The equity markets dropped on average 1.5% Monday and this morning another 1.5% decline is underway.  I mentioned, in A Review of the RCM Investment Strategy, the defensive posture we at RCM have taken. I said, “We have deployed our assets in a manner we feel most appropriate for the environment we are experiencing.”

The following news items should help illustrate what was meant when I wrote, “…the environment we are experiencing.”….

Lending falls at epic pace – WSJ

WSJ reports U.S. banks posted last year their sharpest decline in lending since 1942, suggesting that the industry’s continued slide is making it harder for the economy to recover. While top-tier banks are recovering at a faster clip, the rest of the industry is still suffering, according to a quarterly report from the FDIC. Banks fighting for survival, especially those plagued by losses on commercial real estate, are less willing to extend loans, siphoning credit from businesses and consumers. Besides registering their biggest full-year decline in total loans outstanding in 67 years, U.S. banks set a number of grim milestones. According to the FDIC, the number of U.S. banks at risk of failing hit a 16-year high at 702. More than 5% of all loans were at least three months past due, the highest level recorded in the 26 years the data have been collected. And the problems are expected to last through 2010. FDIC Chairman Sheila Bair said banks are “bumping along the bottom of the credit cycle” and that the number of bank failures in 2010 will likely eclipse the 140 recorded last year.

If “Banks fighting for survival, especially those plagued by losses on commercial real estate, are less willing to extend loans” then what do you think will happen when the following development gains steam?….

SAN FRANCISCO (MarketWatch) — Just when they thought the worst of the mortgage crisis was behind them, billions of dollars in bad loans from the debacle may be rising from the dead and creeping back on the balance sheets of the largest U.S. banks.

Big lenders including Bank of America, J.P. Morgan Chase and Wells Fargo may be forced to repurchase troubled home loans from insurers and mortgage-finance giants like Freddie Mac that had agreed to take on risks associated with those assets during the real estate boom.

The banks are setting aside more reserves to cover the potential costs of such repurchases, cutting into earnings….

Read More…

Of course, we can spend all day debating the reasons for banks’ lack of desire to lend, but the real crux of the issue remains the employment picture. The American people, due in large part to the horrible jobs market, are reigning in spending hence needing less credit….

Mass Layoffs Surge In January, Highest Since July 2009

The BLS has reported Mass Layoff Statistics for January 2010 – the result is plain ugly, and kills any hope for sustained improvement in unemployment data. Not seasonally adjusted Mass Layoff Events (defined as at least 50 persons being laid off from a single employer) surged in January to 2,860, from 2,310 in January, from a 12 month low of 1,371 in September 2009. This is the biggest monthly surge since July when the Mass Layoff Events hit a 12 month high of 3,054. In terms of actual workers, January saw 278,679 initially laid off people. The deterioration was mirrored in the much less credible seasonally adjusted data. Obviously companies were waiting for the end of the year to dump as many people as they could.

ECONX Initial Claims Report Suggests a Much Weaker Labor Sector

The initial claims data weakened for the week ending Feb. 20 as the claims figure increased from 474,000 to 496,000. The consensus expected claims to decline to 460,000. Many analysts, including us, believed that inclement weather conditions across the U.S. would prevent many workers from filing new claims. If this scenario is true, then the actual initial claims figure would be much closer to 550,000… Continuing claims rose a modest 6,000 to 4.617 mln for the week ending Feb. 13. The figure for the week ending Feb. 6 was revised up from 4.570 mln, and the consensus expected claims to remain at that previous level… The job creation data looks to be minimal. The unadjusted claims data from Feb. 6 was down by 85,842 claims while the emergency benefits figure declined 317,933 claims. The decline in original claims is mostly due to workers running out of benefits and it seems the weather made it difficult to process extended benefit applications.

Meanwhile, the health of the credit markets remains the number one issue facing the equity markets today.  You may recall my Feb. 18th post ‘Credit Markets Warning Signal, Foreign Demand for US Treasury Falls ‘ in which I outlined the very real possibility that European credit constriction was migrating across the pond. Well, the following stories add credibility to that concern…

Greek Treasuries Pancake As Bond Vigilantes Chant Death Chorus

Ah, curve pancaking – better known in bond parlance as the death rattle. The Greek 4 Year GGB just traded wider of the 15 Year at a spread of -4bps (yup, negative). This, to continue the parlance lesson, means the bond vigilantes are now pretty sure how the Greek situation will play out. Oh, and Greece, all the best with that €5 billion10 year bond issuance. The 1 Year spot his exploded from just over 200 bps on January 1, to just under 5%, a rout for all short-term GGB holders. We are anxiously awaiting RBS’ rebuttal.

Read More…  

California postpones bond sale – WSJ

California One Step Closer To Insolvency After State Cancels $2 Billion General Obligation Bond Sale

Five days ago a great white hope appeared for the great bankrupt Golden State (Baa1/A-), in the form of $2 billion in GO bonds, which were supposed to be promptly syndicated via underwriters JPMorgan and Morgan Stanley. This would have been the first bond sale for California since November: a critical milestone as the state creeps ever closer to a full-on default. Unfortunately, the creeping just turned into a casual jog after Jane Wells (@janewells) just tweeted that California has cancelled its bond sale “after legislature fails to approve cash management flexibility bill [the] Treasurer said he needed to attract investors.”And seriously, did California think it would succeed where so many other high yield issuers have recently failed?

Read More…

I will rest my case today with a request to review my post titled ‘Looming Defaults and the Effect on Currencies, US$ vs. Euro’.  In this post I describe the competitive devaluation process unfolding and the similarities between Greece and California.

Tags: bad loans, California, commercial real estate, credit markets, euro, FDIC, Greece, initial jobless claims, Treasury, unemployment, US Treasury, US$

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Turn off the TV and forget about the newspaper. If you want to understand the equity market gyrations of the last couple of weeks simply log on to an internet service like Briefing.com and watch for updates to the sovereign debt crisis.   Today’s trading is a perfect example of this new paradigm.  The Greek tragedy has turned into a farce as constant rumors have succeeded in whipping the markets into a frenzy.

Markets opened today’s trading on a firmer note because…

Greek bailout speculation lifts euro – Reuters

Reuters reports euro rose on Tuesday on speculation that European Union nations could bail out errant member Greece, while global stocks were flat and emerging market shares climbed. Expectations about a rescue for Greece followed news that European Central Bank President Jean-Claude Trichet was leaving a meeting of central bankers in Sydney early to attend a European Union leaders’ summit. EU leaders will hold a special summit on the economy on Thursday in Brussels amid increasing worries that Greece and other so-called peripheral euro zone economies cannot handle their debts and deficits. Spreads between German 10-year bonds and Portuguese and Spanish equivalents tightened. The spread with Greek debt was steady, but wide at 365 basis points.

…Then things went into high gear when this story hit the wire:

Germany Preparing Aid Package To Greece, FTD Says — Bloomberg

…The above news hit at 11:48, but wait, at 12:41 the following news splashed the wire and markets swooned:

German govt spokesman says reports about decision on aid for Greece are “unfounded” – Reuters

…But cooler heads prevailed and by 2:43 the market regained its footing as…

Germany considering loan guarantees for Greece, other troubled Euro partners, source says – WSJ

My purpose for the play by play of today’s equity action is to illustrate the lunacy of attempting to build an investment strategy based on short-term market swings.

After a couple of weeks of a strong US$ brought on by the Greek situation, I am inundated with comments from would-be experts that the rally in Gold is over.  These same experts, who are convinced they can spot the top in Gold prices, have been unable to spot the best bull market of the last decade. They have not owned Gold during its nearly 300% increase over the last 10 years, but somehow, through a haze of delusional arrogance, they are sure prices have peaked.  

When will Gold prices peak? Don’t know for sure. Trying to pick a price is a fool’s errand.  But I will tell you this: When Gold is, say, $3000/oz and I’m inundated with comments that prices are headed for $6000/oz I’ll be selling.

The following comments exemplify the actual long term trends we believe require scrutiny during the building of an investment strategy.  Yes, sovereign debt woes are a problem, but so are the debt woes of US states.  Running from the Euro into the US$ appears short-sighted and, to us, resembles the hapless effort of running from the deck into the galley of the Titanic. The only real safety (in a world where governments are playing the dangerous game of competitive devaluation and stimulus leapfrog) is the safety of Gold. Please hold onto the bar….    

In a nutshell, toxic assets have basically been swept under the rug in the hopes that we will outgrow the problem. Leverage ratios across every level of society are still reaching unprecedented levels as the public sector sacrifices the sanctity of its balance sheet in its quest to stabilize the dubious financial position of the household and banking sectors in many parts of the world.

Whatever bad assets have been resolved have almost entirely been placed on the books of governments and central banks, which now have their own particular set of risks, as we have witnessed very recently in places like Dubai, Mexico, and Greece, not to mention at the state and local government level in the United States. We simply have not seen a reduction in the percentage of properties with mortgages that are “under water”, hence the FDIC has identified 7% of banking sector assets ($850 billion) that are in “trouble”, so how can it possibly be that the financial system is anywhere close to some stable equilibrium? – David Rosenberg

Tags: EU, euro, FDIC, gold, Greece, investment strategy, sovereign debt, US$

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              As our economy slowly recovers, many investors are concerned with recouping the money they lost during the crisis. Pulling your funds out of investments all together will do nothing to bulk up your savings, while sinking your money into risky funds can do further damage. So, with black-and-white options not offering solutions, where can investors put their money to work?

Many investors are turning to investments that they feel are safe, such as bank CDs or money market mutual funds. The problem with these “safe havens” lies in the low returns. “The average money market fund yields .05 percent, or $5 on a $10,000 deposit.” With rates of return this low, these investments may not be able to keep up with inflation, let alone fill the gaps left by the losses experienced over the last 24 months.

Another option is to do nothing. Yvon Chouinard, founder of the Patagonia sports outlets, says, “There’s no difference between a pessimist who says, ‘Oh it’s hopeless, so don’t bother doing anything’ and an optimist who says, ‘Don’t bother doing anything, it’s going to turn out fine anyway.’ Either way, nothing happens.” The idea of holding on to your portfolio “as is” and wishing for the stocks you currently hold to rebound may work in some instances. But, if time turns out to be your enemy, your retirement years will be funded only by the amount you currently have, minus the effects of inflation.

As investors actively search for ways to re-energize their portfolios, many are returning to real estate. The real-estate market is hovering around the bottom, interest rates remain near record lows and a large inventory gives buyers an abundance of options. On the residential side, many foreclosures and bank-owned properties can now be purchased for a fraction of their value. The same opportunities are becoming available in commercial real estate as owners are unable to pay off or refinance their loans.

As I have mentioned before, real estate can help your portfolio win the battle over inflation. Real estate’s value will return over the next couple of years. When it does, those who invested now will not only recoup their losses, but they will also have the possibility of dramatically increasing their portfolio’s value.

Shaking Our Stone Age Tendencies

Letting our emotions dictate our investment decisions is a risky behavior. Out of instinct, we all get emotional when we earn or lose money. It is in our wiring to feel connected with the money we have accumulated. We tend to panic when our money is in jeopardy.

We make a connection between money and safety. Psychology suggests that we are programmed to protect our safety the same way our ancient ancestors were. Even though we encounter vastly different problems than our ancestors did, we still attempt to solve them in the same way. Moving with the herd used to be crucial to staying alive. Today however, moving with a herd of investors can weaken your portfolio. Pushing money into an investment simply because the majority of others are is usually the exact opposite of what you should be doing.

In the same vein as the herd behavior, is our tendency to make investment decisions based on past success. Just because a strategy worked in the past does not necessarily mean it will work in the present. Markets change dramatically from week to week. Strategies you used in the Dotcom boom of the late nineties may lead to an unpleasant outcome in today’s market. Sticking to market fundamentals is one thing, but taking on blind risk a second time because it worked out the first, is nothing more than a gamble. It is the same concept behind betting on red because the roulette ball fell in a red pocket the previous spin. No matter what your past performance, prudent due diligence is always necessary to gauge the current market trends, analyze risk and make sound investment decisions.

I have encountered a number of studies that suggest we remember the bitter feeling of losing money more acutely than the feelings we have when we earn the same amount in an investment. A few lousy investment decisions and an investor can be turned off indefinitely. It is important to learn from our mistakes and use the knowledge to our advantage. Our emotions can lead us to make decisions that, in hindsight, are horrible ideas. A bad decision is bad no matter what the outcome. Making money out of an emotional decision is lucky, but the decision itself was still the wrong one.

There is no way to completely escape our tendencies to invest based on emotion. But, by being aware of the negative impact our emotions have on our investment decisions, we can limit their influence. Wise approaches such as hiring investment professionals, practicing prudent due diligence and planning sound exit strategies can all help us become better investors.

Bank Closures v. the FDIC

Last week, federal regulators seized seven more banks- three in Florida and one each in Georgia, Minnesota, Illinois and Wisconsin. The bank failures brought the year’s total to 106, which is the most since the savings and loan debacle brought about 181 failures in 1992.  Plus, with 416 banks on the FDIC’s watch list, the number of bank failures is expected to rise before the end of the year. With bank closures quickly absorbing millions of dollars from the FDIC’s Deposit Insurance Fund, is it possible that our savings accounts are realistically still protected?

The FDIC operates like a basic insurance policy, except banks are the customers instead of individuals or groups of individuals. Banks pay insurance premiums to the FDIC in exchange for its commitment to protect their depositors’ money. In the late 1920s, when banks closed at an alarming rate, depositors had no protection from bank failures. Between 1929 and 1933, banks lost an estimated $1.3 billion of their customers’ money. Today, the FDIC protects several trillion dollars worth of deposits. But as of June, it only had $10.4 billion in its deposit insurance fund—down from about $45 billion earlier this year.

The FDIC’s reserves have quickly depleted as the cost of bank failures outpace the fees the corporation collects. Last month, as bank closures continued to mount, the FDIC’s board of directors considered four ways to bulk up the insurance fund. The options considered were: borrow from healthy banks, borrow from the treasury, levy a special fee on banks or collect regular premiums early.

Borrowing from healthy banks would reduce the amount of money available to the private sector. Borrowing from the Treasury could send the wrong message to the public and have adverse effects on the banking industry. Levying a special fee on banks could push those on the edge into failure. The last option, albeit not particularly attractive either, is to collect regular premiums early. Deciding to follow through with this option, the FDIC stated it “adopted a Notice of Proposed Rulemaking that would require insured institutions to prepay their estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011 and 2012.” The press release indicated that the FDIC estimates prepayments will total approximately $45 billion.

Once approved, the proposed prepayments could give banks a bill for three years of premiums by the end of this year. While the requirement would put banks in a tough situation, the FDIC does not seem to think banks will find it too cumbersome. The FDIC believes that “the banking industry has substantial liquidity to prepay assessments.” As stated in the press release, “As of June 30, FDIC-insured institutions held more than $1.3 trillion in liquid balances, or 22 percent more than they did a year ago.”

The FDIC does have the capability to protect our deposits. However, initiatives that charge banks three years’ worth of premiums at once could help the FDIC weather an onslaught of bank closures without requiring the government to print more money…I hope. 

All My Best,

Thomas J. Powell

Tags: asset management, Bank Failure, Billion, CD, commercial real estate, crisis, Dotcom boom, ELP Capital, FDIC, herd behavior, high return, Inflation, insurance, insured institution, invest based on emotion, low return, Patagonia, prepayments, Real estate, registered advisor, residential real estate, risky behavior, Thomas J. Powell, thomas powell, tom powell, Trillion, Yvon Chouinard

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            Documentarian Michael Moore’s latest project, Capitalism: A Love Story aimed at highlighting a number of flaws concerning the economic system upon which our country is built. In his film, Moore infiltrates Wall Street and Washington D.C. to “explore the root causes of the global economic meltdown.” In one scene, he attempts to make a citizens arrest of the AIG board of directors. In another, he drives an armored car to Merrill Lynch and attempts, kind of, to collect $10 billion on behalf of the American people. While searching for answers in high-profile places, Moore asks financial professionals to explain complex terms, such as derivatives. In an attempt to provide this answer for Mr. Moore, I thought I would revisit a scenario I created last year. The following is a fictional example. It never happened, except for in my head.

            There is and always has been stiff competition between Las Vegas casinos. Located miles from the strip, Sin and Tonic Casino relies on clever ideas from their owner, Dale, to increase profits. In the summer of 2005, Dale decided to unveil a ‘Play Now, Pay Later’ program to his loyal customers. Dale’s customers, most of whom rarely left the casino because they had no home or job to maintain, were allowed to gamble and drink while management kept tabs on how much money they were each blowing through.

            The customers told all of their friends down by the river about Sin and Tonic’s new program and soon the casino was always filled to record numbers for the property.

            Dale decided to lower the payouts on all of his table games and slot machines and also increase the price of alcoholic beverages. But, because his customers were not required to pay right away, no one seemed to complain. Dale’s sales blew through the roof and caught the attention of local banks. One bank referred to Dale’s customers’ debts as “valuable” and offered to increase Dale’s borrowing limit.

            With Dale’s customers’ debts as collateral, the bank turned the debts into securities known as Sin-a-Bonds. Soon, the Sin-a-Bonds were being traded on security markets nationwide. Investors across the country, and soon across the entire world, never knew the AAA-rated Sin-a-Bonds were, in reality, the debts of homeless gambling addicts.

            Leading brokerage firms were selling loads of Sin-a-Bonds and their prices continued to escalate at a surprising rate. Everything was fine until pesky risk managers started poking around and demanding the gamblers to start making payments on their debts. On a busy Saturday night at Sin and Tonic, Dale informed his customers that payments needed to start being made that Monday. The remainder of Saturday night and all day Sunday, Sin and Tonic was filled to capacity.
            On Monday morning Dale and his employees were witness to the first day without customers in the casino’s history. Not one of the customers came in to make payments on their debts and the ones that stumbled around drunk in the parking lot claimed they “hadn’t got no money.” Dale told the bank he could not pay back any of the money they lent him and he quickly decided to claim bankruptcy.

            Sin-a-bonds dropped to near-worthless levels and investors lost their money. Plus, the bank that issued the Sin-a-Bonds saw its capital depleted and they were consequently unable to offer any more loans. The bank laid off all of its employees and closed.

            Dale was unable to pay any of his bills and all the companies that granted him payment extensions had to take massive losses, as Dale was their largest customer. The carpet cleaning service was forced to downsize, the vending companies were left with handfuls of damaged machines that no one else was interested in and alcohol suppliers were left with large inventories that could not possibly be consumed without Dale’s heavy-drinking clientele.

            The brokerage firms that sold the Sin-a-Bonds were in heavy distress. Eventually, the government stepped in to save them by creating a bailout package that was funded by taxpayers from states where gambling is prohibited.

            Dale retired from the casino business and is now rumored to be heavily involved in politics.

Absolute Returns Absolutely

            An increasing number of investment firms looking to capitalize on the fears of their investors have started offering “absolute return” funds that boast the ability to always produce returns. Investment advisors are pushing mutual funds that are designed to produce positive returns no matter how badly the stock market is performing. The idea has been around for decades, but now major financial companies such as Goldman Sachs, Dreyfus and Putnam have all launched similar absolute-return funds.[i] In response to the growing group of clients who want to be able to rely on their portfolio’s positive performance, investment firms have started heavily marketing absolute-return funds. But, are these funds worth all the hype?

            Similar to hedge funds, absolute-return funds focus on making money in all market conditions. By taking long positions in stocks and balancing them with short positions of similar value and in similar assets, absolute-return funds aim to produce returns slightly higher than Treasury bills.  In a dropping market, gains on the short positions are meant to offset losses on the long positions. In a rising market, the long positions are supposed to outperform the shorts; therefore producing modest returns for passive investors. If the sheer makeup of an absolute-return fund is not producing, fund managers also attempt to achieve their target by employing a number of different strategies. For instance, short-selling can help offset market falls and derivatives can shield from undesired volatility.  

            Generally, the techniques used by absolute-return fund managers to stabilize your portfolio’s ride are the sort of diversification practices you can do yourself, without having to pay hefty annual fees. In a recent Reno Gazette Journal article, Registered Investment Adviser Robert Barone recommended the following three steps in order to achieve consistent positive returns:

            First, reduce the allocation to equities in your portfolio to the 30-to-40 percent range. Remember to hold equity positions in companies with sound business practices and low levels of debt.

            Second, increase the allocation to fixed income to the 40-to-50 percent range, but keep the maturities relatively short (no more than three or four years to maturity).

            Third, because of weak dollar policies, increase the normal allocation to commodities to the 10-to-20 percent range.[ii]

            The discussion of investment strategies in this article should not be considered an offer to buy or sell any investment. As always, consult an investment professional to assist you in meeting your investment goals.  

A Broken CIT Will Trip up Small Businesses

            On October 1^st CIT announced the launch of a plan which will aim to enhance its capital and improve its liquidity. According to the official press release, the restructuring plan is designed to “ensure continued financing support for small business and middle market clients.” After being denied financial support from the Treasury in July, CIT was forced to create a restructuring plan in order to attempt to sidestep bankruptcy court. But, because of concerns with CIT’s financial stability, the FDIC has forbidden the company from increasing its deposits, which severely limits the restructuring tools in its belt.

            The target of the restructuring plan is to slice CIT’s $31 billion dollar debt load down to about $25 billion. But, some experts have argued that the amount is not nearly enough to persuade the FDIC to again allow CIT to accept deposits. CIT is offering voluntary exchange offers for certain unsecured notes. Current holders of an “existing debt security would receive a pro rata portion of each of five series of newly issued secured notes, with maturities ranging from four to eight years, and/or shares of newly issued voting preferred stock.”[iii]

            The future success of CIT relies on a significant increase in capital. The restrictions imposed by regulators and the troubling credit freeze have created enormous obstacles for CIT. Financial companies, like CIT, without direct access to Federal Reserve emergency loans rely on funding from short-term debt markets. But, with these markets already shriveled, the possibility of finding new debt buyers has all but disappeared.

            With CIT operating in more than 50 countries, it is peculiar that the government did not deem CIT “too big too fail,” as it has a number of other institutions. The last company of this size that was denied a bailout was Lehman Brothers and its resulting bankruptcy filing tore the financial market to ribbons.

            For over a century CIT has been a huge player in providing loans to small and medium-sized businesses. The company has more than one million corporate borrowers; including popular businesses such as Dunkin’ Donuts and Dillards. If (or when) CIT collapses, the biggest problem will be the scores of small businesses that will find it even more difficult to find capital to fuel their ventures. As constantly noted, small businesses are crucial to our recovery. The credit freeze has already built a wall between businesses and available capital. The crumbling of CIT will only exacerbate the problem and highlight the importance of private capital in the marketplace. Without capital, our financial system cannot begin to encourage economic growth, and without growth a recovery is out of reach.

All My Best,

Thomas J. Powell

Tags: absolute return, absolute return funds, AIG, capital, Capitalism: A Love Story, CIT, credit freeze, derivatives, Dillards, Dreyfus, ELP Capital, FDIC, Goldman Sachs, growth, investment advisors, Merrill Lynch, Michael Moore, Not Categorized, powell perspective, Putnam, Recovery, T bills, Thomas J. Powell, tom powell, Treasury Bills, Wall Street

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           As markets continue to produce signs of stabilization over the next quarter, it is unlikely that unemployment figures will show much improvement. With figures the highest they have been in more than 25 years, unemployment appears to have neared its peak. Lowering the rate to levels our economy can adequately support will prove to be a daunting task. But, with a little encouragement the corporate sector certainly has the power to handle it.

            Last week, Federal Reserve Chairman Ben Bernanke was quoted by multiple major news sources after he told the Brookings Institute, “The recession is likely over at this point.”[1] According to Bernanke, the economy appears to be growing, but not at a pace that will be sufficient for lowering the unemployment rate. Historically, economic upturns after recessions have been stamped with consumer demand. This time around, however, many Americans may not have the ability to help lead a recovery because they have been completely wiped out financially.

            In order to spur consumer-led demand, the corporate sector will again have to make jobs readily available. The unemployed are not the kind of consumers that are needed to invigorate our economy and induce growth. We do not need to turn to an economics textbook to tell us that our broken economic cycle can be patched with more available jobs—this much we know.

            Corporations large and small have been forced to adapt to this constricted economy and the majority of them were required to do so through downsizing. Now, company leaders are reluctant to increase their workforce until they are confident there is a significant increase in demand for their products and services. But, one strong possibility that could provide the encouragement needed to get company leaders hiring again is a temporary change in corporate tax policy.

            A temporary tax break aimed at equaling the payroll costs of adding new employees would strip the risk for companies that are awaiting a full-blown recovery before they hire. Plus, according to a recent article published in The Wall Street Journal:

“The impact of a two-year program on the federal deficit would be relatively modest. Using a conservative set of assumptions, an $18 billion annual program, which represents 10% of estimated corporate tax receipts in the next fiscal year could create nearly 600,000 good-paying jobs …”[2]

            Before they commit to hiring, companies are waiting for consumers to spend. But, before consumers commit to spending, they are waiting for companies to hire. The cycle is stagnant and will remain so until one side is persuaded to change their behavior. A government-sponsored tax break for companies that agree to hire could be the first action taken during this recession that encourages our country’s government, companies and individuals to work together.

Capital River is Frozen; We Can Thaw it

            Because of the severe impact of the recession, the stream of capital that once flooded our economy has been reduced to a trickle. The majority of the flow evaporated when banks were forced by the Fed to tighten their lending standards as delinquent loans polluted their books. Consequently, failing to restore the flow is making it extremely difficult for the Fed to take progressive measures toward recovery and has the potential to drop us back into another recession.

            According to Bloomberg.com:

“The Fed’s second-quarter survey of senior loan officers, released Aug. 17, showed U.S. banks tightened standards on all types of loans and said they expect to maintain strict criteria on lending until at least the second half of 2010.”[3]

With dropping values in commercial real estate, rising unemployment numbers and a seemingly unending onslaught of delinquent mortgages; banks are not lacking reasons to practice strict lending measures. Earlier this year, through a series of stress tests, the Fed found that 19 of the country’s largest banks needed $75 billion in new capital to protect themselves from mounting losses.

            With all of my recent writings and blog postings concerning the benefits of getting our private capital back in the game, I am by no means hiding my agenda for restoring capital flow. The economy will only be repaired once the flow of capital is rejuvenated. It is much easier to lead capital tributaries back into the main stream if they are first flowing. Over the next couple of quarters, banks will continue to deleverage and work toward a balanced lending system. But, without raising more private capital, banks will not be able to establish a lending system that enables credit-worthy individuals and businesses to acquire reasonable loans; which puts an enormous restraint on economic progress.

            Our economy is already positioned to attempt to force a jobless recovery, which will certainly create complications in sustaining a recovery. Trying to force a credit-less recovery will only exacerbate our struggles. Dragging our banks through a painful recovery without sufficient capital will only position them to break and lead us right back through more of the same. By identifying ways to put our private capital back into the equation we are positioning our financial system to rise from this recession stronger and more efficient. By investing in private enterprise, we are sparking long-term, mutually-beneficial relationships between capital-producing businesses and banks (while also earning gracious returns on our initial investments). Now is the time to put our private capital back to work.

Without Our Capital, Banks Get the Axe

            Our private capital plays an integral part in our local economies—which then all collectively have crucial roles in our country’s financial stability. Because banks have become over-reliant on easy credit, they are now struggling to keep their businesses running by raising capital the old fashioned way. Without our capital, our banks (and more importantly our communities) cannot function properly. Not able to fulfill their debt obligations, banks are closing their doors and falling under the control of the FDIC; which “estimates bank failures will cost the fund about $70 billion through 2013.”

            Banks are necessary to ensure that money circulates in our communities. They distribute the money of their depositors to borrowers who have a worthwhile purpose for the money. The banks secure our savings and lend the money to companies or individuals. Banks provide a convenient location for borrowers to acquire funds. Without banks, companies would find it very difficult to borrow large sums of money.

While banks perform their role as intermediaries, they also essentially increase the supply of money. By accepting deposits from its customers and loaning the money to worthy borrowers, banks “create” money. Consider the following simple example. Imagine a customer deposits $20,000 into her bank account. Even though the bills are no longer in circulation, the amount of money in our country does not change as a result of the deposit. Allowing the money to simply sit in the bank’s safe would not earn the bank anything. Therefore, the bank lends $10,000 to an entrepreneur in return for an additional interest fee. The depositor still has a $20,000 credit in her account and the entrepreneur has $10,000, therefore the money supply has increased by $10,000. The entrepreneur purchases supplies with the money and creates a product that he sells for a profit. As long as banks have depositors, they are able play their crucial role of increasing the money supply by making funds available to those looking to find backing for their ventures.

            The word “bank” itself is derived from the Italian word “banca,” which referred to the table on which coins were counted and exchanged in the middle ages. “Bancarotta,” from which the word “bankrupt” was derived, means “broken bank.” Originally, if a banker was unable to pay his debts, the authorities arrived to smash his table in half with an axe. Today, the FDIC seizes failed banks and seeks buyers for their branches, deposits and faulty loans—all, for some reason, without smashing anything with an axe.

All my best,

Thomas J. Powell 

Tags: banks, Bernanke, Credit, economy, ELP Capital, entrepreneur, FDIC, Federal Reserve, las vegas, markets, Money, nevada, obama, private capital, Real estate, real estate investments, recession, Recovery, reno, tax, Thomas J. Powell, unemployment

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Cerberus denies talk of fund defaults – Reuters
Reuters reports Cerberus Capital Management yesterday dismissed market speculation that some of its hedge funds, which have suffered losses and heavy redemptions, are in danger of default. Traders in London and Frankfurt were buzzing with talk that a major hedge fund was headed for default. Much of the talk was directed at Cerberus, a private-equity and hedge-fund firm hit hard by losses at Chrysler and GMAC. “There is absolutely no truth to the speculation,” said Tim Price, a Cerberus spokesman.

Where have we heard this type of denial before? Oh yes, I remember, last year with Bear Stearns and Lehman denials to name just a few. We better keep an eye on this story. We learned last year that big hedge fund failures can lead to big problems for the equity markets.

Weak back-to-school sales spell trouble for holidays - WSJ
WSJ reports shoppers are focusing on deals and limiting buying mainly to necessities, based on August sales estimates that herald another tough holiday season for beleaguered retailers. Despite sales tax holidays in several states designed to spur sales, back-to-school spending remains lackluster, according to industry experts.

Retailers’ recent efforts to shake customers from deep discounts and spur buying by tightly controlling inventories are fizzling. Now, retailers that traditionally rely on back-to-school sales as an barometer of demand for the remainder of the year face tough choices on stocking and hiring. Customers should find ever slimmer pickings and fewer clerks (this doesn’t bode well for those thinking unemployment is close to the peak) as stores hold off on early holiday orders and further trim costs…

We have seen an equity market recovery in the first half of this year based on a return to normalcy in the credit markets. Going forward, a new catalyst will need to develop to push the equity markets higher. One such catalyst will be an economic recovery and in turn better earnings in Q3 and Q4. However, stories like the one above cast a pall over a possible economic recovery and raise the question: Can the equity markets continue to move higher if positive earnings momentum does not materialize?

The following two stories add to the shroud being drawn over any possible recovery in Q3 and Q4…

FDIC’s Bair says commercial loans “looming problem” - Reuters.com
Reuters.com reports the chairman of the FDIC said commercial real estate issues will increasingly drive U.S. bank failures. FDIC head Sheila Bair told CNBC Tuesday evening that commercial real estate loans remain a “looming problem” for banks’ balance sheets and she expects the area to increasingly be a driver for bank failures during the remainder of this year and 2010.

Bair said she would try to avoid tapping its line of credit with the Treasury Department. “We’d like to try to avoid that,” Bair told CNBC in an interview… Bair said the FDIC has not yet decided whether to charge the bank industry more special assessments to replenish the fund. She defended the loss-share agreements that the FDIC has extended to acquirers of failed banks, saying the arrangements have saved the agency billions of dollars over the past two years.

Pace of delinquencies for prime borrowers is accelerating – WSJ.com
WSJ.com reports the long recession and rising joblessness are taking an increasing toll on the nation’s most credit-worthy borrowers, who are now falling behind on their mortgage and credit-card payments at a faster pace than people with poor financial histories.

The mortgage-delinquency rate among so-called subprime borrowers reached 25% in the first quarter but appears to be leveling off, rising only slightly in the second quarter. The pace of delinquencies for prime borrowers is accelerating. Since prime loans account for 80% of U.S. bank exposure to mortgages and credit cards, these losses could ultimately exceed those from weaker borrowers. Such delinquencies on mortgages made to prime customers rose 5.8% in the second quarter, compared with a rise of 1.8% among subprime customers. Still, the delinquency rate for prime loans was 6.4%, far below the 25.4% rate for subprime loans, according to the Washington-based trade group.

Periodically I will post the EPS news or other relevant coverage of companies we find interesting. This is not a recommendation to purchase or sell the shares. I will not engage in the hackneyed approach of other bloggers and give advice about when to buy or sell. The purpose of these posts is to give you, the reader, an idea of what companies our research department deems worthy of review.

Tags: back-to-school, blair, cerberus, CNBC, defaults, FDIC, july retail sales, prime borrowers, subprime, treasury department, virtualization, VMW, VMware

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The stories below offer further concrete evidence that major issues persist in the US economy. When making investment decisions, we prefer to place more weight behind this type of data than “leading” economic indicators the government likes to laud and CNBC types love to regurgitate.

The rally in the US$ last week stalled this week right at the resistance of a long-term downtrend. We expected as much and wrote about the move last week. Treasury bonds however continue to rally. The direction of this market is perhaps harder to predict on a short-term basis due to the open efforts of the Fed to buy treasuries and support the market.

ECONX Initial Claims Disappoint
The initial claims report did nothing to support the economic recovery scenario. Initial claims for the week ended Aug. 15 increased to 576,000 from a revised 561,000 in the prior week. The number lifted the 4-week moving average to 570,000 from 565,750. Initial claims are up 31.5% from the prior year. Continuing claims rose 2,000 to 6.241 million. The 4-week moving average fell by 2,000 to 6.266 million. No major layoffs were announced yet 10 states reported increases in unemployment of more than 1,000. When you factor in that continuing claims were expected to slowly run down as unemployment benefits lapsed and not due to new hires, this report shows the labor market is more troubled than previously thought.

Failed banks weighing on FDIC – WSJ
WSJ reports banks in the U.S. that failed in the past two years were in far worse shape than those that collapsed during the industry’s last crisis, a looming problem for the government agency charged with insuring deposits.

At three of the five banks that failed Friday, increasing the total to 77 so far this year, the financial hit to the agency’s deposit-insurance fund is expected by the FDIC to be about 50% of their assets. The biggest hit on a percentage basis is coming from Community Bank of Nevada, a Las Vegas bank with $1.52 billion in assets and an estimated cost of $781.5 million. The failure of Colonial Bank, a unit of Colonial BancGroup that was sold to BB&T Corp., will cost $2.8 billion, or 11% of the Montgomery, Ala., bank’s assets. For the 102 banks that have collapsed in the past two years, the FDIC’s estimated cost averaged 25% of assets. That is up from the 19% rate between 1989 and 1995, when 747 financial institutions were closed by regulators, according to the FDIC.

The agency’s insurance fund already has dipped to $13 billion, with more than 300 battered banks and thrifts still on an undisclosed FDIC list of problem institutions. One problem is that so many banks took risks when the economy was booming, and are seeing their capital dissipate with alarming speed.

Calpers takes another property hit – WSJ
WSJ reports the California Public Employees’ Retirement System has given up control of its stake in a trophy office tower in Portland, Ore., a sign that even the largest institutional investors are cutting their losses rather than throwing good money after some badly battered real-estate assets. The decision by Calpers, the country’s largest public pension fund by assets, to walk from its investment in the Koin Center, one of Oregon’s tallest buildings at about 509 feet, nicknamed the “mechanical pencil” for its signature shape, also shows that leasing problems are cropping up in even the country’s healthier markets. While it is on the rise, downtown Portland’s Class A office vacancy rate was 6.1% as of June 30, below the average of 12.9% for major U.S. downtown markets, according to Colliers International. Despite Portland’s relative health, in July a partnership that includes Calpers and CommonWealth Partners, defaulted on the Koin Center’s $70 million mortgage provided by New York Life Insurance Co., according to court papers. A state circuit court judge approved New York Life’s request that a receiver be appointed to control and possibly sell the property.

Tishman faces office downturn - WSJ
WSJ reports a partnership led by Tishman Speyer Properties is in default on debt tied to one of the largest office portfolios in the Washington area, the latest in a line of humbling turns for the prominent property developer. Tishman Speyer paid $2.8 billion in late 2006 for what was known as the CarrAmerica portfolio, a collection of 28 buildings leased to law cos, lobbyists and other upscale tenants in and around Washington. But in taking advantage of the easy credit terms of the time, Tishman ended up overpaying. With office vacancies rising and rents falling, the partnership has violated lender’s covenants. Tishman also must find a way to refinance the debt when it comes due in 2011, something that analysts say could be a struggle.

Tags: banks, calpers, commercial real estate, FDIC, initial jobless claims, tishman

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RCM Comment: A real battle is brewing in the U.S. equity markets. The proverbial line in the sand has been drawn and the fight is on between bulls and bears. All three major U.S. indices are trading around key psychological support areas: Dow30 8,000, S&P500 800, NASD Comp. 1,500. What hangs in the balance? A move down that takes out the lows of November ’08 or the beginning of a base and stabilization after a terrible start to the new year. On the bullish side we have the government doing all it can to stabilize the markets. Every day another story crosses the tape with a new plan to bailout the economy, rescue banks or give handouts to borrowers under water. When these stories hit the tape the markets obediently rally. Of course, on the bearish side the government took these same actions last year to no avail and the economic and earnings stories continue to illustrate a dire situation. Example: Cisco Systems (CSCO) a bellweather of the economic situation, released earnings yesterday in-line with expectations. However, the company guided next quarter’s revenue number down 15-20% YoY.

So, who will win the war? I will let others guess at this age old question. Remember, the market makes fools out of most people most of the time. We are not interested in making guesses, we are interested in making money and protecting principle. In order to experience success in this business the ego must be left at the door when walking into the trading room. As my high school ice hockey coach used to say, “A net minder must read and react son, read and react.” The same can be said when minding a portfolio.

Ladenburg discusses FDIC request for increased credit line
Ladenburg Thalmann notes that the Federal Deposit Insurance Corporation (FDIC) has requested the U.S. Treasury to increase the FDIC’s line of credit from $30 bln to $100 bln. At last reading, the FDIC still had approximately $35.5 bln of its own. Firm says implicit in this request is a belief that bank failures are now likely to increase.

Reuters reports that it might be possible to modify mark-to-market accounting rules for U.S. banks facing steep writedowns of troubled assets without abandoning the underlying accounting standard, a senior Senate Democrat said. Sen. Christopher Dodd, chairman of the Senate Banking Committee, told reporters on Wednesday evening after a panel hearing that at least one former bank regulator was discussing how to approach the difficult issue without “walking away from” mark-to-market standards. The issue of how to value distressed assets held by U.S. banks has been one of the most difficult challenges in constructing a bank rescue plan, according to industry lobbyists and lawmakers.

RCM Comment: The markets rallied off the lows when this news hit the tape.

Tags: accounting rules, Cisco Systems EPS, FDIC, Line of credit, Mark-to-Market

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