hedge against such depreciation through guarantees purchased from bond insurers, but those insurers are facing insolvency themselves. Merrill is currently trying to extract termination fees from these insurers and managed to collect $500 million from Security Capital Assurance.

What times we live in that such an iconic franchise has to search between the sofa cushions for whatever loose change it can find.

A Mixed Bag

Will the U.S. Senate smooth out the kinks? The mortgage-relief bill passed by the House on Wednesday has some noble objectives. It seeks to protect hundred of thousands of homeowners from foreclosure and to extract concessions from lenders who floated risky mortgages built to fail. It favors owners of modest means who actually occupy their homes while leaving speculators in pricier properties exposed to market discipline. It creates loan-loss reserves funded by exit fees from relieved lenders and insurance premiums from relieved borrowers. It stiffens disclosure requirements for lenders and mandates a seven-day waiting period between the delivery of mortgage documents and closing. These are all good.

Now for the bad and the ugly. Yesterday I penned my disgust with the GSE bailout. Not only has the Treasury Department been given a blank check for loaning backup to the terrible twins, Fannie Mae and Freddie Mac, but it is not even required by law to demand the most senior position among lenders to these entities. This feeds the suspicion that the bill is intended to prop up Fannie and Freddie's debt (to the debtholders' benefit) as much as it is to rescue borrowers from sky-high mortgage payments.

Other flies in the ointment:

A one-year moratorium on risk-based pricing for FHA-insured loans. The Federal Home Administration is a government program that actually works. It helps mortgage borrowers with weak credit or little upfront cash, and it does so without costing taxpayers money. Congress wants the FHA to insure another $300 billion in home loans, almost doubling its exposure, while preventing it from charging high-risk borrowers extra. Said FHA Commissioner Brian Montgomery at a hearing this spring, "the FHA should not be forced legislatively to compromise its fundamental [lending] criteria at the future expense of the taxpayer." Sorry, Brian, consider yourself forced.

A tax credit for first-time home buyers. This obviously departs from the main mission of rescuing borrowers trapped in unaffordable mortgages. At the same time that the House bill insists on adequate down payments for refinanced loans, it offers to cover (up to $7,500) the down payments of new borrowers with 15-year interest-free loans. These are taxpayer-funded teasers, all risk and no return--a desperate attempt to chew through the housing glut while possibly ensnaring a new generation of distressed borrowers.

A permanent increase in conforming loan caps. Remember that back in February the economic stimulus package passed by Congress temporarily raised the limit for a Fannie or Freddie loan. The new bill makes the increase permanent, from $417,00 to $625,000. Again I ask, how does this help low- and middle-income homeowners? The new cap serves only to restore liquidity and prop up values in the high-end market, where borrowers should have known better.

[update, July 30--]
The National Association of Home Builders admitted in a statement today who benefits most from the temporary tax credit for first-time buyers: "the tax credit will stimulate home buying, reduce excess supply in housing markets and shore up home prices." In other words, the ones who over-built in the first place get to hawk their inventory (buyer-assistance courtesy of the American taxpayer) before prices crash completely.