Mark Byron

The CTRL-ALT-DEL Economy?

Here's an interesting statement from Microsoft boss Steve Ballmer that has had my mind reeling a bit since I heard it Tuesday from, of all places, ESPN talker Collin Cowherd.

"I don't think we are in a recession, I think we have reset," he said. "A recession implies recovery [to pre-recession levels] and for planning purposes I don't think we will. We have reset and won't rebound and re-grow."

Ballmer may well be right; I was kicking this idea around with my Portfolio Analysis class last night, and it seems to make sense. Our financial system has got the jitters if not the DTs, used to using easy credit and free-wheeling derivatives and is now having to function without those financial greenies. The auto industry is undergoing an overhaul, as both Chrysler and GM go through government-shepherded Chapter 11s.

If we look to Washington, we shouldn't see too much help on the fiscal policy front. The massive stimulus package didn't do the trick and the Obama team is likely to move towards higher taxes in order to pay down the budget deficit; that might be good for long-term financial stability, but it won't be overly good for GDP growth

That's doubly true when you couple that with reforms that are likely to come out of Washington. Financial reform will likely lead to more expensive capital and more expensive credit for small businesses, as increased capital requirements for banks will likely lead to higher interest rates on bank loans; if banks need to have more equity on hand, they'll need to have a higher return on assets to offset the reduced leverage. Also, any unfunded mandates for health insurance put on businesses will lower profitability and economic growth.

So, Wall Street is looking for the Betty Ford Clinic (as one student put it last night) and Washington is doing stuff that, while helpful for the little guy, will slow the economy to a crawl.

That is, unless innovation paves the way for growth despite those downsides. Computers seem to have maxed out on their productivity-producing, but every time we think we've seen everything, we get a new ap that changes the game some more; Facebook and Twitter are two areas that have changed things as of late.

Nanotech seems to be just around the corner, but I'm not sure if the pure research we've seen to date is going to turn into real products anytime soon; if it does, it could offset the contractionary nature of our current situation much as improved logistics, the birth of the Web and other computer-generated productivity in the 1990 helped offset the Clinton tax increases and saw a growing economy despite higher taxes.

We may be in for a rather stagnant economy, where the 3% growth that we're used to might not be there until either the next big tech item comes along to boost the economy or our system digests all the financial and regulatory changes coming down the pike.

That's not all that encouraging, but that what we seem to be looking at for the near term.

The Mediocre Coach

I saw this story on the government looking to regulate executive pay (actually a crawler of the news on Fox as we were leaving lunch the other day) and felt like one of those movie heroes as the bomb is about to go off. Everything goes into sloooooow-moootion, and the hero hollers "Noooooooo!" in a deep voice, since everyone sounds like Barry White in slow-mo, as he either starts to run in vain towards the blast or dive out of the way just in the nick of time.

The one thing that could make sense in the proposal is to have stockholders vote on corporate pay raises; the non-binding votes that are in the proposal have very little teeth other than to possibly show up sloppy boards of directors.

What might make more sense would be to have binding votes on top executive's pay. Corporate boards have a tendency to become a bunch of yes-men (have the board meeting in Mexico and they become a Si Section;-) and rubber stamp pay raises; making shareholders approve them would be a step in the right direction. If you coupled that with Internet voting of shares rather than giving proxies to whatever faction (usually the board's) will be at the meeting that you support, that would make the corporate accountability even better.

Most shareholders don't care about the details of their company's board as long as the company seems to be doing well and the path of least resistance is to give management your proxy if they seem to be doing well. If pay raises required an active majority of shareholders to mail-in or click-in saying "Yes, that pay raise is fine by me.," we'd get more reasonable pay package.

However, trying to conjure up a government-mandated formula for how much CEOs make seems counter-productive. One of my general thoughts on government in the marketplace is that it is a good referee (judicial system), a mediocre coach (regulation, industrial policy) and a lousy player (government-owned businesses).

Good decision making is worth money. If billions are riding on a decision, it may well be worth tens of millions to have a good decision-maker. Yes, that means he'll make a gazillion times more than Joe Shoprat, but more is riding on the CEO's decision whether to launch a new product that Joe's decision to pull a defective item off the line. Both are important, but Joe's decision isn't going to make as big of a dent on the bottom line.

What often the problem is with executive pay is that mediocre decision making is getting overpaid. However, that's better left to stockholders than to Uncle Sam, and Uncle Sam is best left out of the loop, with the possible exception of making it a bit easier to keep mediocre CEOs accountable to their shareholders.

Freddie's (Boss is) Dead

Here's a sobering story. Mortgage market-maker Freddie Mac's CFO, David Kellermann, apparently did himself in yesterday. Are you happy now, Senator Grassley?

To be fair to the senator, he was joking when he suggested that the AIG honchos commit hari kari, but a lot of people feel that way towards the financial big-shots. A lot of ill will is flowing towards folks who are often doing the best they can in a bad situation.

If you listen to talkers on both the right and left, there is little but bile pointed towards our financial system's leaders; it's not saying that the chattering classes caused Mr. Kellermann to commit suicide, but it surely didn't help. I know it wouldn't help my mood if I were getting ripped left and right in the media on a daily basis.

Now pundits will wonder if there is some massive problem that is about to hit the fan; what's just as likely is that he cracked under some exceedingly intense pressue.

Pray for his family, the Freddie Mac folks who will get extra scrutiny, and our financial system in general.

Google Perplexed

I was thumbing through some old posts this evening, and found this 2004 piece on Google's IPO. Let's get some good Chianti ready, since I'm going to have to eat these words big time.

If Google has net income of $125 million and is expected to have a market capitalization of $20 billion, the price-to-earnings (P/E) ratio would be $20,000m/$125m or 160.

To put that into perspective, the average stock these days has a P/E of about 25. Eventually, Google will stop growing faster than the economy and settle in as a normal company. At their current market capitalization, they'd have to raise their net income to $800 million to get to a P/E of 25. How will Google do that? Will they get six times the traffic? Three times the traffic but double the profit margin?

...

No, I'm not dissing Google, it's still my search engine of choice. It's sorta like making Michigan a 60-point favorite over Northwestern; they'll win, yes, but I don't think the Maize and Blue would cover the spread. Google's good, but it's not going to cover that 160 P/E point spread.

Well, fast forward to the 2009, if you will. Google now has a PE of 25, 24.81 as reported by MSN Money. Google blew past that $800M target in 2005 and made $4.2 billion in 2008. It may well have leveled out its growth, but has done so with a market cap of $104 billion. Google's wound up tripling in price since its IPO, even after the tanking market of the last half-year.

Google is the 20th biggest company on the US stock market as we go to press. GE, Coke and Toyota are 21,23 and 24, to show the company they're hanging with. Not bad for some computer geeks going to town with a search engine.

AAA

I wind up teaching about bond ratings most every semester, but until now, I didn't know how many companies have a top-drawer AAA rating. GE just lost its AAA rating from S&P and second-tier rater Fitch dropped Berkshire Hathaway down a peg; BH does a lot of insurance and re-insurance, so that will cost them some business. Welcome to Wall Street's Wild Kingdom, Sir Sage of Omaha.

Here's an interesting paragraph-

Following GE's downgrade by S&P, only four companies other than Berkshire retain the highest ratings from Moody's and S&P: American Data Processing, Johnson & Johnson, Exxon Mobil and Toyota.

ADP is the one surprise there; however, they seem to have a near-corner on the payroll processing market. Toyota is somewhat reassuring for the Lexington area, since their big Georgetown plant just north of Lexington is a big employer and magnet for parts suppliers.

Galting the Ground

I just got done grading a capital budgeting assignment for my Executive MBA finance class and was thinking about our current economic downturn. One of the catch-phrases that's making its way around the Blogosphere in the early Obama era is "going Galt", as in Atlas Shrugged protagonist John Galt; in the book, Galt led a strike of high-achievers.

Our economic downturn might not be a coherent strike from the American rich but the effects of the first 50 days of the Obama administration effectively salting the ground for economic growth.

Picture if you will a stock capital budgeting problem; we figure out the future cash flows from the project, then figure out what those cash flows are worth today by discounting them back using our cost of raising funds. If the present value of those expected future cash flows are bigger than what we're investing, we have a positive Net Present Value and we do the project.

The Obama team has created a double whammy (at least) for such projects.

Firstly, he has set the groundwork for higher taxes, both by promising to raise taxes on the well-off (or at least to allow the planned sunsetting of Bush tax cuts); the high deficits caused by the massive stimulus package and other projects will mean that tax cuts of any magnitude are unlikely and other tax increases may be forthcoming to pay for the expanded national debt. That will reduce the yearly cash flows from the projects being considered, since Uncle Sam will be getting a bigger chunk of the profits.

Secondly, the added deficit will tend to raise interest rates and required returns on stocks in the long term. The econ-speak term for that is the "crowding out effect"; as Uncle Sam borrows more money, there's less investable money to go into stocks, bonds and consumer loans, thus driving up interest rates and required returns. That will increase the cost of capital which we discount those future cash flows back at, making them less valuable to the investor.

So, thanks to BO and his buddies on Capital Hill, we have diminished cash flows for future investments and a decreased value for what cash flows we do get to keep. Some projects that might have made sense six months ago don't anymore.

On top of that, businesses that made sense six months ago might not make sense today; as people look at higher taxes, higher costs of capital and a weaker economy (not factored into the calculus above), they might decide to pull the plug on a marginal business, seeing that things won't be getting better any time soon. Note that the big drop in unemployment happened in December, as we saw the massive stimulus package taking shape and seeing Obama lurch more to the left on economics that the business community thought.

Could it be just the lousy economy in general. In part, yes, but part of it might be businesses looking at what Washington was sending their way and not wanting to try to send good money after bad.

Eighty-Sixed

GM's 2008 10-K just got posted, and it is not pretty. Here's the balance sheet carnage; assets of $91 billion, liabilities of $176 billion, and a negative net worth of $86 billion. It use to be you had to be in government to get that level of red ink.

Here is as pessimistic a Management Discussion and Analysis (MD&A) section as I have ever read;

This MD&A should be read in conjunction with the accompanying consolidated financial statements which have been prepared assuming that we will continue as a going concern. As discussed in Note 2 to the consolidated financial statements, our recurring losses from operations, stockholders’ deficit, and inability to generate sufficient cash flow to meet our obligations and sustain our operations raise substantial doubt about our ability to continue as a going concern.

Translation: "Stick a fork in us... we're done." With them $86 billion in the hole, it's time for them to get 86'd.

Make That Sixty-Six Sagans in the Hole

That really sucks bilge water.

For General Motors Corp. nothing has stopped the bleeding. Not cutting 50,000 jobs in the U.S. Not closing 11 factories. Not $13.4 billion in government loans.

The teetering company, once the symbol of American industrial might, revealed Thursday that it burned through $19.2 billion in cash last year on its way to a $30.9 billion loss. The century-old automaker said its only hope of living another year is more aid from the government.

...

The automaker, which reported a $9.6 billion fourth-quarter loss, burned up $6.2 billion in those last three months of 2008, including a $4 billion government loan as the century-old company fought the worst U.S. sales climate since 1982. GM shares fell 17 cents, or 6.7 percent, to $2.38 Thursday.

As we last saw Bird Colonel Motors, they were $59.94 billion in the hole, with $110B in assets and $170B in liabilities. Now, preliminary 2008 data is out (they're late filing their 10-K with the SEC) and BCM had $91 billion in assets and $177 billion in liabilities. That makes $66.2B of golden-brown and toasty badness.

Cue my mythical South Parker-"Dude! Sixty-six friggin' Sagans in the hole. How long does it take you to get the message that your cars suck bilge water?"

Another demotion is coming to Sergeant Motors; we have some sort of Sergeant slaughter coming, which might well be a mercy killing.

GM 2.0-Redux

Yours truly, November 20th-

Here's my framework if I were getting the combat pay as treasury secretary.

(1) Sit down with the UAW and map out a wage and benefit package that will pass muster for the long haul. This may be easier for an Obama administration econ guy early next year, for he can play the bad cop: "If we don't do this right, we'll be looking at losing the House in 2010 and, God forbid, getting stuck with President Palin in 2012. So, we really, really need to do this right."

(2) GM will get cleaned out and started over. Currently, GM has $110 million in assets and $170 in liabilities on the books. I'd offer the creditors $100 billion for the lot and start a GM 2.0 with a new labor contract (see #1) and a revamped balance sheet. We might be able to do it even cheaper than that, since GM debt has been trading at 20 cents on the dollar as of late.

(3) Where do I get that $100 billion for GM2.0?

$20 billion in convertible preferred from Uncle Sam.

$30 billion in common equity from private investors. Toyota might be interested in a controlling stake; they already have major ties to GM and have enough cash on hand to fork over $10 billion or so of that. The remaining $20B can come from an IPO of GM2.0.

$50 billion in long-term debt. We might offer to have Uncle Sam co-sign the debt in return for stock options.

The Globe and Mail, yesterday (hat tip, Mark Collins)-

General Motors Corp [GM-N], nearing a Tuesday deadline to present a viability plan to the U.S. government, is considering as one option a Chapter 11 bankruptcy filing that would create a new company, the Wall Street Journal said in its Saturday edition.

"One plan includes a Chapter 11 filing that would assemble all of GM's viable assets, including some U.S. brands and international operations, into a new company," the newspaper said. "The undesirable assets would be liquidated or sold under protection of a bankruptcy court. Contracts with bondholders, unions, dealers and suppliers would also be reworked."

It may not exactly break down like I suggested but that's the only good way to get that sixty Sagan gap between assets and liabilities filled. After they already spent $800B on a stimulating Valentine's Day dinner, what's another $20B for desert?

Flight to Safety...With a Layover at Stupidity

This story had my Finance students scratching their heads earlier this week-

Investors fearful of deflation and riskier assets scrambled to hand over cash to the US Treasury in return for no interest at an auction Tuesday, while some T-bill rates fell below zero in the market.

Pressures on fund managers to stock up on the safest possible assets in advance of year-end book-balancing added to the bid for government securities, traders said. The U.S. Treasury Department said it sold four-week bills at a high rate of 0.000 percent, a level never before seen, in a $30 billion auction.

So much for the definitional statement that zero-coupon investments always sell at a discount. Yet another one of my notes that I'll have to rewrite.

Why would someone pay to have the government borrow their money?

Here are a few possibilities

(1) A money-market fund wants to have some of each T-bill offering, even if it doesn't earn any money.
(2) Someone had shorted a T-bill and really needed to buy it back.
(3) Fear of a bank collapse. Large investors are on their own if a bank goes under beyond the basic FDIC insurance (traditionally $100K but raised to $250K recently) and they might want it in Uncle Sam's hands for safe-keeping; they can then cash the payback check at any bank that's still standing.

"May you live in interesting times" was an ancient curse. Indeed.

GM 2.0?

Democrats do occasionally, nay, frequently, have common sense, including Madam Speaker

Democratic leaders in Congress sidetracked legislation to bail out the auto industry Thursday and demanded the Big Three develop a plan assuring the money would make them economically viable. "Until they show us the plan, we cannot show them the money," Speaker Nancy Pelosi, D-Calif., said at a hastily called news conference in the Capitol.

She and Senate Majority Leader Harry Reid, D-Nev., said Congress would return to work in early December to vote on legislation if General Motors Corp., Ford Motor Co. and Chrysler LLC produce an acceptable plan.

I'm still working though what might be a viable way forward. Here's my framework if I were getting the combat pay as treasury secretary.

(1) Sit down with the UAW and map out a wage and benefit package that will pass muster for the long haul. This may be easier for an Obama administration econ guy early next year, for he can play the bad cop: "If we don't do this right, we'll be looking at losing the House in 2010 and, God forbid, getting stuck with President Palin in 2012. So, we really, really need to do this right."

(2) GM will get cleaned out and started over. Currently, GM has $110 million in assets and $170 in liabilities on the books. I'd offer the creditors $100 billion for the lot and start a GM 2.0 with a new labor contract (see #1) and a revamped balance sheet. We might be able to do it even cheaper than that, since GM debt has been trading at 20 cents on the dollar as of late.

(3) Where do I get that $100 billion for GM2.0?

$20 billion in convertible preferred from Uncle Sam.

$30 billion in common equity from private investors. Toyota might be interested in a controlling stake; they already have major ties to GM and have enough cash on hand to fork over $10 billion or so of that. The remaining $20B can come from an IPO of GM2.0.

$50 billion in long-term debt. We might offer to have Uncle Sam co-sign the debt in return for stock options.

(4) Ford is only $2 billion in the hole and might only need a modest infusion. Chrysler style loan guarantees might be all Ford needs; remember that the US made money on the Chrysler deal of the late 70s.

(5) I'd have to see the Chrysler financials in order to see where they're at. Since they went private last year, we don't have access to their numbers. I'm reminded of this bit from our Sullivan U faculty advance SACS and the City skit, where "Old Nick" (he of the horns and tail) is tempting some lady instructors into improving their teaching methods-

Old Nick: Well helloooooo ladies…

Miranda: Who are you?

Old Nick: Call me a teacher. Call me a preacher
Where learnin’ is burnin’ I’m the feature creature.
Don’t be passive, learning is massive.
If you teach it right it’s radioactive.
Problem solve, activate, maybe you collaborate.
Introduce experiential, that’ll make ‘em salivate.

Carrie: Salivate? You’re going to teach us to slobber?

Old Nick: Like Pavlov’s dog.

Charlotte: Who's Pablo? What kind of dog? A Chihuahua?

Old Nick: Forget the Cerberus, err, I mean dog, I’m here to help you learn.

For the time being, we'll need to forget the Cerberus..... Capital until they give some up-to-date financials on Chrysler.

It will be interesting to see if this actually gets through a lame-duck session of Congress, or gets left for the next Congress and either the very last days of the Bush administration or the early Obama administration.

Canadian help seems forthcoming, as it was part of the Throne Speech (the Canadian equivalent of the State of the Union address) yesterday. However, the US will have to be doing most of the financial heavy lifting on this one. It might not be as heavy as it might seem if we do it right.

However, doing it wrong might take out a good hunk of our economy. We need to get an economic FEMA in for this creative destruction, lest we take the heart out of our manufacturing sector.

Sixty Sagans in the Hole

I was looking at the financials of General Motors with my Financial Statement Analysis class last night. Here's the butt-ugly bottom line as of their third-quarter 10-Q statement. $110 billion of assets, $170 billion of liabilities. That leaves a negative $60 billion in book value.

Cue South Park.

"Sixty billion in the hole. What the [insert expletive] happened?!?"
"We were hoping the car market would turn ar...."
"Dude! Sixty friggin' Sagans in the hole. How long does it take you to get the message that your cars suck bilge water."

Well, it's $59.94 billion to be exact, but what's $61 million between friends?

The stocks of Ford and GM are so battered, Toyota could buy them both with petty cash. Ford has a market cap of $4 billion, GM has a cap of $1.8 billion, and Toyota is sitting on about $25 billion in cash at the end of the third quarter. Why Toyota would want to is another matter, especially when they'd be paying $1.8B for the privileged to fill that $60b hole.

Getting someone to finance GM during bankruptcy might be problematic, but that may wind up being Uncle Sam's job. Bankruptcy is the market telling you that you're not feeding the bulldog and it might be time to pack it in.

A Chapter 7 liquidation, where GM shuts down and the pieces-parts are sold off, would be very disruptive to the economy and make the next Treasury Secretary ask for combat pay. So, the best solution might be to restructure GM in some way to keep it going but clear off the red ink.

Uncle Sam will likely get stuck with a good chunk of the pension debt; the Pension Benefit Guaranty Corporation (the FDIC for pensions) will likely get the tab if GM goes under. The PBGC is designed to be self-financing like the FDIC, where pension plans pay premiums to finance the failures, but a GM collapse might require a federal infusion into the PBGC.

What might be the best way to fly is to sell off GM or subsets thereof to other interested parties. At minimum, there will be a market to service the existing GM cars out there. Some of the brand names, like Cadillac and Buick, might have enough cache that other car makers or big private equity firms might want to buy the various GM sub-parts.

Or, alternatively, we could set up a GM 2.0 with a retooled debt structure and a manageable labor contract shorn of the huge legacy costs, and use the proceeds to pay off the creditors of GM 1.0. However, floating such a stock in such a equity-hostile environment might not be the best option.

We might see GM be run by the federal government (or a bankruptcy judge) for a few years until the equity markets bounce back. Yes, that's going to warm the hearts of free marketeers everywhere. However, the current "management" proceeded to run the critter into the ground over the past quarter-century or so; I can't see an Obama team doing much worse.

It's going to be an interesting year, one where I'm having to redo my notes for my finance classes on a weekly basis.

Le Deluge

There's one silver lining from today; oil dropped $10/barrel. That should translate into lower gas at the pump in the days to come.

However, the awkward news is that Congress opted not to pass the TARP bill, with the House voting it down 228-205. There was bipartisan opposition, as two-thirds of the Republicans and about 40% of the Democrats voted against the bill. There must be a lot of people looking to get the roll call, since the House web site seems down for the count.

Wall Street is taking it in the neck; the Dow was down 777 points for the day, the biggest nominal drop in history, although with the Dow up at 10,365, it's only a 7% drop compared with the 23% we saw on Black Monday in October, 1987. The S&P 500 was off even more, tanking 8.8% and the NASDAQ index was off 9.1%. My personal portfolio took an even worse pounding, as the bottom-fishing I though I was doing didn't catch the Marianna Trench off to the left; my best stock only went down 7% and one stock got a third of its value shaved off.

What does this mean to the half of us who don't have much if anything in the market? Tougher loans, more bank closures and a likely down economy until things shake out. If you have cash on hand, you can get some deals in housing and in the stock market, but don't expect to get too much in the way of loans anytime soon.

The FDIC will be the next focal point; if the troubled debt can't be bought off the banks, they'll be the next to go, and a run on the banking system might require a FDIC bailout that could prove more costly in the long run than what we were looking at with the TARP package.

At least I got a pay raise today as part of my contract extension; that will offset the losses my small portfolio took, and my stocks should be bouncing back (he says as he whistles past the graveyard). Let's recall that 1987 was an up year for the market despite Black Monday. 2008 might not be that bad in the end.

Don't do anything stupid quite yet. The markets only went down 7-9% today and cooler heads might well prevail tomorrow. We shall see.

Creative Nuclear War

My mind is on overload the last few weeks as we see the financial system transform itself before our very eyes. I would up scrapping the normal opening-night lecture in my Financial Statement Analysis class to hold an ad-hoc seminar on what I christened Black September; we'll get to picking apart balance sheets next week, but my finance majors needed to work through what's been going on.

I don't like the game the "conservatives" on Capital Hill are playing. There are quite a few loose ends to the Paulson plan, but some sort of liquidity-producer is needed. Warren Buffet can come in and give Goldman Sachs a boost (having to fork over a 10% yield on preferred stock is a bad sign and making it convertible is worse), but even he has his limits. $700 billion is roughly the book value of AIG's investment portfolio ($699.5B as of 6/30); granted, not all of that is in illiquid mortgages, but a large scope is required.

Is this anti-free-markets? Yes, but free markets don't handle outliers well, especially when you have limited liability; it doesn't matter how much you go bankrupt if the creditors are left holding the tab. Markets don't usually plan for worse-case scenarios, which leaves Uncle Sam holding the bag from time to time.

Only, if they play their cards right, Uncle Sam may not be "holding the bag." They'll likely be buying stuff up at below long-term market value and be able to sell the stuff back to the market at a hight price once everything calms down.

It isn't often when I want Pelosi and Reid to ram something through over the objections of conservative Republicans, but this is such a case. The conservatives are worshiping at the altar of the Free Market (hallowed be its name, thy GDP come, thy profits be done on Wall Street as it is on Main Street) and not quite catching the magnitude of the problem.

Free markets require the ability to fall flat on your face and fail; the markets work by figuring out what works and what doesn't and letting the stuff that doesn't work go out of business. Shumpeter called that "creative destruction;" the less-worthwhile stuff goes out of business while labor and capital are shifted to more worthwhile stuff.

The modern US-style economy has a bit of a safety net to mitigate some of that destruction, to tend to the people between jobs and to protect the small fry from some of the worst crashes of the market. Here, we have a massive economic meltdown in the offing if some liquidity isn't added to the markets; this isn't just creative destruction but a creative Ike or Katrina.

We need a big safety net for this one; it isn't time to play Flying Wallendas with the economy.

 

The Specialist

No, that's not the next Steven Segal movie, it's the role the US government is fixin' to perform (as they'd say down here) with the credit markets.

President Bush asked Congress on Saturday for the authority to spend as much as $700 billion to purchase troubled mortgage assets and contain the financial crisis.

The legislative proposal is the centerpiece of what would be the most sweeping economic intervention by the government since the Great Depression. (Read the text here.)

Paulson, Federal Reserve Chairman Ben Bernanke and other officials have said in recent days that the lack of easy credit between banks and other financial institutions threatens to inflict serious damage on the economy if not addressed immediately.

The plan would allow the Treasury to buy up mortgage-related assets from American based companies and foreign firms with a big exposure to these illiquid assets. The aim is for the government to buy the securities at a discount, hold onto them and then sell them for a profit.

"What we're doing is first stabilizing the market," Paulson said. "Once we stabilize the market, we need to ask ourselves how did we get here and how do we avoid getting here again." 

Actually, the government has done a number of large interventions; setting up Fannie Mae and then Freddie Mac was a major intervention, giving a secondary market for a standardized set of home mortgages. However, those were spread out over time rather than seeing a trillion dollars of new Treasury debt hit the system in one swoo felp.

What this new critter will do is fill in the gaps that Fannie and Freddie don't do. Some mortgages are either too big (large starter castles don't qualify for purchase) or have too low of collateral for Fannie and Freddie, requiring alternative means to set up a secondary market for them.

One of the problems with financial markets is liquidity risk, the difficulty of getting someone to buy your assets at a fair price. For instance, I bought some Gramercy Capital stock last week, a real estate investment trust that seems to be be getting shorted to within an inch of its life due to the illiquidity of some of its commercial real estate loans; I've never see a company get a price-to-earnings ratio of under 1 when it had future income prospects steady on into the future, so this is an interesting stock. Since there is a ready market for the stock, I know I can cash out at a reasonably fair price at any time.

One of the reasons that I have confidence in being about to cash out of my Gramercy stock if needed is that it's traded on the New York Stock Exchange. For every NYSE firm, they will have a brokerage firm serve as a "specialist" that becomes the buyer and seller of last resort for a stock; in Gramercy's case, it's a firm called the Kellogg Group that serves as their specialist.

If the investment community collectively goes "What the ......., a 0.9 PE?!? Let my buy some of that!" and makes a run on Gramercy, it's Kellogg's job to be selling them Gramercy stock if there aren't any buyers, at increasingly higher prices until the sellers start coming out of the woodwork. Conversely, if some aweful news comes out about Gramercy tomorrow and the bear raid continues, Kellogg will get stuck buying Gramercy stock, albeit at increasingly lower prices until the buyers come out of the woodwork.

So, if I'm looking to sell my Gramercy stock, Kellogg's got my back. For NASDAQ stocks, one or more brokerages serve as "market makers" for the stock that will offer to buy at one price and sell at a slightly higher price, serving a simular role in creating liquidity for NASDAQ stocks.

Non-standard mortgages don't have anyone serving that function at this point; some of the brokerage firms have tried to play the role market-makers, but the job has been a bit too dicey.

Here's where the feds come in. They can stand ready to buy securieties at fair prices, fair given the other risks (length of maturity, amount of equity in property, default risk of the borrower, etc.) and not lose any money. It will not harm the bond markets as a whole, as they will swap out X billion dollars of mortgages for X billion dollars of T-bonds; it may drive the interest rates on T-bonds up a bit, but will firm up the fixed-income market.

As financial entities know they now have a mortgage specialist in da house, the value of their balance sheets will go up, as the liquidity risk on these bad boys will decline, reducing the need for the feds to buy these assets. If banks know they can turn to the (I don't know the name, but let's trot one out) Wholesale Mortgage Acceptance Corporation, otherwise known as Dubya Mac, they might not need to sell to Dubya Mac.

Does this screw up the free markets? A bit, but free markets don't deal with outliers well. Individual farmers don't plant in order to make sure there's enough crops to avoid a famine; it's government's job to over-encourage production in some way to avoid a famine. The financial markets neglected to figure out if there was a secondary market for a class of mortgage and got badly burned when that market dried up.

Think of it is FEMA for banks. Only the most over-the-top liberatians will sneer at the need for help after a hurricane, and the financial markets got nailed with one. However, this FEMA will actually make money if they price things right; easier said than done, however, since the system will be biased towards overpricing the toilet paper.

Breaking the Buck

Here's a very interesting story that Francis Cianfrocca over at Redstate noted. First, a little background on money market mutual funds.

MM funds buy short-term debt instruments, generally from either government entities or highly rated corporations; you don't see any junk-bond grade paper in the money market. People can generally write checks on them or make electronic withdrawals from them like a checking account, so they act much as a big-boy's savings account.

Money market mutual funds aren't FDIC insured like bank deposits, but such insurance is generally not needed. Defaults on commercial paper are so rare that mutual fund companies  consider it a point of honor that if a piece of paper does default, they will buy the paper off the fund at face value, so that the fund management company takes the loss rather the shareholders of the MM fund.

Thus, mutual funds keep things at a stable $1/share (it's industry standard to fix the cost of a MM mutual fund at $1/share) as a matter of course; investors never lose money in a money market fund. Since the tradition is for firms to eat any losses, "breaking the buck" and seeing a fund's shares go below a buck apiece is taboo in the industry; it's been 14 years since a money market fund reneged on eating bad paper.

The Reserve Primary money market fund broke that taboo today, not only dropped the value of its main fund to $0.97 due to bad Lehman paper, but has frozen withdrawls for a week.

I guess I'm going to need to update my notes on the money market before next term. Yet another whomperjaw moment this week.

AIG Whiz

This has to be the craziest week in finance in a generation; Black Monday of October 1987 is still the gold standard for what-the.... moments, but this week is going to be one I'll be sharing with students for decades to come.

First, we had Lehman go under in the wee hours of Sunday and Merrill Lynch gets bought out by Bank of America. I'm still getting my mind around the Merrill deal; the firm that got rolling as North Carolina National Bank winds up merging its way into becoming such a national banking powerhouse that they buy the most prestigious retail brokerage firm around.

Now, we have the Fed bailing out insurance biggie AIG; the Fed gets just shy of 80% of the stock and AIG gets a $85 billion dollar line of credit. This ain't the discount window; AIG will get charged three month LIBOR (the rate international banks charge each other for dollar-denominated loans) plus 8.5%. With three month LIBOR at 2.88%, that makes the loans priced at a 11.38% rate. That's pricey, but at least they get the money.

Why AIG and not Lehman? AIG had sold credit insurance to a number of banks, so if AIG goes belly-up, the insurance is worthless and the credit that was being insured is worth less. That means that all those banks now have balance sheet problems of their own.

This might be a very good deal for the Fed. AIG had a book value (what it would be worth if it sold off its assets and paid off its creditors) of $78 billion dollars; Uncle Sam now has dibs on about $62 billion of that if it plays its cards right. That assumes that the assets can be sold at face value, but AOG had 8% equity. A 5% haircut brings the value down from $78b to $28b.

It will be interesting to see how the stock market reacts to the news; it had stabilized yesterday after taking a 5% hit on Monday. AIG might actually be a good buy at $3 a share. With a pre-takeover book value of $30/share, it would still be worth $6/share after getting diluted by Uncle Sam.

Liberals are Conservative and Conservatives are Aggressive

Here's an interesting MSN Money piece on the retirement portfolios of the VP nominees.

Their retirement nest eggs -- which for both candidates are almost their entire net worth -- are modest in the extreme, amounting to somewhere between $300,000 and $400,000 for each family.

They are also, on the liberal-conservative scale, upside down. Democrat Biden has most of his money in a tax-sheltered annuity, that most timid of investment vehicles. The Republican Palins (husband Todd is the investor) are much bolder, venturing into individual stocks and exotic exchange-traded funds, or ETFs.

If you think $300K is "modest in the extreme", then my nest egg's got a friggin' burqua on; it got about 10% more modest yesterday.

Before I tackle the inversion, ETFs aren't all that exotic as a beast. They're a form of mutual fund that trades like a stock with the advantage that larger investors can cash their shares in for their share of the porfolio of the fund; that keeps the stock price of the ETF from getting too far away from the Net Asset Value of the ETF.

That inversion isn't surprising. Political liberals tend to be skittish about the economy; that's why they want to regulate it and compensate for its excesses and shortcomings. That skittishness can translate into a more risk-adverse investor, so the annuity (a guaranteed set of payments, generally from an insurance company) is a prudent choice for such a skittish investor. "Not taking risks" translates to conservative in investment-speak.

On the other hand, economic conservatives tend to be bullish on the economy, understanding the benefits of the creative destruction of the market. We'll get the occasional crash-and-burns like Lehman but we'll also get success stories, like the Google search engine that you might have gotten here by or the Movable Type software that this post is composed on.

Thus, economic conservatives need not be financial conservative. With a decade or two before retirement, the Palins have the wiggle-room to suffer through bad days on Wall Street like we had yesterday, for there should be plenty of good days to offset yesterday's stinker. They also have the confidence in the market to know that things will get better in the long haul.

That's not to say that economic conservatives can't be financial conservatives; get close to retirement or close to when you'll need that college fund, and the investment mix will shift from stocks and into lower-risk bonds and savings accounts. However, economic conservatives will tend to be more aggressive in their investing.

So, liberals are conservative, conservatives aren't conservative, and I Don't Know's on third.

Maniac Monday

The US markets haven't opened yet, but I'm seeing what is happening to the European markets and, with my best hemi-lovin' drawl, say "This cain't be good." The French CAC is off 5%, the British FTSE 4.7%, the German DAX off 4.1%. All because Lehman is writing a new chapter in their corporate history today, chapter 11.

The European reaction is bad news, since the damage to the US markets should be worse than that. Cue up the Carpenters and the Bangles, because this maniac Monday will get a lot of people down.

Lehmanaid

The big financial story of the weekend is the pending demise of Lehman Brothers, one of the big investment banking firms.

When Bear Stearns hit the fan in March, they had a book value (what their assets are worth less what they owe) of $64/share per their last quarterly statement in February and got bought out for about $8 in JP Morgan stock. Bear Stearns only had 3% equity as of Feburary.

Let's see how Lehman is doing at present. They have about 4% equity on the books as of their last quarter posted at the end of May, and a book value of $28/share. If we use the Bear Stearns buyout as a measure and Lehman gets bought out at an eighth of book value, we'd expect someone to come in at about $3.50 a share, which is right about where Lehman is trading at $3.65.

So, eventually, someone should step forward and buy out Lehman for about the current price. It isn't that they're bankrupt right now, but they're getting close enough to it so that other financial players don't want to get left holding the bag on assets that will get tied up in bankruptcy court.

Keeping the Mort out of Mortgage

The writ (of election) hit the fan this morning in Canada¹ but the **** hit the fan in Washington this afternoon; the US government has taken control of the two main US mortgage guarantors, the Federal National Mortgage Association (a.k.a. Fannie Mae) and the Federal Home Loan Mortgage Corporation (a.k.a. Freddie Mac). Fannie and Freddie served as a secondary market for mortgage loans, buying them off of banks and either guaranteeing and packaging the mortgages to investors or issuing bonds to finance their acquisition of mortgages.

The companies were set up as privately held corporations acting with the government's blessing to create secondary markets with the ability to borrow at governmental rates. Freddie has negative common equity as of the end of June, and Fannie was down to 2% of assets worth of common equity as of the end of June.

If the government plays its cards right, this might not cost the government anything. They are planning to buy some mortgages off of them, mortgages that may likely have declined in value in this market. Fannie and Freddie shareholders might not like it, but the financial markets will.

¹-The headline "Canadian PM dissolves parliament" isn't quite accurate. That's the Governor General's job, hence his meeting this morning. Usually, the GG goes along with what the PM wants, so it was effectively Harper's call, but not constitutionally. Or am I reading Canadian law wrong?

Freddie's Not Quite Dead

The stock market might be jittery on Monday; they'll have to be told that it's Bernie Mac who died, not Freddie Mac.

Freddie might not be that far behind. They have $12 billion in equity as of the second-quarter ballance sheet as of 6-30-08. Given that they have $800 billion in assets, it won't take much of a loss before they might need some help. Their market cap (what you can buy the company for at the current stock price) is down to $3 billion, so the market is writing things off quite a bit, giving a market-to-book ratio of about 0.25.

That's a very bearish sign for a stock, for you should be able to quadruple your money if you bought all the stock, sold off the assets and paid off the creditors.

Is there more than $12 billion in losses coming for Freddie? Possibly. Will the federales come in with an equity investment if that happens or comes close to happening? Possibly.

The stock market is assuming another $9 billion of red ink as their over-and-under on Freddie, or a generous buy-in from Uncle Sam to bail out both Freddie and their investors.

Mortgage Musings

It looks like we're going to get a mortgage reform bill through Congress that the president will sign. It passed the Senate 72-13, so it seems rather bipartisan.

Most of the stuff in the bill isn't a budget-buster. One of the more common-sense approaches is to allow the FHA to issue new mortgages to defaulting home-owners if the mortgage holders would agree to write the loan down to 90% of the value of the house.

In many cases, people got into houses either with teaser rates or low ARM rates that went up back when short term interest rates spiked last year. This will allow some of those folks to get a long-term fixed-rate loan that makes since; the FHA insurance will largely be self-financed.

Many of the changes seem solid, like giving Fannie Mae and Freddie Mac better oversight, upping the down-payment needed on a FHA loan from 3% to 3.5% and raising the size of mortgages that Fannie and Freddie can insure.

The one that seems a bit problematic is the $7500 rebate to first-time home buyers that will get paid back at a $500 year clip over 15 years. That's tempting to me: I buy a house and Uncle Sam zeroes out one of my credit cards. As a renter who would likely qualify as a first-time home-owner, that might get me house hunting.

However, the logistics of getting that $500/year back from folks is likely to be problematic and be the source of much liberal weeping, wailing and gnashing of teeth in the years to come. There will be pressures to waive that payback in the future.

There are some nanny-state flourishes that the right side of the Peanut Gallery won't like, but this seems to be a reasonable package to shore up the mortgage system.

Financial Overload-Part I

Tons of stuff is happening in the financial arena, and it's starting to blow a gasket as I try to process everything. On the good side, oil dropped $6/barrel today, which might get gas prices back under $4/gallon.

This Bud's for Fern'ers-Anheuser-Busch has agreed to be bought out by Belgium-based InBev; Becks and Stella Artois are the most prominent InBev products. I'm not a beer drinker, so I don't have a dog in the fight. However, it will give more jingoistic beer drinkers pause to know that their Bud is now owned by some financial muscles in Brussels.

I think it was a Miller ad campaign where they had faux football refs flagging foes for freshness violations. In one ad, they threw the hankie at a shipment of Bud, where the AB rep retorted "You can't flag the King!" A few folks are hollering "You can't buy the king!"

I'm not going to agree with Clair McCaskill on too much, but the weak dollar did make this deal feasible. American investments are cheap with the week dollar; we saw a Lexington horse auctioneer sold to a Dubai firm recently.

IndyMac, when are you comin' back?-Yesterday, as it turns out; the California-based bank was the second largest to be closed by the FDIC on Friday, but was quickly returned to operations under FDIC ownership Monday.

If you had five figures or less in the bank, things are normal; the FDIC covers deposits up to $100K. If you had more than that in IndyMac, you may get a bit of a "haircut" if the assets aren't worth the liabilities.

Personal finance 101- you shouldn't have more than $100,000 in a bank for a number of reasons. The lack of FDIC insurance is one, and the fact that you should have the money where you can get a better return if you have that much money is another. Ten or twenty thousand in CDs and money market funds might be a OK place for rainy-day funds, but any more than that should be in some form of stock or bond or mutual fund investment.

You can't sue a member of congress for doing something stupid, but if you could, the IndyMac shareholders and depositors could roast Chuck Schumer slowly over a mesquite flame. Yes, the bank had its problem, but Schumer basically yelled "fire" in a crowded building over some crepes Suzette.

I'll get to Fannie and Freddie later;  FIN 510 beckons.

Salt of the Earth

The boys at the "Pink Palace" on Abbott Road in Midland have been busy; Dow Chemical just bought Rohm and Haas; despite the very Germanic name, it's an Philly-based firm founded by a couple of German immigrants a century ago.

The $78 per-share deal includes money from a Kuwaiti sovereign wealth fund and Warren Buffett's Berkshire Hathaway. The price represents a 74 percent premium to Philadelphia-based Rohm and Haas' closing share price of $44.83 on Wednesday. The Haas family, descendants of one of the company's founders, holds about 65 million shares, a 33 percent stake worth nearly $5.1 billion based on the purchase price.

Chief Financial Officer Geoffery Merszei said the quality and reputation of Rohm and Haas' businesses, brands, products and technologies _ as well as its work force _ make the premium worth paying.

One of the interesting footnotes in the deal is that Rohm and Haas own Morton Salt. That rung some bells for this Midland kid, for it was brine wells in Midland that brought Herbert Dow up from Cleveland to set up his first chemical plants a century ago.

I'm not sure if it's good for Dow stockholders; a 74% premium is rather stiff, but when I see Berkshire Hathaway in on the deal, it makes me breathe a bit easier. Buffett may have his head up his keister on macroeconomics, but he knows his finance and is loathe to overpay for a takeover. The $78 takeover price divided by it's current earnings per share of $3.14 give R&H a P/E ratio of 24.8; that's a bit steep compared with other chemical companies, which are averaging 13.2.

At minimum, it will make sure that Dow continues as a major independent player in the chemical market. Part of the unique nature of Midland is that we have a major corporate headquarters in a town of 40,000, which brings a lot of money and a lot of culture that wouldn't flow to towns of similar size. If it just became a factory town and the corporate part was shifted somewhere else, Midland wouldn't be Midland.

This takeover makes it harder for anyone else to take Dow over, and that's good for Midland.

We Windfall Down, We Get Up

Here's a list of five companies financial data for the last five years (in millions of dollars). Which ones look like they deserve the windfall profit treatment that is being proposed by many on the left, including both senators Clinton and Obama?

                                                                                                                                                                                                                                                                                         

		2007	2006	2005	2004	2003
Company A	Total Revenue	51,122.00	44,282.00	39,788.00	36,835.00	32,187.00
	Net Income	14,065.00	12,599.00	12,254.00	8,168.00	7,531.00
	Net Profit Margin	27.51%	28.45%	30.80%	22.17%	23.40%
Company B	Total Revenue	291,438.00	274,316.00	245,486.00	196,604.00	168,508.00
	Net Income	20,845.00	22,315.00	22,026.00	17,090.00	12,941.00
	Net Profit Margin	7.15%	8.13%	8.97%	8.69%	7.68%
Company C	Total Revenue	220,904.00	210,118.00	198,200.00	155,300.00	121,277.00
	Net Income	18,688.00	17,138.00	14,099.00	13,328.00	7,230.00
	Net Profit Margin	8.46%	8.16%	7.11%	8.58%	5.96%
Company D	Total Revenue	16,593.99	10,604.92	6,138.56	3,189.22	1,465.93
	Net Income	4,203.72	3,077.45	1,465.40	399.12	105.65
	Net Profit Margin	25.33%	29.02%	23.87%	12.51%	7.21%
Company E	Total Revenue	404,552.00	377,635.00	370,680.00	298,035.00	246,738.00
	Net Income	40,610.00	39,500.00	36,130.00	25,330.00	21,510.00
	Net Profit Margin	10.04%	10.46%	9.75%	8.50%	8.72%

Companies A and D seem to have far higher net profit margins that the other three; D's profit margins have tripled over the last four years, while A has stayed disgustingly high throughout the period.

Companies B, C and E have seen their net incomes go up in the last four years, but they've been much less profitable, with only E managing to break a net profit margin of 10%.

It would seem that A and D would be the companies with excess profits, charging far more than things cost them.

Unfortunately, company A is Microsoft and company D is Google. Company's B, C and E are BP, Chevron and Exxon.

These big oil companies are making big profits, but mainly due to the fact that the cost of their products have roughly doubled. If you double sales, you'd expect to double profits; if you doubled sales and kept the total net income the same, why go through all the extra work and risk to do the extra sales?

We don't see Barack and Hillary screaming about Bill Gates gouging folks for Windows Vista or Office 2007 or see congressmen looking to have Google cut their advertising fees they charge. Yet they're making more of an economic profit than the oil companies are.

Windfall profits taxes wouldn't cut gas prices; it would actually raise them in the long run, by discouraging the big companies from investing in new projects that would bring more supply to the market. You'd merely get a wealth transfer from stockholders of oil companies to the US government. It's one way of raising money in a politically-popular manner.

The problem is, there really isn't much of a "windfall profit" in the mix; if you're taxing income over X billion dollars extra, as the likely format would be, you're merely taxing bigness. If the threshold was $10 billion, watch Exxon's $40 billion in income morph into four or five Mini Tigers each making $9 billion.

Thankfully, such proposals are election-year talk that won't be translated into law, at least while Dubya's sitting in the Oval Office. 2009's another matter, but even then, the logistics of such a law will make it hard to pass and harder to actually get any money out of, since Big Oil that would be big enough to be tax will become Not-Quite-That-Big-Oil via spinoffs in a hurry.

Liquidity Traps and Snares

2.25%. That's the new Fed Funds rate, dropped by 0.75% today. That wasn't even the big news of the week to date, which was the Fed-shepherded takeover of investment bank Bear Stearns by JP Morgan.

The low Fed Funds rate (that's the rate banks lend Fed deposits to each other at) brings to mind the monetary theory concept of a liquidity trap, where the Fed or other central banks drops rates down to near-zero, but the economy doesn't budge. Once you've got the Fed Funds rate down to near zero (we're not there yet, but we only have two more of these 75-basis-point jobs before a third would take us to zero), Bernanke and friends have shot their wad on interest rates.

Liquidity has different meanings in economics and finance. In monetary policy econ, it's having the right amount of money in the system; a tight monetary policy would have not enough liquidity in the system, while a loose policy would have too much liquidity. You want things lubricated, but not so much so that you get a truckload of inflation.

What the Bear Stearns case was about was a different type of liquidity issue, one of being able to sell an asset at fair price quickly. For instance, your house is less liquid than a share of Microsoft stock; you can call your broker and get the MS stock off your hands at the market price in a matter of minutes, but it may take weeks or months to get a fair offer for your house. If you're willing to take a 20-30% hit, you might be able to sell your house today, thus a house isn't overly liquid an investment.

We'll talk about liquidity risk in an investment, but normally, it's in the form of an obscure investment, like a very small stock or an small-town municipal bond that will be hard to find a buyer for on short notice when compared to a bigger known issuer. However, what we're seeing in a lot of the mortgage-based securities that Bear Stearns was issuing are investors not quite sure how to value the underlying investment and staying away from them in droves.

We're used to seeing markets work in most every case; sometimes, the price will drop like a stone, but eventually, buyers will be found at the right price. However, there's enough uncertainty with some of the Bear mortgage offerings (you really can't initial Bear Stearns without making a nasty statement) that the investment community wasn't touching Bear's offering with a ten-foot Hungarian. Even the more mundane dealings of Bear were endangered when people weren't quite sure what Bear's balance sheet was worth.

Thus, the lack of liquidity in the mortgage market caused the Fed to step in, guarantee part of Bear's portfolio and arrange a shotgun marriage with JP Morgan. The Bear got snared in this new liquidity trap.

We might need some sort of sub-prime Fannie Mae, doing for that sector of the mortgage market what Fannie does for the conventional mortgages, bundling them, insuring them and packaging them to mutual funds and institutional investors. The markets didn't trust Bear Stearns to do the job.

Is this a valid "bailout" for the Fed? Yes, if you think through what would have happened if Bear were left to stew in its own natural juices. A Bear bankruptcy would be exceedingly messy, as assets and liabilities of Bear's on other firm's balance sheets get frozen, a cascade effect might bring down a number of other firms as well.

The scenario that comes to mind in comparison is Chrysler. A Chapter 11 Chrysler in the early 80s would have very ugly for Michigan and the US economy. A Chapter 11 Bear Stearns today would be almost as bad, even worse when you consider what the trail of repurchase agreements might take out. The US government made money off of the Chrysler deal in 1979 and the Fed might make money off of the Bear Stearns deal, so it might not even cost us a dime in the long term.

Is the Fed rewarding risky behavior, the "moral hazard" that has been bandied about in the financial news this week? Buying out a firm that was trading for over $100 a share not that long ago for $2 isn't much of a reward.

The question that comes through my mind as a finance professor is whether Wall Street got a bit too far ahead of itself. Creative finance is often, if not usually, a good thing. However, creativity occasionally shanks one into the trees, and the SEC, the Fed and other regulatory authorities might want to think through whether there might have been some backstops that could be used to stop future debacles.

On the other hand, what the Fed just did might be just enough of a backstop. "Let 'em play" and occasionally step in to clean up a mess in as market-friendly a way as possible could be a valid reply.

Lots to think about there for the finance prof this week.

The Benefits of a Deficit Hawk

I just got done with my International Finance class this evening, and I gave them the following question to kick around-

Group question 4: Deficit hawk John McCain does well on Super Tuesday February 5th; world financial markets think that he’ll do a better job at reigning in the US deficit than his more supply-side inclined GOP foes.

How should the dollar react to that electoral news?

All else being equal, and assuming that the statement above is true (and I think that it is a fair statement), the dollar would tend to rise, since markets would be expecting that we'd have a better chance of reigning in the budget deficit. That would mean that we'd need to raise less funds overseas, driving down the supply of dollars in the foreign exchange markets and raising the value of the greenback.

We could use the help, since about that time, those drunken sailors of the Potomac Navy (as McCain might put it) will be passing some sort of stimulus package. While such deficit spending may help the economy if spent (the consensus in my class tonight was that it will be either saved or used to pay bills), deficits will require more debt, which means more borrowing, some of which will be by foreigners, which will drive the value of the dollar down.

The postive McCain effect would be expectational, while the stimulus effect would be real; the irony would be the markets would be seeing the expectation of future deficit decreases along with the reality of mad spenders inside the Beltway. One can only hope that they cancel each other out and the dollar doesn't continue down the crapper.

Talk of tax cuts on the Republican side of the aisle may be good long-term economics, but it isn't good short term geopolitics, especially in the currency markets. So as the right side of the Peanut Gallery trashes the Bull Moose, note that he might make gas a tad bit cheaper if he does well next month.

Black Monday +20

I can remember this day 20 years ago. I was coming back from Saginaw Valley State after a 3PM Financial Management class that Monday afternoon. As I was pulling into Midland and channel surfing on the radio, I caught the tail end of the stock report on the local radio station; all the stocks were tanking 20% or so.

I was no financial expert, being in the process of taking my first finance classes, but I knew enough to know that something had hit the fan. I was living with my parents at the time, and my dad was already back from teaching at Midland High. The first thing out of my mouth when I hit the door was "what the heck happened today?"

What happened was the worst day in market history, as the Dow Jones Industrial Average tanked from 2,246.73 on the previous Friday's close to 1,738.74, a 22.6% hit. It wasn't just the Dow; the S&P 500 took a 20.5% belly-flop as well.

Today, the stock market went down almost as much today in nominal terms, 367 as opposed to the 508 of Black Monday. However, that was only a 2.62% drop, since the Dow is well above 13,000, even after its tumble today.

Many things have changed in 20 years, including how we did stock research. Rather than thumb through Value Line at the library, who updated stocks on a quarterly basis, you can hop onto finance sites like MSN Money or Yahoo Finance and get up-to-the-minute information and a slew of financial data; Yahoo even lets you download daily stock price results in spreadsheet form.

However, even though things have changed, what hasn't changed is that stocks are still a great long-term investment. The DJIA has gone up almost eight-fold since Black Monday, a steady 10.8% annual clip, a good return even despite the index not counting dividends.

Big Pool o' Money

The GM-UAW strike was short-lived; they settled after one day of striking. Maybe the UAW needed the practice and wanted to make sure how to do a strike.

Here's the interesting part; they are taking their retiree health care benefits off-balance-sheet by setting up a UAW-run investment fund to finance it-

GM and the UAW said they had agreed on a precedent-setting contract that shifts $50 billion in retiree health care obligations from the company to a union-run trust and establishes a two-tier wage system in GM's U.S. plants.
...
The retiree trust is at the core of the agreement. GM will infuse the fund with about $35 billion -- around 70 cents on the dollar -- in return for erasing retiree obligations from its books. The arrangement is expected to translate into a significant increase in GM's credit ratings, resulting in a corresponding decrease in borrowing costs.

That's going to be one large chunk of change to manage. If it were a mutual fund, it would just miss breaking the top 25; per Marketwatch.com, the 25th largest fund had $38 billion in net assets.

However, that's a piker compared with CalPERS, the California state employees retirement fund. Per the Wikipedia for CalPERS, they had $250 billion invested as of 6/2007.

Will the GM fund be active in cleaning up corporate governance like CalPERS has? Will it be politically charged, where they invest in union-friendly businesses only?

However it works, the UAW has a big chunk of change to manage.