The Daily Reckoning PRESENTS:
we take a brief pause from our usual format. For the next two days we will surrender the floor to our friend and colleague Dan Denning, substituting our usual guest essay for a few more notes and insights. Read on…
*** Helicopter Ben and Bazooka Hank…Fire at will…
*** Buying common for less than intrinsic…and more!
Greetings from the Lucky Country. We are hard at work where the rubber
meets the road in the China-resource boom (the coal/iron
ore/gold/bauxite/vanadium/molybdenum rich Aussie outback).
Along with you, we wish the U.S. crew and Bill best of luck in releasing
I.O.U.S.A. into the wild today. It’s a timely movie on an important
subject. And Addison has much better hair than Al Gore.
In the meantime, the markets are in full swing. And since the sun never
sets on The Daily Reckoning Empire, allow us to take a look at the scene
and tell you what we see: a gunfight.
First, it looks obvious now that Henry Paulson is outgunned. Remember in
July the U.S. Treasury Secretary said that if it was clear to the market
that the Treasury COULD buy convertible preferred shares in the GSEs, it
would probably restore order and prevent any more naked short selling and
the total collapse of the U.S. housing market. Taxpayer money would not
have to recapitalize Fannie and Freddie.
Paulson told Congress that a new regulatory arsenal for Treasury and
`Helicopter Ben’ at the Fed would be enough to turn the psychological tide
(ignoring the fact that it was solvency problem, not simply a poor frame
of financial mind).
“If you have a squirt gun in your pocket,” Paulson told the Hill, “you may
have to take it out. If you have a bazooka in your pocket, and people know
you have a bazooka, you may never have to take it out.”
Freudians discuss.
In the meantime, to paraphrase Jim Malone (Sean Connery’s Irish Cop in The
Untouchables), never bring a squirt gun to a gunfight, Mr. Paulson.
What the market really wants to know is what the Treasury is prepared to do.
And so the market has called Paulson’s bluff. “What are you prepared to
do,” it asks?
*** Shares of Fannie Mae fell 26% yesterday, while cousin Freddie was off
22%. The death/nationalization watch for the GSEs is now on round the
clock. But what does it mean for U.S. investors? And what happens next?
As the Barron’s story pointed out this weekend, both companies are
effectively insolvent. But the charade that everything’s just fine
continues.
One reality check may come soon. Fannie has nearly US$120
billion in debt that matures by the end of September.
Freddie has US$103 billion in debt.
Can the GSEs roll it over?
Who’s going to buy it? The Russians? Central banks? Private equity? Bueller? Anyone?
If the GSEs can’t fund their operations or roll over their debt, what
point is there in having a government sponsored mortgage lender that
cannot provide liquidity in the secondary mortgage market?
We shudder at what this means for the U.S. housing market…but the phrase `lower
prices’ comes to mind.
Facta, non verba. Deeds, not words.
Paulson hoped that by publicizing the fact that the Treasury could buy
equity in the GSEs and recapitalize them, it wouldn’t actually have to do
anything. He wanted all of the benefits without any of the risks and
actions. That pretty much sounds like the ethos of America’s financial
economy in the early 21st century.
Harry Callahan had a .44 Magnum, the most powerful handgun in the world.
And the punk he was chasing down didn’t know if Dirty Harry had fired five
shots or six. It was a gamble the punk didn’t take because the magnitude
of an imprecise calculation would result in a large hole in his head.
The difference here is the market knows that without direct
nationalization, the GSEs won’t last the month, and perhaps not the week.
Common equity shareholders (those that are left) are headed for the
gallows. This particular verbal weapon: “Hey if we really need to, we’ll
buy $25 billion in preferred convertible” – ended up firing blanks.
*** But what happens if the Treasury steps in now?
We don’t know yet. We don’t know if it will restore any stability to the mortgage market. We’re pretty sure it won’t arrest the fall in U.S. home values. It may even
precipitate a blow out in the spreads on GSE debt versus Treasuries, forcing the Feds to bring GSE-guaranteed debt onto the taxpayer balance sheet.
About the only thing you can be reasonably certain of this week is that
the direct assumption of GSE liabilities should be a negative for the U.S.
dollar. Even if the Feds reorganize the company, liquidate the riskiest
assets, and refloat it as a public company…there’s a lot of uncertainty
for two of the largest financial institutions in the country.
Markets don’t like that.
On the other hand, there is always the remote possibility that the
appearance of a resolution to the decline and fall of the GSEs will give
the stock market a shot in the arm. Irrational rallies are frequent when
you are in a permanent state of crisis, as the financial markets now seem
to be.
But it all seems to be reaching a crescendo this week, doesn’t it? In the
bigger picture, that crescendo sounds like this: debt-financed consumption
is not a long-term strategy for economic success.
A minor, but building theme, might be this: buying common stock for less
than underlying value (intrinsic value, net tangible value, or earnings
power) is a sensible investment strategy.
Translation: keep your eyes on the resource prize. All stocks (commodity
stocks included) are in for some volatility as the financial markets wait
to see which dominoes fall next. But the selling in equity markets simply
makes some resource shares a lot more attractive. This is assuming, as we
do, that the trends of urbanization and industrialization and rising per
capita incomes in the emerging world will not be derailed by the collapse
of America’s Ponzi finance).
*** One interesting question: High in their bazooka-armed helicopter, do
Paulson and Bernanke have quick enough trigger fingers to prevent
deflation in financial assets from precipitating more selling in stocks
and more failed small and regional banks (as the assets on those balances
are market to market and liquidated)?
Our guess, although it is not a happy one, is that they do. The Fed is
becoming a buyer AND a lender of last resort. It will manage the great collateral laundering in the financial markets, exchanging Treasuries for
mortgage-backed securities and other dodgy debt. It can do this by
expanding its balance sheet as much as it needs to in order to accomplish
the task, something it has not yet begun to do
“I have not yet begun to defile myself,” as Doc Holliday says in
Tombstone.
*** Meanwhile, we don’t reckon there’s any real need to worry about
“pushing on a string.” That phrase refers to the inability of Fed policy
makers to get money into the system by lowering rates.
The futility suggested by that metaphor is based on the presumption that a
middle-man, the bank, is necessary to get credit and new cash into the
hands of people who will use and abuse it. If the banks won’t pass the
Fed’s easy credit on to consumers and corporations, then interest rates as
a tool for deflating away debts aren’t effective. So the theory goes.
But the stimulus package from last year showed that the government is more
than willing to bypass the banks entirely if it needs to. Treasury can
simply write checks to Americans, or, through the wonders of the Internet,
make direct deposits into your bank account. That’s how our stimulus check
arrived this year…although that probably means the money can be taken
away just as quickly and easily as it was given, can’t it?
Drug dealers always give away free samples to get users hooked. After
that, it’s easy. Debt is addictive and destructive. That’s what makes the
behavior of our money pushers so revolting and morally reprehensible.
They’re a bunch of pushers in suits.
Mailing checks to Americans is a direct stimulus. But it’s a desperate
measure. When you are that transparent about so-called “wealth creation”
and “economic growth,” the nature of the system is exposed for anyone who
cares to see it. Markets care.
That means it probably can’t go on for long until people begin to lose
confidence (which happens when you lose purchasing power quickly).
Dollar-denominated assets should fall as Bazooka Hank fires away. So
should the dollar. Gold and silver, we reckon, have taken plenty of heavy fire in the last month, but will come out of all this looking like they always do: shiny, durable, and like real money.
But even then, there will be another wave of fiat fraud. Public spending
can be ramped up indirectly with an increase in the kind of massive public
works that FDR pursued in the 1930s. President Obama/McCain better start
working on some new agency acronyms.
National Rail System (NRS)? Check! New Manhattan Project For Oil Shale
(NMPFOS)? Check! A War To Rebuild America’s Infrastructure (WTRAI)? Check!
The checks are in the mail America! Spend all you want. We’ll make more!
Our point?
The GSE nationalization may be a kind of starter’s pistol which causes the
Fed and Treasury to roll out all their inflationary guns…and fire at
will. Stocks appear to be caught in the crossfire. They’re falling as
financial assets deflate. But some stocks have tangible assets. What does
that mean for resource stocks? More on that tomorrow.
Regards,
Dan Denning
The Daily Reckoning
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