TED Spread Narrows, But Not Enough

We are making progress, but this spread needs to shrink another 100 basis points to return to where it was before credit markets started to tank in August 2007. With three-month Treasuries yielding close to zero, this remains an elusive target.

Sales of USED Cars Are No Better

With new-car sales dropping dramatically, we are left to wonder if value-conscious consumers are migrating in greater numbers to the used-car market instead. Not so, according to the chart above, which shows that the supply of used cars is outstripping demand. Wholesale used-vehicle prices fell by over 11% just in the two-month period from September 1 to October 31, as unit sales plunged by 16.5% in September and another 19.7% in October (source: Manheim Consulting).

The number of used cars sold annually in the U.S. far exceeds the number of new cars. In 2007 41.4 million used vehicles (passenger cars and light trucks) were sold, triple the number of new vehicles (13.7 million). So weakness in the used-car market is a good indicator of how the average American consumer is struggling. It is expected that in 2008 1.6 million repossessed vehicles will be added to the inventory of used cars for sale.

Defaults on auto loans will likely increase in 2009, as declining used-car prices make it more difficult for distressed borrowers to extricate themselves. For them, the most economic course of action comes to suspending payments and sparring with the repo man.

GM V-P Lutz: "Market Collapse"

U.S. Auto Sales, 1995-2008

Thanks to Alan Greenspan's easy money, American consumers glutted themselves on automobiles over a ten-year period. By 2006 there were 1.2 registered vehicles in the U.S. for every licensed driver. Think about that for a minute. If every licensed driver got in a car and hit the road at the same moment, that would still leave over 40 million cars sitting idle in garages and driveways. Going way out on a limb here, I will suggest that we need no new cars right now. Those parked cars represent at least a three-year supply.

That is not even counting unregistered new and pre-owned inventory on dealer lots, which are plumb full. In fact, finding a place to store new vehicles is getting to be a problem. "We are seeing cargo buildup at ports of entry on both coasts as well as at other inventory points such as factories and rail yards and dealerships," said Christopher Connor of Wallenius Wilhelmsen Logistics. Pretty soon unsold cars will be floating at sea on drifting container ships, alongside the ones with excess crude oil and the barges hauling solid waste to nowhere in particular.

As we exit 2008, we are selling cars in the U.S. at an annualized rate of 10.5 million. Most estimates for 2009 fall in the range of 11-12 million units. Robert Lutz, former product guru at Chrysler and now Vice-President for Global Product Development at General Motors, said in a Fox interview earlier this week that at these run rates, there is "no viability for the domestics, no viability for the Japanese, no viability for the Germans." The $15 billion now being offered by congressional Democrats to the Big Three is merely a "short-term liquidity measure" that "gets us to the next Administration." His characterization of 16.5 to 18 million units as "normal" may be a bit disingenuous. If that is what he thinks is necessary for Detroit's survival, get ready for some bankruptcies.

[update, December 12:]
GM announced today that it will reduce Q1 (2009) production at its North American plants by 250,000 units. The announcement came just ten days after it had projected Q1 volume of 600,000 units, which, if we do the math together, means a revised expectation of 350,000. A year ago GM was producing over 1 million units per quarter and losing money doing it. GM's 8.375 percent bonds due in July 2033 are now trading at 15 cents on the dollar, effectively yielding 57.6 percent--which tells you what bond traders think of GM's long-term prospects.

[update, December 22:]
Toyota announced today that it will lose money for the first time ever in its fiscal year ending March 31. Sales for the year are expected to decline 18% to 7.54 million units worldwide (2.17 million units in the U.S.). Last week Honda said it expected its U.S. car sales for the year to fall 14 per cent to 1.59m units. "When the American car market shrinks to 11m vehicles," points out Koji Endo, industry analyst at Credit Suisse, "no one is going to make money.”

[update, January 15, 2009:]
GM today cut its estimate for 2009 U.S. industrywide auto sales to 10.5 million units, which, if accurate, would be a "disaster," according to consultant John Casesa. “It’s a level of demand that is far below Detroit’s break-even point.” GM needs to submit a viability plan to the U.S. Treasury by March 31--or else give back the $13.4 billion in emergency loans released, not by Congress, but by the Bush Administration.

Wait, Don't Tell Me: A Vegetarian Stir-Fry?

Copyright 2008 The Financial Times

Wrong answer. Renminbi literally means "people's currency." Until July 2005 the renminbi, issued by the People's Bank of China, was worth about 12 cents American. This was a favorable exchange rate for the Chinese, who have been exporting like crazy to the rest of the world and have amassed a trade surplus with the U.S. that now exceeds a quarter of a trillion dollars annually, not exactly lunch money.

Since 2005 the renminbi has been allowed to float (slowly) against the dollar and has appreciated over 20% in three years (see graph). As far as the Bush Administration is concerned, that trend is our friend because it prices American-made goods more competitively. Chinese authorities, on the other hand, are not wild about it, and this week they seem to be signalling that they have had enough. On Monday the renminbi dropped out of a narrow trading band and fell by 0.73 per cent.

So most Americans are thinking, "Who cares? I don't like stir-fry anyway." They should care. Dubya cares. He's got his Treasury Secretary, Henry Paulson, over in Beijing right now trying to sweet-talk the Chinese into sticking with the "reform process." Truth be told, China is experiencing an economic slowdown just like everyone else, and displaced workers are rioting in the south. Government officials would like to keep the lid on, and a weakening currency is one way to do it.

If speculators (remember them?) smell blood in the water, things could quickly get out of control. A rapid devaluation of the renminbi is in no country's best interests. Among the domino consequences would be devaluations of other Asian currencies as well as protectionist measures in the West. To defend its currency, China would have to start dumping U.S. Treasuries, driving up interest rates and exacerbating our own recession. And if we can no longer borrow from the Chinese, how are we gonna pay for all these bailouts at home?

Let's face it, the Chinese are now calling the shots. They are choking on U.S. debt and do not want the U.S. trying to inflate its way out of the current credit crisis. Zhou Xiaochuan, the Governor of the People's Bank of China, lectured Paulson earlier today. “Over-consumption and a high reliance on credit is the cause of the U.S. financial crisis,” Zhou said. “As the largest and most important economy in the world, the U.S. should take the initiative to adjust its policies, raise its savings ratio appropriately and reduce its trade and fiscal deficits.” Translation: Don't expect us to clean up your mess. No sooner were the words out of his mouth than Zhou hopped on a plane to Washington, D.C., for a Group of Thirty (G-30) meeting, at which incoming Treasury Secretary Timothy Geithner will surely hear the same message.

My fellow Americans, get ready for a lower standard of living in the coming years.

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.

When Is a Bailout Not a Bailout?

When the President says so. "I don't think it's a bailout," insisted George Dubya last week as Congress was putting the finishing touches on a bill that would provide a financial backstop for mortgage lenders Fannie Mae and Freddie Mac. The President's reasoning? "The shareholders still own the company."

The Prez seems confused on two points. First, when he said "bailout," he probably meant takeover. After all, a major criticism of the mortgage-relief package is that it would be the first step toward nationalization of Fannie and Freddie, a government takeover of two distressed companies that cooked the books and rewarded top executives handsomely while taking on huge risk. Gains were privatized; losses will be socialized. Such an outcome must not sit well with our Capitalist-in-Chief.

Make no mistake, the owners are getting bailed out. The bill passed by the House of Representatives yesterday enables the Treasury Department to extend an unlimited line of credit to Fannie and Freddie. This obviously adds value to the franchises; witness the tripling in share prices in FNM and FRE over the past two weeks. If it walks and talks like a bailout, it must be one.

And it might, in the end, be a takeover as well--the other point of Dubya's confusion. Not only will the U.S. Treasury lend boatloads of capital to the GSEs, but it will buy their stock (or accept it as collateral for the loans). You might call it the Paulson Put, a taxpayer-funded option that protects shareholders from further downside. Republicans are choking on the idea, but heck, it's an election year. Besides, the President at the last minute has changed his mind about a veto, a sign that confusion and desperation reign supreme.

Mama Merrill!

Make it four consecutive quarters of red ink for Merrill Lynch, which reported Q2 earnings last Thursday. Did I say earnings? I meant losses, which have piled up to $19 billion over the past year. It took the investment firm four years to earn that much money--and only one to watch it go poof!

Write-downs for impaired assets came to almost $10 billion for the quarter, or over $40 billion since a year ago. To raise cash, Merrill sold its 20% stake in Bloomberg LP for $4.4 billion and its controlling interest in Financial Data Services for $3.5 billion. For now it is retaining its 49% stake in asset manager BlackRock Inc., but expect that one to go by the end of 2008. Merrill must liquidate, as it is simply no longer able to raise new capital. The window is closed.

Reporting the same day, executives at the nation's largest investment bank, Citigroup, were doing fist pumps. They lost only half as much as Merrill and only half as much as they had the quarter before. Progress! Still, over $7 billion in write-downs were taken, bringing the overall total to $40 billion since the credit meltdown began last August. If this keeps going, we'll soon be talking about some serious money.

Bay State Blues

State government in Massachusetts is running on fumes, finally cobbling together a budget two weeks into the new fiscal year. Presented with a $28.2 billion dollar budget, Governor Deval Patrick attacked it with a rusty jackknife, whittling away $122.5 million in earmarks. "We've got to prepare now for economic troubles ahead," Patrick said at a signing ceremony yesterday. "Our present circumstances demand increased restraint." Credit the governor with facing up to the new reality.

The budget takes half a billion from the Commonwealth's rainy-day fund and tacks on a buck to the cigarette tax. Even so, the business-funded Massachusetts Taxpayers Foundation foresees $1 billion of red ink in 2009, with capital gains tax revenues drying up and federal healthcare reimbursements falling short. Patrick himself realizes that more cuts may be needed, and he has asked lawmakers for the same authority to make mid-year cuts that was accorded Governor Mitt Romney in 2003. "Granting that authority now, before the end of the legislative session," said Patrick, "enables us to respond quickly and responsibly in the event of a serious downtown."

Troubles? Downturn? It appears that longtime economic adviser Rosy Scenario has been given the pink slip.

Phil 'er Up

Don't worry, be happy, says former senator Phil Gramm in a newspaper interview appearing Wednesday. Easy for him to say. He's already got his, having parlayed his political experience into a vice-chairmanship at Swiss banking giant UBS. Serving as John McCain's top economic adviser, Gramm insists that all this talk about America in decline is just that, talk. "Misery sells newspapers," he scoffs. "We have sort of become a nation of whiners. You just hear this constant whining, complaining about a loss of competitiveness."

O.K., let's check the headlines for the past 48 hours. GE to sell Japan unit to Shinsei for $5.4 billion. Citi to sell German retail unit to Credit Mutuel for $7.7 billion. Merrill may get $5 billion for Bloomberg stake. Earlier this spring Bear Stearns sold itself to JP Morgan Chase, and Lehman Bros. is next. Folks, this implosion in American finance constitutes the biggest yard sale in human history, and Gramm says that it is all "mental?"

To his credit, candidate McCain has distanced himself from Gramm's remarks. Meanwhile, Mr. Consumer, please ignore the four-dollar gas, the ten-dollar mozzarella, the pink slip, and the eviction notice. You are only imagining those things.

The Future of Gaming in Maine?

Build it, but will they come? Maybe not, if the chart above is to be believed. While the new Hollywood Slots opened with considerable fanfare this week in Bangor, less attention has been paid to the sliding stock price of the parent company, Penn National Gaming, Inc. Notice the 50% haircut since the first of the year. Investors are apparently worried that revenues will dry up in the current recession.

Yesterday a leveraged buyout of Penn National was called off. The original offer, announced in June 2007, was $6.1 billion, or roughly three times annual revenues. This translated to $67 a share, a 30% premium at the time. The day after the announcement, PENN shares gapped up about ten bucks. But that was the high-water mark. In August credit markets began to implode (that was when MaineFail defaulted, remember?), and by mid-January PENN had retreated to its pre-offer price.

By the one-year anniversary of the offer, the deal had still not closed. Investors, sensing that the LBO partners wanted better terms, began dumping the stock, which got a one-third discount in just two weeks. Now the buyers have walked away, although it will cost them to do so: a termination fee of $225 million, plus the purchase of $1.25 billion of preferred stock with no guaranteed dividend before the 2015 redemption date. That adds up to a $1.475 billion cash infusion for Penn National, which says that it will pay down debt and repurchase stock. Oh, and if there is anything left after that, they might expand their business--maybe.

As Maine voters go to the polls on November 4, they should realize that the gaming industry is in trouble. Call up any stock chart you want. Pinnacle Entertainment was trading at 35 in February 2007; now it is under 10. Over the same period, Isle of Capri Casinos has gone from 30 to under 5. MGM Mirage, trading for 100 as recently as last October, is now under 30. It can be assumed that insiders are among those jumping ship.

Will the anonymous backers of the proposed Oxford County casino be the next to walk?

[update, July 10:]
The stock price of MGM Mirage fell another 22% to 23 today following news that Nevada's gambling revenue fell 15% in May. The drop-off was even more precipitous in Las Vegas, where "the decline in Strip revenues is worse than the period immediately following Sept. 11, 2001," according to a UBS analyst. Revenues away from the casino floor are also under pressure, forcing reductions in flights and room rates.

THIS Will Get Their Attention

UBS, pronounced oops. Last month UBS Financial Services bought back auction-rate securities valued at $37 million that had been previously sold to 17 Massachusetts cities and towns (see May 8 post, "Pain in the ARS"). At the time the firm declared the matter "resolved." Now UBS is being prodded to do the same for individual investors, who have been unable to unload their ARS since the market froze in February. All told, over $200 billion of investment capital is trapped in these illiquid securities.

The Massachusetts Securities Division will file civil fraud charges today, alleging that UBS misrepresented ARS as cash-like investments with iron-clad protection of principal. Even worse, UBS continued to market the securities to small investors even as the firm was warning larger institutional clients of potential risk. Such two-tiered treatment of customers seldom goes over well with regulators.

Passive investors who thought they were safe started to smell the coffee in May, when their monthly statements from UBS began showing ARS as "fixed income" positions, not "cash." This meant that their securities could fluctuate in value, just like bonds. Sure enough, UBS has begun marking down the value of some of these investments on customer statements. "Your future," purrs the marketing jingle, now discounted at your friendly neighborhood broker.

Banc of America and Merrill Lynch are also in the crosshairs of Massachusetts regulators. Any money firm that spells "bank" with a "c" is guilty until proven innocent. As for Merrill, its rap sheet is as long as the Nile. I had a brokerage account with Merrill's Boston office back in the late '70s and early '80s and got personal attention from a customer rep named Don Martineau. He got me into Prime Computer before the stock took off, and that's how I paid for my honeymoon. Years later, though, long after I had moved to Maine, Martineau was convicted of bilking clients of millions and did some time. The "kulture," it appears, has not changed.


[update, 1:45 p.m.--]
Remember those preferred stock offerings that Merrill, Lehman, and Citigroup issued this spring to fortify their balance sheets? Those shares are now trading at 9.5% yields, which means (1) the share prices have declined since and (2) any new deals would have to be priced with double-digit yields. The day is coming when deals cannot get done at any price, and that is when the sugar will really hit the fan.

[update, July 24--]
New York Attorney General Andrew Cuomo announced today that he is joining the posse going after UBS for pushing auction-rate securites. "Not only is UBS guilty of committing a flagrant breach of trust between the bank and its customers, its top executives jumped ship as soon as the securities market started to collapse, leaving thousands of customers holding the bag," said Cuomo in a press release. Cuomo is seeking to compel UBS to buy back the ARS at face value, plus penalty. His lawsuit is the latest of two dozen against brokerages in nine states alleging marketing fraud.

Bad Money

Obama? McCain? It won't matter, according to Kevin Phillips, author of the new book Bad Money. The wheels are already in motion, and there is little the next President can do to prevent the coming train wreck. "This books," writes Phillips in his preface, "is about the insecurity of America's future as the leading world economic power, given a debt-gorged and negligent financial sector, and the vulnerability caused by the nation's expensive dependence on imported oil." To make sure you get the point, Phillips adds an ominous subtitle--Reckless Finance, Failed Politics, and the Global Crisis of American Capitalism.

It is tempting to blame it all on the Bush II Administration, but let's be clear. These problems have been building for two decades, and simply escorting Dubya into retirement will not solve them. Since Alan Greenspan was appointed Chairman of the Federal Reserve Board in 1987, total debt in the U.S. has quadrupled to more than $40 trillion. That debt overhang is three times the country's annual Gross Domestic Product, a multiple surpassing the prior record set following the stock market crash of 1929.

Much is made of the Dubya Deficits, but government borrowing (federal, state, and local obligations added together) is less than one-third of the total private-sector issuance (financial, corporate, and mortgage). "In reality, public debt wasn't the big ballooner," points out Phillips, "private debt was." The risk to any society, as debt metastasizes, is that resources are allocated away from production and toward the useless pursuit of paper profits. Financial services in the U.S. now account for more than 20% of GDP, while manufacturing has shrunk to 12% (it was almost 30% the year I was born). The hollowing out of American manufacturing will make it that much harder to work off our debt.

"Money is 'bad,'" writes Phillips," when a leading world economic power passing its zenith...lets itself luxuriate in finance at the expense of harvesting, manufacturing, or transporting things." Phillips makes no predictions about how severe or prolonged the looming downturn will be, but he is pretty sure that down is where we are headed. For a reality check, let's check some headlines. How about this morning's? Citigroup Inc. today will begin laying off 10% of its investment banking staff, bringing its total headcount reduction for 2008 to over 15,000. And the American Federation of State, County and Municipal Employees, a public employees union, says about 45,000 government layoffs have been announced this year due to budget shortfalls.

And it's only Monday.

Quick Hits: Seeking Scapegoats

The massive deleveraging taking place in our economy, for all its impact, lacks suspense. When the dominoes start falling, the eventual result is known beforehand. That is why I can leave town for a week, dabble at farming in the Berkshires in the June sunshine, return home, learn of top executives at Lehman Brothers walking the plank during my absence, and not be surprised. I offered in my June 4 post that Dick Fuld's tenure as CEO was at risk. Turns out that the CFO and COO took the fall instead.

I fail to see how guys like Fuld can, or should, escape. These corporate execs get paid obscene amounts of money and should be held accountable when things go awry. Their compensation and severance packages should be heavily taxed (hear that, John McCain?). As they say on the farm, manure is a good thing only if it is spread around. Piled in one place, it stinks. The same thing goes for money.

[update, June 27:]
Bloomberg News is reporting that CEO Fuld will forgo his bonus in 2008. Last year Fuld made $40 million, less than a million of which was his actual salary. The rest was his bonus. How's the guy going to carry on without it?

Who pays for fixing medical mistakes? Sadly, it is either the patient (the victim) or those who pay insurance premiums (the rest of us, which makes us victims as well). Massachusetts wants to change all that. Yesterday state officials, in concert with the state's largest private health insurer (Blue Cross and Blue Shield), announced that hospitals or doctors may no longer bill for the costs of extra care following any of 28 different types of screw-ups. The extra costs may range from hundreds of dollars per case for preventable bed sores to thousands for post-surgical infections.

This cost-containment measure is long overdue--and essential if affordable health coverage is to be extended to the entire population. Again, it is all about holding perpetrators accountable. Until recently practitioners got away with medical errors, which went largely unreported. Who knew, for instance, that more people die in the U.S. each year from faulty treatment or diagnosis than from cancer!

American healthcare, when you think of it, is more like Russian roulette. When seeking services, there is a sizable chance that you will end up infected, indebted, disabled and/or drug-dependent. For that, you pay the highest per capita healthcare costs in the world. Now excuse me while I go for my aerobic workout.

Hoop Heaven

First K.U., now the C's!

Back From the Berkshires

Friends on a Mission youth group

United Baptist Church of Peru
Monterey, MA
06-14-2008

More Gloss Than Grit

It's a mouthful, this so-called Evergreen Mountain Four Season Resort & Casino. Doesn't exactly roll off the tongue now, does it. The long name bespeaks the project's aim to be all things to all people: a creator of jobs, a magnet for tourists, an anchor for investment, a benefactor of state programs, a guarantor of student loans, a steward of the natural environment, and a liberator of honest Maine folk just looking for a little entertainment close to home. It is Seth Carey's very own economic stimulus package for Oxford County.

But Seth has retreated to the background. Instead, Pat LaMarche, one of Maine's most recognizable public figures, has come to the fore to champion the idea of casinos in Maine. Last evening she made her pitch in Rumford before three dozen people in the Town Hall auditorium. At stake is a referendum question on the November ballot that, if passed, would give the ever-green light to construction of a casino "somewhere in Oxford County." What's more, the venture would be protected from any and all competitors for ten years.

Saying that the project is in the "conceptual" stage might be generous. Lacking a business plan, Carey has been unable to secure a favorite-son endorsement from the River Valley Growth Council, which hosted last night's forum. LaMarche threw out a few figures--4,000 visitors a day, a thousand jobs, repatriation of a million Maine dollars now going to Foxwoods--and promised more by November 4 (Year Five total revenues? revenues per customer?). She estimated ripple-effect job creation at 40%; for every ten casino jobs, four more would be created in the local economy.

Representative John Patrick led a discussion about how the Maine Legislature would have the opportunity to massage the bill if it passes. Though Patrick supports the initiative, he admits that it might need some "fixing" by the Legal and Veterans' Affairs Committee, on which he has served. Alas, Patrick is termed out and will be running for County Commissioner, begging the question as to who will remain in the House to shepherd this thing through. Talk of "trusting the Legislature" to get it right brought involuntary twitches from more than a few in last night's gathering. Something about foxes and chickens...oh, never mind.

LaMarche's patter was a reprise of her radio-host shtick as she tried to cozy up to her audience with local trivia and home-spun aphorisms. Clearly she is being paid to lend credibility and buy time while Evergreen tries to get its act together. Which is exactly what Evergreen promises: entertainment.

Quick Hits: Lehman Ducks, Lame Duck

"The worst is behind us," said CEO Richard Fuld in April at the annual shareholders meeting of Lehman Brothers Holding Inc. Oh, yeah? Then why did the Wall Street Journal report yesterday that Lehman may be issuing more common stock to raise $4 billion--just two months after a preferred-stock offering? The report sent Lehman's stock down almost 10% in one day, bringing the cumulative decline to over 50% since January 1.

Late yesterday Lehman, the fourth largest U.S. securities firm, denied rumors that it was borrowing from the Federal Reserve. "We did not access the primary dealer facility today," insisted Treasurer Paolo Tonucci. That lending facility allows an investment bank temporarily to swap illiquid assets for U.S. Treasuries, buying time until either the assets resume trading or the bank raises new capital.

Lehman next reports quarterly earnings on June 16, and losses are expected. By month's end Fuld may be gone, following Wachovia's CEO (G. Kennedy Thompson was dismissed Monday) into early retirement.

I'm here to give you some important advice, said President George W. Bush to Furman University's graduating class on Saturday. "My advice to you is not to dig a financial hole that you can't get out of. Live within your means."

Words from the master. During the Bush II adminstration the federal debt has increased by two-thirds to $9.4 trillion, and outstanding debt to foreigners has doubled. The private sector has followed suit, with home mortgage debt doubling and domestic financial debt (engineered by the likes of Lehman Bros.) increasing by two-thirds. These are staggering numbers. Says former comptroller general David Walker, "we have gone from a point where we were projected to pay off all the federal debt and have fiscal sustainability for 40-plus years to a point where we have large and mounting debt burdens and the simulation model that is used by GAO to project fiscal sustainability crashes in about 40 years."

[For more on Walker's concerns, see my Feb. 25 post.]

The Maine Mantra: Relief to Taxpayers

Taxpayers everywhere, not just in Maine, want relief. But Mainers, more than most, may be entitled to it. Year after year the Tax Foundation has ranked Maine among the two or three most heavily taxed states in terms of the combined state and local tax burden as a percentage of per capita income. Maine's figure of 14% compares to the national average of 11%.

Governor John Baldacci would like Maine to retreat to the middle of the pack. In 2005 he signed LD 1, a measure to limit year-to-year increases in public spending at all levels--municipalities, school districts, counties, and state. Formulas were devised to calculate for each budget a Growth Limitation Factor, itself a function of changes in average personal income and property valuation. Each town must calculate its own GLF, which is the maximum percentage increase that may be applied to its Property Tax Levy Limit. Any spending above the limit must be approved through an override vote.

My town, good old Peru, Maine, will act on a proposed 2008-09 budget by referendum on June 10. For the first time, Peruvians will be asked by the Selectmen to override the LD 1 cap. Actually, the Selectmen nearly forgot to ask. When it was pointed out to the Board that the municipal budget would expand by 9.2% with passage of all articles, somebody said uh-oh! and called the Maine Municipal Association for guidance. Hence Article 3-A , a late insertion to the warrant that first appeared in the annual town report.

At a public hearing last night, the Selectmen justified the juiced-up Levy Limit by insisting that the budgets for 2006 and 2007 were artificially lean and that you cannot run a town for so little money. I happened to chair the Board during those two cycles. So if anyone deserves scorn for holding the line, it is I. [Never mind that the merger with SAD 21 was growing Peru's school spending by double digits annually, effectively starving the rest of the budget.]

If Article 3-A and all subsequent spending articles are passed, the municipal budget for 2008-09 will reach $583,400. Together with an expected $1.3 million school assessment and a $76,853 county assessment, total appropriations will fall just shy of $2 million. The total tax commitment will come in at roughly $1.555 million, which, according to Selectman Jim Pulsifer, may raise Peru's mill rate from 14.3 to as much as 16. Bon appetit.

What $8 Gasoline Will Buy

Eight reasons you'll rejoice when we hit $8-a-gallon gasoline - MarketWatch

Bates College Commencement, May 25, 2008

Brett Hine, Bates 2008, B.A., Music

Drinking Water in Short Supply

Pictured above is the reservoir for the city of Barcelona, Spain. So where is the water, you ask? And what's with the building? Submerged when the reservoir was commissioned 40 years ago, the building once again sees the light of day, thanks to human thirst and climate change. Barcelona now imports water on tanker ships.

Dwindling water supplies are also a problem in parts of the U.S. Last week the San Francisco Chronicle reported that the East Bay Municipal Utility District is now rationing water to its 1.3 million customers. After two dry years and the driest spring on record, the District has declared a water-shortage emergency and instituted a drought management program that would cut overall use by 15 percent. The rest of California may soon follow, as the Sierra Nevada snowpack is only 67 percent of normal. Orange County began rationing to its 330,000 customers last year.

Drought has also hammered the Southeast, where reservoirs are dangerously low. There are even rumblings of a border war between Georgia and Tennessee over rights to a part of the Tennessee River. Elsewhere efforts are under way to make brackish water potable. Albuquerque, Las Vegas, Orlando, San Antonio, and San Diego are all currently considering desalination plants.

Reading stories like these, Mainers are quickly reminded that they are sitting on an increasingly valuable resource: clean, fresh water. It is an asset which multinational corporations are eager to monetize, and they are blitzing local planning boards with large-scale proposals to pump groundwater, bottle it, and truck it outta here. To their credit, some communities are resisting. Perhaps Maine should consider legislation similar to what Vermont passed last month, declaring the state's groundwater a public trust and establishing a permitting process for high-volume users.

So THAT'S What They Mean by Self-Storage!

Sometimes you have to get out of rural Maine to recognize broad cultural trends, especially emerging ones. In June 2001 my daughter and I hit the road to look at college campuses. We exited Maine on U.S.-2 and wended our way across northern New England and into New York for our first stop, Skidmore College. All told, we visited ten colleges in seven states over eleven days. We saw a lot of the upper Midwest.

There were three things that we saw too many of: single-occupant vehicles (particularly SUVs), golf courses, and the newest of the three, self-storage facilities. Let me dismiss the first two quickly. We all know about Americans' over-reliance on the automobile. Idling in congested commuter traffic on Chicago's freeways (there's a misnomer) reinforced my conviction that cheap gasoline is a curse. As for golf courses, they swallow up wildlife habitat and farmland to benefit relatively few people. They are an ecological scourge.

So what about self-storage units? At the time we joked about how Americans have so much STUFF that they cannot fit all of it in their domiciles anymore. There are houses for people and now houses for their stuff. Remote storage seems a tacky testament to modern consumerism and excess.

Now for the newest trend, reuniting people with their stuff. This is no joking matter, as explained in the N.Y. Times earlier this week. People facing foreclosure on their homes need to park their stuff temporarily, so they turn to self-storage units. Problem is, the people who cannot keep up with their house payments also tend to fall behind on their storage rentals, thereby running the risk of having their stuff auctioned off. The solution for some people is to walk away from the house and move in with their stuff (storing themselves, as it were), which must drive local code enforcement officers crazy. My suggestion: put car pads next to the storage units and use retired SUVs for housing.

For more on the booming storage industry (and on the vultures who descend on the property auctions), go here:
Losing a Home, Then Losing All Out of Storage

[update, May 14, 2009--]
James Quinn at Minyanville has calculated the following: "Americans have accumulated so much stuff that their McMansions can’t contain it all. In 1984, there were 6,601 self-storage facilities with 290 million square feet space; in 2008, there were 51,250 “primary” self-storage facilities representing 2.35 billion square feet - an increase of more than 2.0 billion square feet. There's 7.4 square feet of self-storage space for every man, woman and child in the nation; thus, it's physically possible that every American could stand -- at the same time -- within the space we've allotted to self storage."

Mother, Meet Meredith

Meredith Whitney is today's E.F. Hutton: when she talks, people listen. And what she is saying today about four of Wall Street's biggest firms will not please shareholders. The Oracle of Oppenheimer describes the outlook for Merrill Lynch, Goldman Sachs, Lehman Brothers, and Morgan Stanley as "far more bleak than that reflected in the market." She has cut 2008 earnings estimates for the group in half and singles out Mother Merrill for an "underperform" rating.

Whitney first made a name for herself last October 31, when she pointed out that the biggest U.S. bank of them all, Citigroup, had insufficient cash flow to cover its dividend to shareholders. Unless it slashed the dividend, raised capital, or sold assets, it was on a path to bankruptcy. Within a week Citigroup's CEO was gone. By January Citigroup was implementing the measures recommended by Whitney, who by then had received death threats for telling it like it is.

This was a classic the-emperor-has-no-clothes shift in perception. Investors were forced to accept that valuations were spun out of thin air. Balance sheets were (and still are) stuffed with derivative dark-matter that is illiquid and hard to price--marked to myth, not to market. How can anyone figure out what these firms are worth? "You can't really know,'' says Whitney. "The financial disclosure is terrible. They're all either liars or they don't know--but I assume they really just don't know.''

And for that company executives have been paid mega-millions, way more than what Whitney makes as a lowly analyst.

Bull in a China Shop

In its zeal to solve one problem, Congress has created another. Lawmakers thought they were doing the right thing last year when they mapped out a timeline for increasing the supply of biofuels in the U.S. The goal: reduce our dependence on foreign oil. The strategy: expand domestic production of renewable fuels five-fold to 36 billion gallons annually by 2022. Corn farmers will be the big winners in the early going, as annual production of corn-based ethanol will double to 15 billion gallons.

It has been just five months since President Bush signed into law the Energy Independence and Security Act of 2007, supported by all four members of Maine's congressional delegation. Already the ethanol mandate is coming under fire. Last Wednesday the Senate Homeland Security and Governmental Affairs Committee examined whether the rush to corn-based ethanol is contributing to higher food prices. Susan Collins of Maine, the senior Republican on the committee, thinks so. The week before she had joined 23 other Senate Republicans in drafting a letter to the Environmental Protection Agency (EPA) calling for a change in the mandate. In the words of presidential candidate John McCain, "this subsidized program--paid for by taxpayer dollars--has contributed to pain at the cash register, at the dining room table, and a devastating food crisis throughout the world."

Did he say subsidy? That's right, ethanol blenders qualify for a federal tax credit of 51 cents a gallon for helping to meet the Renewable Fuels Standard (RFS) mandate passed in 2005. That comes to $2.5 billion a year. Corn growers get their own subsidy, and they are further protected by a tariff on imported ethanol of 54 cents a gallon. That keeps Brazilian sugar-based ethanol out of our market, to the consumer's detriment. Ethanol from corn costs $1.05/gal. to make with a per-acre yield of 400 gallons. Ethanol from sugar cane costs $0.81/gal. at 590 gallons per acre. Which business would you rather be in?

All told, corn ethanol is subsidized to the tune of $1.45 per gallon. But a gallon of ethanol does not deliver the same energy as a gallon of gasoline. In reality the subsidy comes to well over $2 for every gallon of gasoline replaced. We get way more bang for the buck for subsidies paid directly to the oil industry. Meanwhile, diversion of corn (as much as one-fourth of the crop) from food to fuel has jacked up food prices by 25%--"the best example I've seen of the law of unintended consequences," said Collins at Wednesday's hearing.

When it comes to predicting consequences, politicians struggle. As Henry Hazlitt wrote many years ago in Economics in One Lesson, "the art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups." Subsidies and tariffs tend to lead to a sub-optimal allocation of resources, to stubborn inefficiencies. "Free prices and free profits will maximize production and relieve shortages quicker than any other system."

If we must subsidize something, perhaps we should move away from corn ethanol and toward cellulose ethanol derived from crop wastes, wood wastes, and perennial grasses. Corn currently gets ten times the subsidy as the other biofuels combined. A more balanced program would allow different regions of the country to match their R & D to the available feedstocks. As it stands now, corn-belt agribusinesses get fat while the rest of the world starves.

[update, May 15:]
The U.S. Senate today passed the Food, Conservation and Energy Act of 2008 by a lop-sided 81-15 margin. Among many other things, the bill reduces the tax credit for ethanol refiners from 51 cents a gallon to 45 and expands subsidies for cellulose ethanol, steps that Senator Collins would presumably support. However, she voted against the entire package, perhaps because it proposes to spend roughly $300 billion over five years and preserves subsidies to farmers making as much as $750,000 in annual farm income. Currently there is no limit whatsoever; President Bush had proposed a limit of $200,000. The President has threatened a veto, but the Senate has enough votes to override.

Pain in the ARS

Why can't we ever get lawyers like that? I ask on behalf of all Mainers, who can only watch with envy as Massachusetts Attorney General Martha Coakley adds another notch on her belt. This time it is UBS Financial Services Inc., the latest Wall Street firm to be nailed for marketing "enhanced" cash investments to municipal entities. As reported on the front page of this morning's Boston Globe, UBS has been coaxed (sorry, couldn't resist) to repay $37 million to 17 cities and towns for auction-rate securities (ARS) for which there is no longer a market. Towns had been parking excess cash in ARS, which rolled over weekly or monthly until the market seized, to juice returns.

The settlement with UBS follows an earlier deal with Merrill Lynch whereby the City of Springfield was refunded $14 million for money invested in collateralized debt obligations (CDO). In each case, the broker/dealer was forced to admit that the investments in question were not permitted by state law, which restricts municipal cash to highly liquid accounts that guarantee the principal. Also in each case, the broker/dealer admitted only to a one-time misdemeanor. "UBS is pleased this matter has been resolved," said a company spokesperson.

Maybe it has, maybe it hasn't. Massachusetts Secretary of State William Galvin has issued subpoenas to UBS, Merrill Lynch, and Bank of America regarding the sale of ARS to individual investors and businesses. Conducting its own investigation is the Securities and Exchange Commission. If a pattern of abuse is revealed, then aggrieved investors, public and private, will be lining up for restitution.

The State of Maine continues to wait for resolution of the MainSail II fiasco. Creditors were alerted in March that "no valuation of the Issuer's asset portfolio [...] provides any reasonable expectation" that senior secured parties will get all their money back. Other investors may get nothing. The assets (which have shrunk in value by two-thirds since Maine jumped into the pool) are now in receivership, so the eventual outcome for investors will be, if not entirely satisfactory, at least orderly. Price discovery awaits.

Meanwhile, Maine Treasurer David Lemoine, still ticked off at Merrill Lynch for pushing the MainSail investment, has blackballed the firm. The State will be selling nearly $120 million in general obligation bonds later this month, and Merrill will be getting no piece of that action. “Until the Mainsail II matter is fixed and I am satisfied that the Merrill Lynch brokerage culture is trustworthy," said an exasperated Lemoine, "this office will not bring Merrill Lynch into any of our bond deals.” Take that, Merrill Lynch.