Britannia Radio

Tuesday, March 24, 2009 Another milestone on the road to ruin... There will only be one winner from the Geithner Plan... A “Katrina moment” for Obama...why the Chinese are unsettled... Barry Ritholtz on America’s nationwide belt-tightening...and more! Another Day, Another Trillion Dollars By Bill Bonner London, England Another day...another bailout...another rally on Wall Street... And another milestone on the road to ruin. “Geithner plan welcomed,” says the headline story in today’s Financial Times. “Stocks rally on news of toxic assets proposal,” continues the commentary. Stocks did indeed rally. The Dow rose 497 points...putting some bounce back in the bounce. We’ve been expecting a healthy rebound. Normally, after such a long and steep sell-off, you can expect a rebound that recovers 30%-50% of the losses. We have not had such a rebound...yet. Maybe this is it. Otherwise, the financial news is mixed. House sales in February were unexpectedly high. Then again, prices continued to fall. AMEX looks like it is going to be downgraded...as credit card debt now looks as though it could be heading in a subprime direction. The dollar continues to fall, (to $1.36 yesterday) and gold continues to stay in the same place – around $950. Our intrepid correspondent, Byron King, believes the precious metal has a ways to go yet...see his special report here. But let’s focus on the big news: the Geithner Plan. The gist of the story is that the government will create a public- private fund to buy up to $1 trillion in the banks’ mistakes. These assets will be auctioned off – in a market sustained and supported by public money. This is a “win – win –win” situation, says Bill Gross of PIMCO, the world’s largest bond fund. We didn’t see the rest of his analysis so we’ll have to guess. It’s a win for the banks because they get to clean out their refrigerators. It’s a win for investors because they get to buy the throwaways at huge discounts – with government guarantees – and then they’ll discover that it doesn’t all have fuzz on it. And it’s a win for the government, because it finally gets rid of that nasty odor coming from the kitchen. We have neither the time nor the stomach to look closely at this program. But we don’t have to; even from a distance, it stinks. Why? Because there’s not that much ‘win’ to share out. The assets are worth what they’re worth. By all accounts, they’re worth a lot less than the banks thought they were worth originally. In a better world, the bankers would take their losses, admit their mistakes, and blow their brains out...or at least change careers. In fact, we have a suggestion: they should go into government; there they can make as many mistakes as they like and no one will notice. But this is not a better world; it’s a world that is full of sin and sorrow...one with a fool on every corner...and an ace up every sleeve. There won’t be three winners from Mr. Geithner’s plan. There will only be one. Whatever the toxic assets are worth, they will be sold for either more or less than that amount. If they are sold for less, investors will realize a profit. The banks – and their government backers – will lose because they will have given up an asset for less than it was really worth. On the other hand, if the toxic assets are sold for more than they are worth, it is investors who will lose. Investors’ objective is clear: they want to make money. And they won’t invest unless they think they’re getting the assets for less than they are worth. Bankers’ and the government’s motivations are more complex. Mostly, they just want the problem to go away. So, we’ll put our money on the buyers of the toxic assets, not the sellers. Most likely, they will be the only winners. They will buy the more palatable pieces of meat at good prices; they’ll leave the most toxic pieces for the government. Most likely, the government will be an even bigger loser than it is now. But the government will lose twice. First, it will lose money in the poker game with private investors. Then, it will lose again when its expensive flimflam fails to restart the economy. The banks will be better off once they’ve cleaned out their cupboard. No doubt about it. They will be ready to lend again, right? But to whom? The problem the bank bailout is designed to fix is only a piece of the larger problem...and not the essential piece. Banks have had plenty of money to lend – despite their own toxic assets. The Fed has been willing to give them the most elastic line of credit in history. The problem was not that they didn’t have the money to lend, it was that they didn’t have a creditworthy borrower to lend to. Take the case of mortgage lending. In their vaults, they have billions of dollars’ worth of mortgage-backed assets. They know that those assets are ‘toxic’ because homeowners can’t pay their mortgages and the value of their collateral is going down. So, those mortgage-backed assets are getting marked down to what investors think they might really be worth. But what bank wants to take on more mortgage debt? Housing prices are still falling. And homeowners are still in trouble. Toxic assets are being marked down in ANTICIPATION of the poor homeowner going broke. He still has to go broke...and get back on his feet...before he’s a good credit risk. And that logic applies to the entire economy. Businesses, homeowners, and investors need to clean out their cupboards too, before the credit cycle can turn up again. And that is a very long process.... More thoughts to follow...but first, let’s check in with our team in Baltimore... “In the markets, the buying fervor of this bear trap has reached historic proportions,” writes Addison in today’s issue of The 5 Min. Forecast. “You’re looking at the best 10 days for the Dow since 1938. “After yesterday’s 6.8% shot, the index is up 18.8% in the last two weeks of trading. If history does in fact rhyme, the Dow might be sitting pretty for a while: “The last time the Dow rallied over 18% in 10 days, it held on to most of those gains for over a year.” “In fact, the Dow at 110 in 1938 ended up being a long term level of resistance,” continues Addison. “The market traded flatly for the next four years, briefly dipped below during the worst of WWII, and then staged a sure and steady rally for the next 30 years. “So all we have to do is fight and win another global war, pay down our debts and ignite another phase of industrial production... then we’ll be fervently buying, too.” The 5 Min Forecast is an executive series e-letter that provides a quick and dirty analysis of daily economic and financial developments – in five minutes or less. It’s a free service available only to subscribers of Agora Financial’s paid publications, such as Strategic Short Report. This publication allows subscribers to make gains – no matter what the market does. Learn all about Strategic Short Report by clicking here. Back to Bill, reporting from London... According to Frank Rich in the International Herald Tribune, President Obama may be having a “Katrina moment.” The storm caused by AIG bonuses just keeps blowing out windows and taking off roofs. Bailouts are stupid and corrupt, of course. But they play a key role; they help divert the public’s attention...like a guy who picks a fight in front of a liquor store, while his friends rob it. So far, a poll found that Obama himself has avoided the public’s anger. But the poor AIG executives are being hounded, even at home. Employees are “living in fear,” says one press report, as “busloads” of protesters arrive in front of their Connecticut homes. Then, the TV cameras catch these poor schmucks as they tell their sad stories. “My husband lost his job at the carwash...and now I have to see these crooks living in houses that I could never even begin to dream about.” Here at The Daily Reckoning, we do not envy the AIG crew. Nor do we have any desire to take their money away. They stole it fair and square, as far as we’re concerned. But the lumpen are much less open minded. The House of Representatives actually passed a resolution imposing a 90% tax on AIG bonuses. The measure looks clearly unconstitutional to us. It’s a penalty tax...a Bill of Retainer, specifically outlawed by the Constitution. You’re not supposed to be penalized, after the fact, without due process of law. But who cares? Members of Congress never read the Constitution anyway. And it’s probably better that they don’t. If they took it seriously, they’d have to punish themselves. But while all this wind was passing through the press, the important story was highlighted at Salon.com: “Economists agree: Print. Money. Now.” What worries us is that this is all too obvious and too predictable. The economists agree, because they see no alternative. The real problem is not a lack of money for the banks to lend – they can borrow all they want from the Fed at near-zero interest. The real problem is too much debt. And printing money will help ease the debt burden. On paper, people will owe as much as ever, but it will be a whole lot easier to pay with the dollar going down by 10% ...or 20%...per year. So, print...money...now...is just what the Fed is doing. Bernanke said so. And he says he’ll keep doing it as long as necessary. This unsettles the Chinese, of course. They’ve got $1.4 trillion in dollar assets. They told the United States that they expected it to protect the value of the Chinese holdings. But how can the feds do that? Quantitative easing is an increase in the QUANTITY of money. Generally, an increase in the quantity means a decrease in the QUALITY of it. That’s how it works. And that’s exactly what the feds want. So, the poor feds! Out of one side of their mouths, they had to reassure their biggest creditor that they’d protect the value of the dollar...while out of the other, they have to reassure the markets that they will create enough inflation to get the economy moving. They are caught between Scylla...and Charybdis...on the one hand the rock of deflation...on the other, the Chinese. What can they do? Our guess it that they are aiming to muddle through...with just a little bit of QUALITATIVE decline in the dollar – not enough to cause the Chinese to panic – but enough to get U.S. consumers, investors and businessmen to loosen up. Good luck to them. But there’s no such thing as a controlled “run on the dollar.” Once investors start running for cover, it’s every man for himself. And who knows where it will end up? Foreigners are already exiting U.S. agency debt. It wouldn’t be very surprising that they suddenly rush for cover from all U.S. dollar debt. Therefore, is it not obvious that the dollar will fall? And bonds will be crushed? And gold will rise? Almost too obvious. Still, we now have taken down our “Crash Alert” flag for the stock market. But we hoist another one: a Crash Alert flag for the dollar. The horror! The French leftist newspaper, Liberation, convened a forum of intellectuals to discuss how to get the world economy out of its funk. University professors, social workers, journalists – hundreds of them. We’ll wager that not a one of them had a clue about what is going on...and every suggestion they made would make the situation worse. Meanwhile, we were surprised to see that the leftist English newspaper, the Guardian, actually shares our critique of the bailout efforts. “The rich need a dose of capitalism,” writes Andrew Lilico. “Capitalism punishes those who invest in companies that fail.” Well...that’s the way it’s supposed to work. But the meddlers, improvers, and chiselers are out in force. And what’s happening in that heart of financial darkness, Zimbabwe? The Guardian also reports that children are eating rats to survive. For many, only gold is keeping them from starving. Unfortunately, they don’t have much gold. The Zimbabwe inflation rate is still running around 230 million percent, despite recent reforms (we don’t know what happened after the government took 13 zeros off its currency; maybe it’s putting them back). So, the only reliable money is either foreign currency – or gold. Many people are panning for gold in the few streams where it is present. Until tomorrow, Bill Bonner The Daily Reckoning ----------------------- Special Offer ------------------------- Your Weapon Against Financial Wipeout You won’t see a penny of the trillions of dollars in bailout money in your personal accounts, but all is not lost for your financial future. You don’t have to follow in the United States’ footsteps and financially unravel...there are tools available to you to help protect yourself and your assets in our "Emergency ‘Personal Bailout’ Bundle" – which we are offering you for free. In this bundle, you’ll learn not only how we got into this mess in the first place, but also a strategy for getting out: a carefully laid-out plan that includes a direct and personal cash "bailout" strategy... plus up to a year’s worth of free "post-crash" stock research. Get it now...click here to find out how. ---------------------------------------------------------------

The Daily Reckoning PRESENTS: For years we’ve been looking at how the binge of luxury spending in the United States would come to a tragic end. Today, we are lucky to have Barry Ritholtz, a name you might recognize from his book, Bailout Nation, The Big Picture blog, or frequent TV appearances, examining this important topic. Below, Barry takes an in-depth look at the belt-tightening happening across the nation. Read on... Downsizing America By Barry Ritholtz New York, NY For the past couple of years, I have been giving a speech at conferences titled Downsizing America. It discusses a fact of life: America’s economy is getting a little smaller. This “shrinkage” is likely to be a secular – as opposed to cyclical – set of changes. But that’s a touch of an exaggeration. What it really means is that U.S. consumers are going to engage in less-conspicuous consumption than they used to. The days of consumers making up 70% of US GDP are likely to fade. I expect to see the economy move back toward consumers being 65% – a sustainable level that existed prior to the credit and housing boom of the 2000s. Out goes the conspicuous consumption of the 1990s and 2000s... Lean and green is in; grotesque and self-indulgent are out. Downsize that McMansion! Replace the SUV with something fuel-efficient! Save, instead of consuming! This is much more than a philosophical view – it’s what all of the economic data over the past year have been practically screaming. This will have a significant impact on the overall economy. And businesses are going to have to pick up some of the slack. Capital expenditures are going to have to do their part as the balance between consumer and business consumption reverts to more normalized ratios. The present environment makes it likely that businesses will focus on investments that can pay for themselves quickly. That means expenditures on items like business intelligence software, ways to become more energy efficient, and the like. "Out goes the conspicuous consumption of the 1990s and 2000s... Lean and green is in; grotesque and self-indulgent are out. Downsize that McMansion! Replace the SUV with something fuel-efficient! Save, instead of consuming!" But that’s just guesswork. In terms of actual data, here is what the new, leaner American economy looks like: Asset Deflation: Equity portfolios are on average down about 40%. Dividends are being slashed, stock repurchases canceled. Even with the recent rally, stocks are off more than 40% from their peaks. And on a national basis, home prices are down 25% Consumer Spending: Down significantly, after the US had its worst Christmas retail selling season in 40 years. The paradox of thrift – people saving at a time when the economy needs them to spend – has turned the savings rate positive. Conspicuous consumer consumption has been replaced with conscious capital conservation Retail Stores: Have been extremely hard hit. Many of the big chains are filing bankruptcy like Circuit City, Linens ‘n Things, The Sharper Image, Steve & Barry’s, Tweeter, Mervyns, and Fortunoff. The survivors like Starbucks, Macy’s, Sears, and Office Depot are closing stores left and right. In many cases, the surviving chains will see as many as 10- 20% or more of their existing stores close. By the time we finally emerge from this recession in 2010, retail shopping will have a much smaller footprint than before Employment: Over 4 million jobs lost already, with anywhere from 2-4 million more to go, the work force and labor pool are also being downsized. Unemployment broke through 25-year highs, to tag 8.1% last month. U-6, the broadest reading of unemployment (including part-time underemployment), was just under 15% in February; this is the highest reading in decades. The only age cohort seeing employment gains is the 55-plus group. This is due to their ugly realization that the market collapse means they cannot retire. Hence, it’s back to work for the silvered-hair crowd Finance & Wall Street: The Street has been hard hit – look for much smaller revenue, with staff cuts of 25-35%. The asset managers that get paid a percentage of assets under management have seen the value of their assets drop 45-50% – and with that comes a revenue drop of the same percentage. Who are the safest players? Those with green profit and losses, and/or substantial assets under management. And who is at risk, besides finance employees? Everyone else Autos: US auto sales have simply plunged. Annual sales are down 37- 50%, depending upon the nameplate – from an annual US rate of 15 million to barely 10 million cars per year. Its not just Detroit, either – Toyota, Honda, BMW, Lexus, Nissan, and Mercedes are also suffering University Endowments: The intellectual engine of America’s brain trust has just taken an enormous hit to the frontal lobe: Harvard, Yale, Stanford, MIT, and others are down 25-30%-plus over the past 6 months alone. These big endowments fund professorships, grants, student scholarships, and pure research. The loss will be deeply felt over ensuing years, and even decades Wages: US wages have been punished by globalization. They have been stagnant over the past 10 years. We are likely to see contractions in wages over the next 1-2 years or longer. This is consistent with our thesis of the downsizing of the US consumer Media: Circulation and advertising dollars at major newspapers are falling. It’s likely that 50% of print newspapers will be gone, or web only, in 5 years. The Seattle Post-Intelligencer just went web only, the biggest such paper to do so yet. Will Fox Business channel, which launched at the peak of the stock market in 2007, manage to survive this onslaught? I’d say it’s less than even money Pharmaceuticals: We witnessed huge 15-20% R&D cuts at several major pharmas (Pfizer’s huge research layoffs most recently). That means staff cuts also. This doesn’t bode well for new drug development and cures; the misallocated resources over the past decade have led to lots of dead ends. I expect to see a lot more consolidation in the pharma area, and more mergers between pharma and biotechs. What is the sum total of all this? US GDP will contract 5-7% in 2009 Q1 and Q2, 2-4% in the second half of 2009, and will flatten in 2010. Back in 2001, we forecast the US economy could hit $15 trillion by 2010-11; that now gets pushed back to 2015-17. There is a silver lining to all of this: First, the unhealthy reliance on credit seems to be going away. We cannot grow by borrowing and spending – but we can grow by producing and spending. Second, the massive misallocation of capital in society has also been revealed. Out goes financial engineering, in comes making money the old-fashioned way – earning it. Lastly, for those of you who managed to avoid the worst of the bloodshed – you may have moved to cash in early 2008 or (God bless) you were short for some of the run downward – this is a “target-rich environment.” Whether you are looking for value stocks, artwork, rare collectible automobiles, or vacation properties – there is many a deal to be had. Those contractors who didn’t return your calls in 2005? They are begging for work. Toxic paper at 10-20 cents on the dollar ain’t all that toxic. And the owner of that 40-foot sports cruiser who can’t make payments is a motivated seller. Note that this isn’t being heartless or greedy. Recessions end when values become so compelling that activity begins to pick up. We are not quite there yet, but we are much closer than we were a year ago. Distressed sales create opportunities for the cash-rich buyer who was cool enough not to chase the top or get panicked at the bottom. Make a low-ball offer and see what comes of it. Who knows, you might even help turn the economy. Regards, Barry Ritholtz for The Daily Reckoning Editor’s Note: In addition to Bailout Nation and The Big Picture, Barry Ritholtz is CEO of FusionIQ, a research firm that provides web-based services to individual investors and traders. Barry knows the world’s biggest firms have teams of professional investors that are faster, better prepared, and have a lot more money at stake than you or I. The odds are really stacked in their favor and against the little guy. The big firms work around the clock with the best mathematicians and researchers around. Everyone’s looking for an edge. Fortunately, Barry offers a unique advantage that’s available at a very special discount to Daily Reckoning readers. Barron’s said his service helps, “determine the strength of some 8,000 publicly traded equities... the most tradable issues and sectors with the lowest component of risk.” In 2008, the service helped Barry avoid a lot of trouble. He recommended selling or shorting Bear Stearns when it was over $100, and very publicly said the same about AIG. He told his readers to sell Fannie Mae over $40 and Lehman Brothers at over $30. While Barry’s contrarian calls caught a lot of grief from fans of those firms, in the end his clients have strongly thanked him. He made all those calls using his unique system called FusionIQ. If you would like to learn more about FusionIQ, he has a very special offer for Daily Reckoning readers...click here.