But when the sun disappears and inky darkness fills the sky, Dubai’s cityscape lights up and takes on a magical quality.  Crowds fill its restaurants in the evening, the apple-scented smoke of the shisha in the air. “I love Dubai at night,” my host and friend — let us call him Andy — said as we sat out drinking and chatting on the balcony of his flat. “It’s like something out of Arabian nights.”

Andy is an example of what Addison Wiggin (my publisher and companion on this trip) and I have come to call a Penthouse gypsy. They go where they are treated best, wherever in the world that may be. They have money, own businesses and invest in real estate. They are smart and independent and value their privacy. And they aren’t living in the U.S. or the U.K or Europe.

Andy’s apartment sits on a man-made island in the middle of a man-made lake. It’s called The Old Town Island, even though it’s brand-new, because it looks like a part of old Arabia — or at least the old Arabia of Hollywood and Westerners’ dreams.

The Old Town Island stands in sharp contrast with the ultra-modernity of Dubai’s signature buildings, with their curves and sail shapes washed in multicolored lights. These structures give Dubai the air of an eccentric rich man’s playground. There is a casual indifference to costs. Only the rich could build such things in deserts.

For example, The Old Town Island sits next to the Burj Dubai, which is the world’s tallest building, at 2,684 feet. That’s nearly twice as tall as the Empire State Building. (The Middle East, by the way, held the record for tallest building for 3,900 years — thanks to the Great Pyramid of Giza — before the West took the crown.)

The Burj Dubai hotel will open soon. It is a symbol of Dubai, of its ambition and can-do spirit, its boldness and its wealth. By 2008, Dubai had as much property under development as Shanghai — even though the latter has a population six times as large. Everywhere in the world, there is a tug of war between utility and a desire to build pretty things. In Dubai, though, utility seems to lose. Instead, the goal is to make the largest, longest, tallest — you get the idea.

At the Burj, the smallest suite is 7,200 square feet. The electricity needs of this building in the desert are enough to power a small city. Think of just the power needed to pump water to its upper floors so you can flush a toilet. No wonder Dubai and the UAE (of which Dubai is a part) are starved for power.

No wonder, too, that the UAE has the largest carbon footprint per capita of any place on Earth. People here also use more water — 145 gallons per day — than any other people anywhere. Yet there is no river and hardly any water resources. The water resources Dubai enjoys comes from turning seawater to fresh water.

One question I kept asking myself on this trip was how sustainable all this is or could be. But that leads to some interesting and surprising answers about why Dubai exists at all.

Four Reasons Why Penthouse Gypsies Love Dubai

Don’t assume that Dubai is like Las Vegas, a sort of Arabian Disneyland in the middle of the desert. There was a reason why people settled here long ago — and why the Penthouse gypsies do so today.

The old Dubai actually had the best of the creeks of the southern Gulf. I visited the twisted old creek while in Dubai. Dhows still make their way across the Gulf to Iran, India and East Africa and back again, as they have for centuries. There isn’t a container in sight in this old port. The big commercial port in Dubai now is Jebel Ali — the world’s largest man-made port. But in this old port, goods are offloaded by hand, largely on the backs of Pakistani and Indian workers. The goods are stacked right offshore — sacks of pistachios, crates of cigarettes, boxes of toothpaste and other goods.

Dubai, then, is a port city. Its main business is trade. The ruling sheiks opened up Dubai as a free port to the world — no taxes, no hassles. “Free trade was mother’s milk for Dubai,” writes Jim Krane, author of the excellent City of Gold: Dubai and the Dream of Capitalism. Trade is what made Dubai wealthy. Dubai has more in common with the Venice of the 12th century… or with Singapore or Hong Kong today.

As with all free ports, it has had a history of being a haven for smugglers. Early on, traders would smuggle gold through here on its way to India. Gold, guns, slaves, diamonds, drugs — all ran through Dubai.

Of those, gold is the key driver. Dubai is still called the City of Gold. There are gold souks all over. People here seem to love their gold. While I was there rumor spread that the GCC — along with China, France, Japan and Russia — were having secret meetings in which they were planning to stop pricing oil in U.S. dollars. (The GCC stands for Gulf Cooperation Council and is made up of the six Gulf states, including the UAE.) Instead, a basket of currencies would replace the dollar. This basket would include gold. True or not, it helped generate some buzz in the gold market, sending gold to a new all-time high.

Today’s real boom in Dubai depends on a few key factors, and it’s not all about oil money. After spending some time here, chatting with Penthouse gypsies like Andy, I would boil it down to four successful ingredients:

Low regulations, low tax. This has probably been a Dubai advantage for a hundred years, but people here told us repeatedly how easy it is to set up shop in Dubai and how your privacy is protected. There are also no income, property or corporate taxes. Zero. (The city funds itself with taxes on hotel occupancy, liquor sales and restaurant meals, as well as permits for roads and such. Part of the budget also comes from the Sheikh’s business interests — such as Emirates Airlines and the aluminum smelters.)

In 2002, Dubai allowed foreigners to own property in so-called “freeholds.” That was a big milestone that kicked off a wave of immigration. So now there are these freeholds where the Penthouse gypsies live in high style in very nice communities.

The backlash of Sept. 11. Before Sept. 11, Middle Eastern oil-exporting countries reinvested $25 billion a year in the U.S. After Sept. 11, that slowed to about $1.2 billion a year. Arabs no longer felt welcome in the U.S. and feared what might happen to their wealth. So guess where the money went?

Arab wealth started flowing back to the home countries. The economies of the eight states of the Gulf Coast grew 60% from 2001–08. “Cash poured into Dubai,” Krane writes. And Dubai’s growth rate topped China’s, averaging 13% per year.

Essentially, the repatriation of Arab wealth from the U.S. was a big driver and still continues to be today. As the Middle East region gets wealthier, a good chunk of that wealth will flow through Dubai.

Finally, the UAE fixes the value of its currency to the dollar — at least for now. What this means is that as the U.S. printed dollars, the inflationary effects were exported to Dubai. That put Dubai into trouble. Lots of speculative capital flowed into building islands in the shape of date palms or creating residential communities with robotic dinosaurs from Japan. Now Dubai is suffering through a massive real estate bust as a result (to the advantage of the Penthouse gypsy).

Still, Dubai’s important position in world trade is many layered, like a wedding cake. As Krane writes: “Dubai today is the Middle East’s capital of commerce, one of its biggest recipients of foreign direct investment, its top financial center, biggest port and airport and home of the largest number of foreign businesses.”

Quite a list, considering air conditioning arrived only in 1967. Today, Dubai is a key crossroads on the New Silk Road. It fills the gap between New York/London and Singapore/Hong Kong. And as long as Dubai is kind to money, the Penthouse gypsies will come.

For investors such as you and me, the Dubai story is part of the greater New Silk Road. Dubai’s and the New Silk Road’s booming populations need food, water and power. The increasingly larger cities need infrastructure. Its growing wealth needs a storehouse of value. On this latter front, the Penthouse gypsies we met all prefer gold and/or a mix of currencies, such as Norwegian kroner and Singapore dollars.

Regards,
Chris Mayer

November 12, 2009

Penthouse Gypsies Flock to Dubai was originally featured on Whiskey and Gunpowder

The forward P/E multiple on the broad stock market is not nearly as high as it was during the Internet bubble, but it’s at extreme highs if one accurately diagnoses the unsustainable stimuli currently driving global economic activity.

Just like low-quality earnings paint a misleading picture of a company’s value, this low-quality economic activity destroys wealth and promotes a dependence on sustained fiscal largesse.

Such a diagnosis would filter out how fiscal and monetary policies are distorting the efficient allocation of capital. Investors should interpret government spending as noise and interpret private sector behavior as the signal. In today’s state-sponsored economy, you cannot totally separate one from the other, but it’s still important to acknowledge the distorting influence that stimulus programs have on capital spending and hiring decisions.

What happens when the stimulus wears off? Why, we have even more excess capacity in sectors where stimulus was directed. Exhibit A: cash for clunkers. Exhibit B: the tax credit for homebuyers that will exacerbate the structural glut in housing supply. In the financial media, I’ve seen investor after investor defend these programs as valuable and necessary, which demonstrates their ignorance of sound economics.

We’re propping up zombie institutions, throwing good money after bad, and rewarding incompetence — all at the expense of prudent people’s savings and the capital that will be needed to fund the industries of the future. Top investors don’t tolerate low- or negative-return-on-capital decisions by the executives running their companies, so it’s puzzling to me why so many of these investors advocate the same type of economic malpractice on the part of government policymakers.

The latest sideshow for public consumption — a “paymaster” regulating pay at large banks — is another example of the government’s misdiagnosis of the problem.

Rather than regulate pay in the hopes that it discourages risky banking behavior, we should be phasing out the government guarantees of the banking system’s liabilities. That, I assure you, would discourage foolish risk-taking among bankers. Case in point: Goldman Sachs behaved in a much more responsible, sustainable manner when it was a privately owned partnership without government guarantees, rather than the high frequency trading, TLGP-hogging, heavily lobbying institution that it is today.

Like an addictive drug, today’s fiscal and monetary policies have made everyone feel better, but have further weakened the structural health and sustainability of the economy. If you doubt this, just look at the horror in most investors’ eyes when they are confronted with the prospect of a Fed Funds rate above, say, 2% — up from today’s range of zero percent. The addiction to E-Z credit and government support everywhere you look is one of the clearest reasons that this economic recovery is an elaborate illusion.

Yet we still see examples of extreme inefficiencies in the valuation of certain stocks. It feels eerily similar to the tech bubble, with investors behaving as if today is the last chance they’ll ever get to buy Amazon.com stock at less than 80 times earnings.

Whether it’s the sky-high multiple on Amazon’s maturing business, which seems to be discounting that every Chinese citizen will own a Kindle within 5 years, or the expectation that banks employing creative accounting have seen the worst of their credit losses, many investors are putting real money behind their belief in a super-bullish economic environment.

The reasons to be cautious and bearish are overwhelming. A market correction back to more normalized valuations may happen at any point.

Lastly, I attended the Value Investing Congress in New York last week, along with Addison Wiggin and Chris Mayer.

The most important takeaway for me was the audience’s apparent skepticism towards the two most bearish presenters: David Einhorn and Eric Sprott. Both hedge fund managers are bullish on gold and critical of Washington, D.C.’s wealth-diluting fiscal and monetary policies. The tone of the Q&A sessions after these presentations tells me that most investors are still very, very skeptical of investing in gold. That’s good news for gold bulls.

It’s also good news for stock market bears that so many believe in the Keynesian theories they read in their college economics textbooks. GDP growth driven by government spending is misleading, and damaging to capital formation. Much of today’s top line growth is coming at the expense of future profits — when mal-investments will be written off.

Regards,
Dan Amoss

October 28, 2009

Economic Misdiagnosis Due to Government Stimulus was originally featured on Whiskey and Gunpowder

It’s also the time of year when the Jenkins family winds up plans for an October vacation. This year my family and I are planning a big trip to Orlando. Can’t wait to go. Hoping the pinched nerve that I have suffered with most of the summer will be under control by then.

But as entrancing as all of that news may be, I have something bigger on my mind today.

Setting the Stage: The Big Picture

As just about everyone knows, the stock market crashed in a big way in 1929. Analyst Nick Guarino reminds me that it rallied 15 times before it hit bottom fours years later, having lost 90% of its value.

And the truth is, when adjusted for inflation, the market didn’t break even again until 1960. (If you’re a “buy-and-hold” investor, you MUST account for inflation. It is the single biggest “invisible” tax in our wonderful Fed managed economy.)

But before people could get too happy with making money again, along came President Johnson and the “Great Society.” I don’t know who it was so great for — the market began crashing again in ’66. Once again, adjusted for inflation, it didn’t get back to breakeven for another 30 years.

So, 30 years from the Great Depression to the Great Society. Then 30 years from the Great Society to the Great Depression II. Each of the peaks resulted in 10-15 years of declines. Of course, they didn’t fall straight down. That’s the “trick” of the whole deal.

Each rally draws in a few more people, a little more money, until there are no suckers left. Then when the bottom hits, it has takes 15-20 years to “recover.”

It will take a very long time to recover from what we’ve been hit with: Exxon/Mobil lost two-thirds of its profits… that’s 66%! The “World’s Company,” GE, saw a 47% collapse in profits. Toyota, the recession-impervious carmaker, posted its largest yearly loss EVER and is looking at losses this year, too. Insurers have been hit. Computer giants have taken a whacking. Even Disney is down over 25% in the third quarter.

These are not “bumps in the road.” They are “driving off a cliff.” By some estimates, inflation-adjusted earnings are down 90% in the last 20 months.

We are now in just the second year of this disaster. We are witnessing an almost perfect copy of the first Great Depression. And there are more nasty little secrets in the economy, waiting like ticking time bombs to explode. We will see more businesses in trouble, more banks failing, more foreclosures and more commercial real estate losses.

At the end of June alone, there were over 5,300 commercial properties in the United States in default. That’s more than double the number from the end of 2008 — and there are still six months to count. Still think American companies are recovering? What will a 300% rise in commercial defaults do for jobs? Profits? Banks?

So don’t let the recovery pundits fool you, even though they’re out in force.

Setting the Stage: Zooming in Our Focus

No doubt you’ve heard the optimists: “The Recession is over.” “The Recovery has begun.” “Better get in on the ground floor now if you hope to recover all that retirement money you lost last year.”

Just look at the evidence, they say:

* Markets up 50%. In the greatest bull run since the Great Depression, stock indices are forging higher. The numbers are swelling. Ride the wave!

* Housing numbers are turning north. Over the past six months, there have been some the fall in some housing numbers are slowing, and some have turned up. Building permits. Existing home sales. New home sales. New housing starts. Pending home sales. Hmmm… nice!

* Manufacturing looks like it’s exploding. Yesterday the Institute for Supply Management manufacturing index posted a stronger-than-expected rise at 52.9. Well above expectations, and well into the 50+ territory that signals expansion. Looking better and stronger than it has in 2 years. It would be a mistake to bet against it!

But you probably know what I’m going to say right now: Don’t believe a word of it!

The September Syndrome

No market goes up forever. Isn’t that one of the first lessons we learn when chasing a bull market?

This one is no different. Could it go higher? Sure. But just how far can you stretch a rubber band? Eventually, it is going to snap back.

And, as it happens, we’re heading right into “snapback” season.

Historically, the month of September is the worst month for stocks. Hands down. Indices fall more in this month on average than in any other month of the year.

In fact, the S&P has declined in 11 of the past 20 Septembers. You may be inclined to say, “That’s not so impressive.” But an average decline of 10 points is something worth noting. Additionally, 40% of those falls consisted of declines that were 75-125 points. That’s huge. No other month has such an anomaly. And it seems to me that this September may be ripe for the picking.

In fact, the first day of September was a real whopper. And Monday (although technically an August day) was not so august for U.S. equities. Thus, as the calendar turns over, we have two days in the down column. Today is not looking so good, either.

But as bad as September is, October has the reputation for being a real bloodbath. It certainly possesses a number of the largest down and crash days. But in order for a crash of monumental proportions to take place, there has to be some lofty level from which to fall.

I get physically sick when people tell me how they are moving (what’s left of their money) back into equities. I try to reason with them; I try to warn them. It breaks my heart to see pensioners barely getting by. You remember all the drama from recent years, how we were told that the elderly were forced to choose between food and medicine? Do you remember the seniors who were reportedly sharing their cat’s food so they could buy their prescriptions?

And that was during the go-go boom years. I cringe when I think of what lies ahead for them.

Will it start this fall? Has the band stretched far enough? Has Wall Street suckered in all the money that will venture out into the street? That’s all they’re after. Draw everyone out of the woods. Get all those who believe that it’s time to buy and hold into the game again. A 50% rally? Child’s play! This time the Dow is headed for 18,000!

Better tread carefully. This is without question the area of thinnest ice. One misstep by the government, a foolish line slip or a negative surprise, and the entire “recovery” falls like a house of cards.

Keep your money, and your exits, close… and don’t be afraid to take profit.

Regards,
Bill Jenkins

September 3, 2009

Suckers Rallies and the September Syndrome was originally featured on Whiskey and Gunpowder

In a recent editorial, Peter Schiff reminded me of what my late friend Harry Browne, the former Libertarian Party candidate for president, used to say: “The government is great at breaking your leg, handing you a crutch, and then saying, ‘You see, without me, you couldn’t walk.’” That maxim is clearly illustrated by the financial industry regulatory reforms proposed recently by the Obama administration. (“Would you like a broken arm, or would you prefer a broken leg?”)

Every economic problem we face can be directly traced back to the federal government and the interfering laws that it continually passes. Remember the Resolution Trust Corp. back in the 1980s? It became “necessary” to bail out the savings and loan industry because so many of the S&Ls gambled wildly with their depositors’ money. Sound familiar? How could the S&Ls of the 1980s and the too-big-to-fail banks of the ’00s make such horrible business decisions? Were/Are the management teams just stupid or are they also incompetent?

Consider this: We’ve had a record number of bank failures just this year. As of June 19, 2009, the FDIC has closed 40 banks at a net cost of over $11.5 billion. Are you worried? Why not? Oh, your account is insured. By whom? So when the management of the bank that controls your deposits makes stupid business decisions, you don’t care? The FDIC will bail out your account. Not only that, the “insured” amount was increased from a “mere” $100,000 per account to $250,000 this year (this extra coverage expires at the end of 2013 and reverts back to the $100,000 figure in 2014 as currently scheduled). Do you see a slight problem here?

Just for giggles, suppose there were no FDIC and your deposits at any bank or S&L were simply not insured. Would you then perhaps have a slightly different outlook as to the safety of your money? Would you perhaps behave somewhat differently when selecting a bank in which to deposit your funds? Why? Do you now see that the FDIC is a federal government-sponsored insurance scheme to protect you from greedy and stupid bankers? Or do you perhaps see that the FDIC actually facilitates excessive risk-taking on the part of the bankers, since they have nothing to loose? Do you suppose there might be a slight moral hazard hiding somewhere in this mix? If the bank did not have the FDIC insuring your deposit and that same bank had to compete in the open, free market for your deposit account, would you suppose that the bank management might behave in a slightly more conservative manner? Wouldn’t you behave in a slightly more conservative manner when selecting a bank?

Now consider the actions of the too-big-to-fail companies, be they banks, insurance companies, Freddie and Fannie, or even automobile manufacturing companies. What’s to restrain the management of those companies? If they mess up, the government will protect them. And as we’ve all observed, the very folks that made the stupid and reckless business decisions will still get their multimillion-dollar bonuses. Would you be willing to make a wild guess that maybe there is a slight moral hazard hiding somewhere in this scheme?

What about the business management that continues to make prudent decisions and continues to operate profitably? What is their incentive? How are they rewarded? The same federal government that bails out the too-big-to-fail companies totally ignores the hardworking, successful managements of the smaller businesses. Actually, it’s even worse than that. The companies and individuals that are successful now get penalized, because their tax dollars are used to bail out the unsuccessful. They get to subsidize the failures. Isn’t that a wonderful reward for doing a good job?

So I again ask what am I missing? Am I the only person (or only one of the very few) concerned? When I/we comment about these obvious inequities, does anyone pay attention? Does anyone question the wisdom of the federal government’s decisions? Based on the feedback I’ve received from the congressmen and -women who claim to “represent” me, they certainly don’t care. Aside from the folks who attended the various Tea Parties on April 15, the rest of the folks don’t seem to care. What am I missing?

One of the factors that caused me to write this white paper is the incredible discussion of so-called “green shoots” from our eminent Fed head “Helicopter” Ben Bernanke and the observation of the recovery light at the end of the tunnel that now seem to be so visible to the mainstream media. As Ronald Reagan used to say, the media know a great deal that just isn’t true.

There has been a tremendous recent effort to create “transparency” in and from government. Using that as a diversionary tactic, the public’s attention is now away from the facts. While perception is important and can mask facts for a period of time, it cannot avoid ultimate economic laws of nature. In this case, the public’s attention is being diverted from the undeniable facts that we are nowhere near the bottom of this economic downturn. Banks are still hiding toxic waste in their off-balance sheet accounts. These virtually worthless assets are not just going to disappear with no one noticing. Sooner or later, these near-worthless assets must be accounted for. The so-called bank stress tests were a joke. The intent was just to give the public the perception that the worst is over.

It isn’t. We have at least one more major leg-down in our economic future. And I believe that leg will take us to a Dow of 5,000 and perhaps as low as 3,000. Yes, the Dow may continue upward to 10,000 from its current level of 8,500, but then it will head down once again. All we have to do is look at Japan 1989-present and our own economy from 1929-1932. Oh, yes, it can happen again! Absolutely nothing has been done to prevent a repeat of this history. In fact, what has already been done by the federal government interference with our markets almost assuredly guarantees that it will happen once again.

What is it that will happen? A depression. Why? Because too many government interferences have occurred over the decades since the last depression. Perhaps it might be helpful to first define the difference between a recession and a depression — at least by my definitions of the terms.

Business cycles frequently become what are referred to as overheated economic cycles. (Note that every one of these so-called overheated situations is a direct result of government monetary interference with what otherwise would be free market behavior.) So a so-called cooling-off period of adjustment then takes place to correct the malinvestments that were made during these periods of irrational exuberance (thanks, Alan). These adjustments happen rather quickly, and then the recession is finished. You’ve heard it called the “V” recession because we tend to enter quickly but then we tend to also recover quickly. Today, the mainstream is talking of a “W” recovery, meaning a double in-and-out recession. But recessions usually take place rather quickly and are then finished. In a depression, structural changes to the economy actually occur and then it takes years to readjust. Can you say Japan? The new version of the resulting economy is a major change from the prior economy. Old bubbles are never reinflated, but new bubbles are ultimately formed. Note that our federal government is trying to reinflate the last bubble, meaning a return to a consumer-led economy. It simply won’t happen. We’ll waste a tremendous amount of taxpayer money and it will all be for naught.

Ultimately, a new bubble will be created. In the past decade, we’ve enjoyed the Greenspan dot-com bubble followed by the real estate bubble. Now we are starting to form what I see as a bond bubble. In the process, everything in the path of this “recovery” is being socialized: banks, insurance companies, mortgage lenders, even automobile companies. Yet to come will probably include national health care. If you think private health care is expensive, wait until you see how much “free” health care costs. But this is what I mean by “structural” changes. It’s new territory for most of the participants.

What do you think will be the end result: inflation or deflation? I think we’re in for both deflation and inflation — in that order. Short-term deflation, but longer-term inflation. So I’d invest to protect myself against inflation. That means precious metals, energy, and commodities such as foods and water. Period. For the foreseeable future. Speculations would be in the area of biotech, nanotech, and stem-cell-tech.

I also hope that my comments are just being realistic — not doom and gloom. I admit my emotional reactions may be affecting my opinions. I hope not. But I’d rather be overprepared than underprepared or unprepared.

Considering that the value of our dollar is being actively destroyed by our government, how will you protect yourself and your family from further destruction of the dollar? Are you aware that the dollar is now worth 4% of what it was worth when the Federal Reserve was created with the charter mandate to provide a stable dollar? What did I just say? Are you happy with 4 cents of purchasing power left for your hard-earned 100-cent dollar? Don’t take my word for it — it’s on the Bureau of Labor Statistics (BLS) Web site. My recommendation includes making investments in areas that are not dollar denominated. As such, you can expect to benefit from a currency hedge as well as from the performance of the investment itself. Today, all currencies are fiat, so this becomes a relatively moot consideration — see my next comment below.

Still another area to consider is foreign exchange. Consider Swiss francs and Chinese renminbi (yuan) for starters. Also consider the Brazilian real, due to the country’s incredible discovery of offshore oil. The real would be a speculation, while the franc and yuan are slam-dunks. Norway’s kroner is also a consideration, due to the country’s oil economy. I’d stay away from the Canadian loonie simply because Canada’s economy is so closely tied to the US’.

I believe we are in a depression, not just a recession. By that, I mean we’re in for major structural changes, not just a clearing of some malinvestments that got out of hand in recent years. The Dow could go as high as 10,000 before the next drop, but there will be another drop. As I said, I expect the Dow to go as low at 5,000 and possibly 3,000. I know how that sounds, but that is what the markets are telling me. While we will then recover, it will be a long, drawn-out recovery. Years, not months. This is not the muddle-through recession that so many expect. I’m guessing we’ll remain in this morass for at least five years, if we’re lucky. We could go the way of Japan, which hasn’t recovered yet after two decades! The more Washington interferes with the markets, the more severe the problems then become and the longer the recovery period. As Bill Bonner is fond of saying, we’ll see “a corrective force equal and opposite to the deception and delusion that preceded it.” And of course, we could just be headed into outright and total socialism, so all this attempted planning could just be for naught.

But back to my original question: What am I missing? What do you know that I seem to be overlooking? Why am I not in agreement with all the mainstream economists and government officials such as “Helicopter” Ben Bernanke and Timothy tax cheat-in-charge-of-the-IRS Geithner? Why is it OK for the U.S. government to “fire” all the profitable Chrysler dealerships because they donated to the Republicans while keeping the unprofitable Chrysler dealerships because they supported the Democrats? Why is it OK to medically insure the 47 million uninsured at the expense of the folks that actually pay the premiums? Why is it OK to bail out AIG because it insured Goldman Sachs? Why is it OK to “gift” a major ownership of General Motors to the UAW simply because the union supported the Obama election campaign? Why is it OK to stiff the Chrysler and GM bondholders who, by USA contract law, have first right to the assets of the corporations in case of a bankruptcy? Why is it OK to simply ignore and override centuries-old corporate law? Why is it OK to issue presidential edicts that circumvent corporate and civil law? Why? What am I missing? Why?

There is much, much more to be said on this topic. However, what I’ve already written is probably more than enough for the moment. By the way, were I a registered broker or financial adviser, the securities rules and regulations would prohibit me from telling you the above. So don’t be too hard on your current financial adviser. The government would suspend his/her license for telling you the truth.

Regards,
Tex Norton

July 10, 2009

FDIC Fosters Moral Hazard Among Banks was originally featured on Whiskey and Gunpowder

For what you care to make of it, here is an oddball way to analyze what you should buy and to diversify your holdings pleasurably, and probably far more safely than what is left to try.  There are two basic choices:  give the other half of your shirt to someone like Edward Jones and see how long it takes to lose it, or put everything into cash, metal, and gold sands, volcano power, or something else totally outside normal stocks and the ken of mere mortals.  Agora Financial comes up with a lot of interesting propositions in areas I am totally ignorant about, so I decided to stick with what I know, which is luxury items and grocery stores.  Huh?

At present fundamentals are roughly as safe as downtown Beirut, and Technical Analysis isn’t working well because volume is controlled by a few enormous funds, while government intervention is playing havoc with individual stocks, whole industries, the value of the dollar, interest rates, and so forth.

What we could use is a way to “read” what volume, movement, and patterns once told us, and some sensible way to decide what will store intrinsic value best.  Never mind profits, just holding on to the current value of what we have will do nicely in a world with 1/4% interest rates on a CD.

If you want to know what the average Joe is thinking don’t pull out your big blue book of ten-year stock charts and start looking for cycles. This is a whole new game and requires modern tools.  Two you need are absolutely free and available 24/7 on your Internet and the other is usually set out on Thursdays, free to pick up.  The hopes and fears of these bad years are to be found on Craig’s List and e-Bay and in what I will always think of as the “Thrifty Nickel,” now called “American Classifieds.” Those will tell you a lot more about economic and psychological conditions than the S&P will. Not a Keynesian in the bunch.  What is fascinating is how the offerings demonstrate traditional Technical Analysis basics, including volume, support and resistance levels, and trends.  Best of all, they are totally independent from the actions of managers of large funds peering at each other in terror wondering what “a prudent man” should be doing.  Glory be, there’s a way to take the pulse of the country at the most fundamental (pun intended, of course) levels, ranging across a wide socioeconomic spectrum.

The prevailing mood of the country, measured by this method, demonstrates two factors clearly:  at ground zero individuals are still having to turn loose of their toys to survive, but there is a sense, through recovering prices in some areas, that the economy is looking up in many eyes.

It may seem a little odd to analyze the economy in terms of what luxury goods in private hands are available and bringing, but consider that those are where intrinsic value was stored when times were good in the past.  Many Americans are being divested of past treasures because the credit-based consumerism of the last couple of decades had most people believing that times would always be good and that their houses were a sure source of ever-increasing equity, much better than old-fashioned savings accounts and paying cash.  They raided their brick piggy banks consistently, and then the housing market smashed.  No savings, upside down mortgages, houses such a glut on the market that in some cases banks have demolished–literally–brand new “MacMansions” complete with the de rigueur granite kitchen counters, rather than see them destroyed by squatters. The stock market plunged half way to ruins and despite a hefty Spring Fling a lot of folks see it going down again sometime soon. That left the Baby Boomers more than a little concerned about what were supposed to be their golden years, and those ten years or so younger in agony over the paper profits despite being warned for a couple of years to get out.  Yes, it cost a nasty sum to get out of the fund a manager had locked you into until ‘10, but not nearly as much as leaving it there would have.

Back down in the trenches it is even possible to read a lot from the sequence in which goods have come on the market.   First went the toys bought by young men who put windfalls into bass boats, fancy trailers to haul them, and bigger or extra trucks.  Life was good, jobs seemed secure, no wife or kiddies, buy that value on credit…and then hours started being cut and jobs lost [Painfully close to home—Ed.].

Farmers in trouble from rising fuel, feed, and power costs had to start turning loose of “extra” tractors and implements, almost unheard of in the annals of mechanized mules which are good for many, many decades of service.  It is amazing how many tractors seem to be needed; we’ve got four and still don’t always have just the right one for an atypical job.  Given the choice of giving up a perfectly good 1954 John Deere or his youngest, some men might have wistful thoughts before listing Big Red for sale.  This is part of knowing both the value and price of everything as well as what people set the most store by, not useless information.

The $150/barrel crude oil hit independent truckers an unbearable blow, and many small firms had no choice but to shut down.  I have trucker friends who said it wasn’t worth the wear and tear on their rigs at what they would make on a job with Diesel rising four dollars.  The man we got Black Dog #5 (the pride of the now defunct Long Shot Trucking Company) from had tears in his eyes when he had to sell the Dawg, his joy and the last “tractor” to go, and spent half an hour pointing out all the glories of that beautifully-maintained beast that will haul a dry van box with 55,000 pounds of goods in it after he had clinched the sale.  What we paid for it is practically a sin, but he couldn’t hold out “until times get better.”

Then the “We’ll travel when I retire” dream popped, and motor homes and big travel trailers started coming up for sale, along with golf carts, and finer cars.  Reduced income, 401Ks in the cellar, houses that can’t be sold without the most horrifying loss, “down-sizing,” and something had to give.

This time last year we bought six used motor homes and travel trailers in excellent shape for fifty dollars a running foot, never more than a hundred.   These days the price is more apt to be $150/rf. The high-end models still aren’t selling, and little is as sad as a dealer’s lot, but either all of the more modestly priced rooms on wheels have changed hands or those who own them are feeling a little less frantic.

Grandma’s sterling silver that was only used at Thanksgiving has been all but a glut on the market for months…Silver has a special place in my heart, and the thought of treasures that have been in the family for perhaps a couple of centuries cast on the altar of believing things would never change, the house would always provide extra income hurts. Silver is rising dramatically on e-Bay; it requires more and more knowledge and research to find bargains.   Last month I was buying sterling flatware at roughly $10-12/utensil, and tonight people are asking $15-$17 for standard patterns. The latest trend is also turning loose of fine china at bargain basement prices.

I still won’t buy the classic hedge of postage stamps (very fragile, don’t know enough), loose diamonds (not sure the IDC can maintain inflated prices; am buying sapphires and rubies), or antiques other than jade and bronze (more portable, sturdier.)  This weekend good antique furniture appeared in large amounts suddenly, although the prices are “overly sanguine,” shall we say?

In some ways storing intrinsic value in items like the last two may not sound exceptionally bright, but that’s one of the hazards of shopping.  You find things you just can’t resist.  I have a printout on my desk right now for a 1985 XJ6 Jaguar we’re going to go look at tomorrow: one owner, always garaged, 138,000 miles, custom wheels worth two-thirds of the asking price, engine you could eat off of, all of the touches for which a real Jaguar is famous, and she’s got to go.  He’s asking $1200 for a very luxurious car with at least another hundred thousand miles in her. In short, it is a grand time to want to buy cars if you have cash, even new ones.

A classic Rockefeller story is of purchasing a yacht early in the thirties for a thousand dollars a running foot, which, he said, “Seemed like a very good price for a yacht.”  Indeed, it was…and he had the cash at the right time.

The moral of this tale is to use what you know best to manage your cash correctly now.  Other than that, put it in gold, silver, survival supplies and equipment…and even a few things that merely make your eyes light up.  Life is short, and beautiful objects of intrinsic beauty will gladden your heart and are a lot more pleasurable than giving in to that urge to get back into the market.

I saw in 1992—when the interest rate dropped to a shocking four per cent—that in years to come widows and retirees were going to be in for very bad times.  Why didn’t anyone else who isn’t a professional analyst?  Why didn’t they believe their “men of affairs,” as financial advisors used to be called?

I expect that this will turn out better than a prospectus promising that if we buy six stocks two will fail, three will do reasonably well, and one will give us thousand per cent returns.  If I’m wrong, I’m buying at 25 cents on the dollar in a lot of instances, and a Jaguar will always be a Jaguar.  The world seems to be one giant yard sale, and I submit that traditional luxuries will recover sooner than Government Motors will.

Regards,
Linda Brady Traynham

May 14, 2009

Gathering Intrinsic Value in the Aftermath of the Credit Bubble was originally featured on Whiskey and Gunpowder

Mind you, this is if you want to be in the equity market at all. There is a very good case to be made for NOT being in the equity market this year, or only being in those asset classes and single stocks you think will appreciate (or grow earnings) faster than the rate of inflation.

But let’s be more direct and say that this is still a bear market. The bear market began in 2000 with the popping of the tech bubble. The Fed fought back in 2003, setting a low-interest rate policy the rest of the dollar-pegged world followed. This kicked of leveraged booms in residential housing, credit derivatives, and stocks, bonds and commodities.

All those bubbles are popping. You do not wipe out twenty-five years of credit and leverage excess in a mere eighteen months. We are barely halfway through the liquidation/loss realisation phase. The essential question is which assets are going to perform the best as governments inflate and create a new bubble in government debt? And by the way, it’s going to be very large bubble.

Forget the $1.8 trillion deficit the Obama White House admitted to. The true scope of government borrowing is breathtaking, and rather sickening. More importantly, you have to wonder where the money is going to come from, and what will happen when it’s not forthcoming from private investors.

Consider the chart below, courtesy of Niels Jensen, writing in John Mauldin’s “Outside the Box” e-letter. Niels shows that according to IMF estimates, twelve governments around the world (the ‘Dirty Dozen’) will have to issue $10.2 trillion in bonds to cover future banking losses and funding requirements in the credit markets as a result of the ongoing financial crisis.

The ‘Dirty Dozen’ and $10.2 Trillion in New Bonds

Ten trillion is a huge number. But there’s every chance the number is, in fact, a conservative estimate of government borrowing requirements. It is based on smaller than expected losses in the banking sector (the bogus scenarios modeled in the U.S. Treasury’s ’stress tests’) and a lower-than-average increase in public borrowing to deal with a financial crisis.

The IMF estimate is that public sector borrowing will grow to an average of 27% of GDP in Western or industrialised countries. But according to a study by economists Carmen Reinhart and Kenneth Rogoff published last year, governments almost always underestimate the amount of public borrowing that takes place in the wake of a banking crisis.

They do because—as the government here in Australia has done—they underestimate the blow to tax takings that comes from lower bank lending and lower economic growth. Tax takings fall while spending generally increases, especially borrowing to subsidise lending in key sectors like say, high-risk mortgage lending and property development. Think of the AOFM’s role in buying securitised residential mortgage backed securities and Ruddbank.

So how big could government bond borrowing needs get? Under the ‘best case’ scenario (lower loan losses, quicker economic recovery) Rogoff and Reinhart say public sector debt would grow to an average of 40% of GDP, leading to global borrowing needs of $15 trillion-50% higher than the IMF’s estimate. But that’s just the best case scenario.

Using the chart below, Reinhart and Rogoff suggest that in previous banking crises, government borrowing as a percentage of GDP has risen to an average of 86%. Under that scenario, now you’re talking $33 trillion in global government bond issuance in the coming five years to deal with the rest of the losses in the banking system.

The Mother of All Bubbles in Government Debt

You can see why we think all this talk of recovery and rally is a bunch of hokum. Maybe it won’t be quite 86%. Or maybe it will be more. But we know for a fact that global governments are going to flood with world with bonds in the coming years. But will investors buy them? If they don’t, you can expect much higher bond yields and much more money printing. That means inflation.

What does an investor do? Well it’s worth noting that Microsoft appears to be preparing for massive inflation by borrowing. The company is selling $3.75 billion in debt in order to buy back some of its own shares. Obviously Microsoft reckons the real value of the debt will diminish with inflation while the current purchasing power of the borrowed money allows it to buy back its own shares.

It’s a nifty trade and provides the example of buying equity in world-class businesses at cheap prices. There have to be a lot of investors in the world out there who see the endgame of this explosion in government debt and would much rather buy equity. That alone means the “weight of money” argument for equities could send shares higher.

We have to admit we are extremely dubious of this strategy because it says nothing about how these businesses will perform in a world saddled with so much debt. But we suppose if you are a truly a long-term investors and have decades to wait, buying equities at these lows is, a) a much better idea than buying government bonds, and b) about the only sensible investment strategy if you’re going to stay in the equity markets.

What does an investor do? Well it’s worth noting that Microsoft appears to be preparing for massive inflation by borrowing. The company is selling $3.75 billion in debt in order to buy back some of its own shares. Obviously Microsoft reckons the real value of the debt will diminish with inflation while the current purchasing power of the borrowed money allows it to buy back its own shares.

It’s a nifty trade and provides the example of buying equity in world-class businesses at cheap prices. There have to be a lot of investors in the world out there who see the endgame of this explosion in government debt and would much rather buy equity. That alone means the “weight of money” argument for equities could send shares higher.

We have to admit we are extremely dubious of this strategy because it says nothing about how these businesses will perform in a world saddled with so much debt. But we suppose if you are a truly a long-term investors and have decades to wait, buying equities at these lows is, a) a much better idea than buying government bonds, and b) about the only sensible investment strategy if you’re going to stay in the equity markets.

But let’s say you don’t want to buy-and-hold blue chip stocks. And let’s say you want to be in the market and not just in gold, vodka [or bourbon—Ed.], bullets, and canned goods. If you’re a “financial survivalist” what else can you do?

Try uranium and lithium (as investments, not meals). We reckon the government WILL decide that because energy is an industry that’s going to survive the credit crisis. China is building twenty one-gigawatt nuclear reactors at the moment. China will not be able to supply its own uranium needs. Australia, with over 30% of the worlds proven uranium reserves, is in position to capitalise, should it so choose.

According to Scotia Capital Inc. China strategist Na Liu, China’s nuclear industry will consume 15,700 tonnes of uranium per year by 2020. “At this rate,” she writes, “China’s currently known uranium resources can only last for five to 10 years. Clearly, in our opinion, it is imperative for China to secure long-term supply through imports or investment.”

So you see, for the resource speculator, an inflationary boom can be the best of times. It is a high-risk exercise. But junior resource stocks are one of the asset classes that CAN go up faster than the rate of inflation. And if, as we believe, the explosion in government bond issuance is going to lead to an inflationary rally in stocks, then dabbling the junior resource stocks and small caps is like hitching a front seat on a rocket.

Remember, this is pure speculation. You only hope your rocket is like Richard Branson’s new Virgin Galactic space plane, and not the nuclear missile Slim Pickens rides in Dr. Strangelove.

And what about red wine? The bottle shop across the street from the Old Hat Factory is closed for renovations. In its clearance sale, we were able to pick up a few bargain bottles of Penfolds Bin 389 Cabernet Shiraz. That is wealth you can either drink or store. We’ve done a little of both.

But you can also sell it! There appears to be a roaring trade in Penfolds wines on e-Bay. There are certainly worse things you could spend depreciating paper money on. We’re also hearing that the 2004 vintage of the Penfolds Grange is the best ever. Can’t wait to find out.

Regards,
Dan Denning
Australian Daily Reckoning

May 13, 2009

Very Large Bubble of Government Debt was originally featured on Whiskey and Gunpowder

If you don’t want to be lumped in with this group, listen up… You need to understand something about the investment world. It feeds on your interest and greed. Without these two things, the people that are running the show – yes, the same people that drove it into the ground – don’t make any money.

Think about this for a second. When you hear about “investment opportunities,” does the person speaking know how to decipher every line of a balance sheet or income statement? Can that person understand “Wall Street Speak”? If so, does that person get paid on the basis that his or her “investment opportunity” trade more often?

My point is… brokers profit from you trading often, most of your friends that day trade probably don’t know a lick about a discounted cash flow model, and your early edition of the Wall Street Journal is full of advertisements from these same “investment opportunities” it is featuring on the front page. Get it now? Your interests don’t align with the things you hear about investments.

You can be best friends with a banker, but do you think the CD you just tied your money up in will outpace inflation? [Remember we have a 10-digit budget deficit in the U.S.]

Even here in the investment newsletter industry, we have our share of pushers. At Agora Financial, we aren’t allowed to invest in our own recommendations. We are the minority, when it comes to conflict of interest. Unfortunately, such conflicts do exist elsewhere.

I don’t mean to scare you. I don’t mean to intimidate you. I just wanted to set up what the rest of the world considers too boring to even discuss.

It’s a type of investment that may not be sexy. It may not be popular in message boards. But it does make a select few tons of money with next to no risk.

I’m talking about enormous yields, limited and known downside, and investor benefits above and beyond what most investment managers will ever advise their customers to buy.

This is the kind of investment that Warren Buffet takes advantage of every chance he gets. In fact, investments like these are about the only thing the kept the old bat afloat last year.

You hear about sweetheart deals and how investor elites practically get away with murder on Wall Street. One of the investments I’m about to show you is the exact tool they use. In fact, Berkshire Hathaway – Buffett’s investment company – can count the gains from these investments as assets even before they arrive in its trading account.

You can’t do that with the gains you expect from the shares of Google you bought when it IPOed 5 years ago. Those gains are non-existent until you sell your shares. And when you do sell, the government will tax the hell out of your gains.

Berkshire Hathaway’s investment, on the other hand, counts as real income, and is taxed at a relatively small flat rate. Beat that, stock market!

Alright, I’m done hyping… I’m talking about preferred stock. It’s the only kind of equity that is considered fixed income. Meaning, holders of preferred shares can expect – and claim – the interest from these shares as future assets.

While this may sound boring or “unsexy,” this is how the rich – like Warren Buffett – stay rich and even grow their wealth. It’s also how folks like you and me bank a few extra bucks when you can’t even count on your Google shares to increase in value.

I know from being a long-time reader of Whiskey that there’s a good chance you’re a gold bug. So am I. But do I think gold will pay me quarterly paychecks that are taxed at a flat dividend rate? Hell no!

Even when you cash out the gold you’ve been storing since the 1970s for massive gains, you will pay equally massive income tax on it [Well, some of you will—Ed.]. Dividends, which are how these preferred shares pay out, are currently taxed at a flat 15%. Average income tax is around 39%-40%. You can do the math.

Unfortunately, the people supposedly in charge of discussing opportunities like these are busy pushing more exciting “opportunities” like the “Next Microsoft” or whatever company just bought an ad in their paper.

I’m not saying there’s no room in your well-balanced portfolio for great opportunities you hear about on the 7th green at your local golf course. I’m just saying, the ones you should be hearing about just aren’t sexy enough.

Regards,
Jim Nelson

May 12, 2009

Fed Up with Wall Street Shenanigans was originally featured on Whiskey and Gunpowder

A few weeks ago I explained why I’m going to have to spend the next few years as an indentured servant to the feds to pay the taxes and penalty on my 401(k) withdrawal…but if I hadn’t done it when I did, I may never have seen that money again.

The Wall Street Journal reports that 401(k) investors are finding that they can’t get their money.

“When Ed Dursky was laid off from his job at a manufacturing company in March, he couldn’t withdraw $40,000 from his 401(k) retirement account…”

“I hate to be whiny,” said Mr. Dursky, “ but it is my money,”

Turns out that the money you put into the 401(k) can be locked up a lot longer than you’d like. Most plans allow investors to borrow from their own accounts and some even allow outright withdrawal of matched funds—with the requisite 10% penalty and income tax. The only way to get all of it, however, has been to terminate employment…but now even that’s not good enough.

Of course if you’re the kind who pays attention to things like history and human nature, you’d have noticed the funny smell around the defined contribution plan a long time ago. And you would have seen this coming.

Here at Whiskey Bar we never stop casting a suspicious eye at the government and we turn our noses at their offers for help. We regret that this time around the feds aren’t the ones keeping voluntary and involuntary retirees from their cash.

Still, if the entire mess hasn’t filled you with fear and loathing, then I’ll have what you’re having.

General economic collapse means that fund managers are finding it in their best interests to limit reallocation and withdrawal by 401(k) investors. It doesn’t matter if you’re a 69-year-old recent retiree or a laid-off schlimazel who was counting on the money you’d saved to see you through a few months of unemployment.

Folks are starting to catch on to how important it is to own gold. We harp about that every day in these pages. Not a one of you reading this doubts for a moment that the value of little green pieces of paper that so many others take for granted is only good as a politician’s promise.

So what escapes me is why anyone smart enough to save in gold and silver would still tuck money away in a defined benefits plan. The circumstances concerning retrieval have always been extreme. We were assured this was for our own good. After all, this was supposed to be retirement money; the rules had to discourage us from getting at it ahead of time!

But the whole set up smacked of the sort of paternalism that really should have raised our hackles.

And now we discover that fund managers can keep our retirement funds…even after we’ve retired…or been separated from the payroll under less pleasant circumstances. Looks like in some cases, some folks may never see that retirement money. The value of their locked investments may dwindle to nothing or they may die of old age before things are sorted out in the courts.

I remember years ago when I began my working life and didn’t know enough to be wary of the state’s siren songs about financial security. I thought the 401(k) such a wonderful idea. As suspicion toward leviathan grew I still harbored a child’s hope that at least this whole “invest pre-tax and get a company match” thing wasn’t a trap. Of course, turns out it was…

The federal government itself hasn’t yet taken a turn at freezing 401(k) accounts, but this sudden if inevitable betrayal by fund managers should serve as a warning.

Please don’t let this happen to you. No matter how the feds try to lure you with tax-deferrals, no matter how tempting the company match is, don’t fall for it.

Granted, money you deposit anywhere besides your mattress can be nationalized or misappropriated, but putting funds into something like a 401(k) is akin to forcing your head into the mouth of the lion.

So what can you do?

Well, you don’t have to bind your retirement money with government red tape.

Fellow editor Jim Nelson sits just a few feet from the Whiskey Bar and in response to my outraged cussing over this news about 401(k) freezes he’s offered to share his own strategy for building retirement wealth.

And this is money that can’t be penalized by the feds for early withdrawal, or kept from you by callous fund managers…

Be sure to be reading when Jim Nelson stops by tomorrow to tend the bar.

Regards,
Gary Gibson
Managing Editor, Whiskey & Gunpowder

May 11, 2009

401(k) Investors Can’t Get Money was originally featured on Whiskey and Gunpowder

I’m like a former child star, tidying up the cell he shares with his prison boyfriend and wondering where it all went wrong…

How many of you are wondering on this latest April 15 — as I am — how this present slavery became so thorough?

I just grudgingly did my taxes. Turns out I owe my lecherous Uncle Sammy more money in fees and surprising amounts of progressive taxes than I can truly hope to pay in one natural lifetime. How could this have happened?

It’s a sad and sordid tale of misspent youth, ruinous debt and the women and booze that caused them. You see, I wasn’t always the stalwart Austrian economic schoolboy and ascetic doomsayer you’ve come to know and love. Like my fellow benighted consumer statists, I prayed in the same temple of credit worship and government trust.

I thought Citibank would lovingly provide my electronic toys and shiny vehicles at negligible interest forever and ever. I thought the government was giving me the best of every world with social security and the stock-boosted defined benefit plan.

Live and learn.

The 401(k) is a trap. The banks and the government — as usual — have given the populace enough rope to hang themselves with credit and intimations of retirement security…and the ability to borrow from the retirement accost or even withdraw from it…at very high cost…

Try to take out that money you’ve been saving. I dare ya. See, the deal is that you cannot use it before the age of 59 ½ except under a narrow band of circumstances. If you contract with the devil, don’t be surprised when you wind up in hell.

If you need that money before you’re halfway through your 59th year — say to pay off those enormous debts that the banks were so happy to let you run up — then expect to pay a 10% vig off the top and then have whatever you save count as income on the year. In a progressive tax system, that means you get to watch roughly half of it disappear.

The 401(k) only works under circumstances that don’t exist in the real world. The fiat currency in which you save won’t be worth diddly by the time you are allowed to get it. Try to take it out before that and the government will kill you with fees and progressive tax.

And I certainly hope you don’t still believe the one about growth and interest outpacing inflation.

Looking back, the come-on does bear a strong resemblance to those internet scam letters I get in my inbox. The maliciousness of the scammer and the greed of the victim have to work together closely and well for the crime to take place.

“We’ll let you save pre-tax (taxes we impose in the first place) dollars, and guard your account (forbid you from taking it out without making it extremely costly).”

When I jumped ship from my last job to become your editor, I made the mistake of demanding all the money I’d trusted to Fidelity under the rules of the defined pension plan. I wanted nothing further to do with them or the banks…but they sure don’t make escape easy or cheap.

For the love of God and the sake of liberty, don’t do it. Steer clear of these complications.

Having the government guard your retirement money is more than a little like putting a wolf on watch duty at the door of your hen house.

Much like Morgan Freeman’s character in The Shawshank Redemption told the parole board: I wish I could meet the young man I used to be, talk some sense into him. I’d tell him that the bankers and the government were not his friends, that those mortgages, credit cards and tax-deferred government accounts were not in his best interest.

Alas, it is too late.

I entered into this bondage willingly, but ignorantly. I didn’t have a clue how dangerous bankers and government gangsters were. I accepted the promises of ease and plenty and I’ve been justly rewarded for my gullibility. I suspect I’m not alone.

I don’t believe, however, that most of my fellow slaves have woken up yet. More and more, however, are starting to stir.

Surely millions of them will be sending off a hefty check to their masters even as they stew about how the government is bailing out rich, evil banksters.

As you read this I will indeed be joining a few folks that have some notion that government by its nature uses money that it doesn’t earn. They demand at least a little accountability, a little representation to go with the taxation. Roving Whiskey reporter Samantha Buker and I will be attending the Tax Day Tea Party in both Annapolis and Baltimore. (We’ll let you know how it goes.)

These Tea Parties will be held nationwide today. Folks want to know what the hell is going on with the money continually hijacked from their paychecks. But how many of them wonder at the criminality of the income tax itself, no matter what it goes to support? How many realize that greedy conmen in nice suits are eating out their substance, legally but immorally? Does anyone question the notion that government must be funded?

An income tax and a fiat currency: what a fine pairing. The one is a gun in the face and the other is a shell game. Both break the Eighth Commandment and both will lead to complete ruin.

Far be it from me to incite you Shooters more than I normally do. Whether or not you fund the fraudulent thug that is government is between you, your god and those with the power to investigate and arrest you. This tax day, I just want you to think very carefully about the whole shebang.

At the very least, stay the hell away from any enticements the government may offer. You have to earn an income in their paper and odds are there’s no way to keep them from tracking everything you collect…but instead of a 401k, you may want to look at gold and silver.

For those of you already entangled in the web of the defined benefits plan, tread very carefully. As we say here in the Whiskey Room: sometimes there is no forgiveness, only punishment.

And today your editor accounts for the sins of his youth.

Oh well, Baltimore is a fantastic place to make less money and ride out an economic disaster all while owing obscene amounts of money to the imperial government. The city never really picked itself up from the postwar urban freefall. Won’t be so good in the event of the collapse of industrial society, but if you’re gonna be down and out, this is the place to do it.

Regards,
Gary Gibson

April 15, 2009

A Tax Day Lament and a Warning was originally featured on Whiskey and Gunpowder

At the time, I got excited. I thought real action was coming. Unfortunately, my initial prejudice against fellow Americans held up. They are lazy, gullible, and apathetic. If I touched a nerve there, prove me wrong. I’m about to show you a significant flaw that has already made a small group of people serious money. If you want in, it’s time to man up.

Further Perversion of MBS Ridiculousness

So far, the U.S. government has piled up more than $2 trillion worth of debt to finance bailouts for banks, insurance companies and even the struggling auto industry. And unless you are the CEO of one of these companies or worth enough to make sweetheart deals like Warren Buffett, you haven’t received a dime of this money. That’s all right, because the government’s overreaction to this recession left an opening for gutsy investors.

As you know, mortgages have been the central problem in today’s economic meltdown. From there, greedy financial product creation boards went crazy. You’d have to be living under a rock not to hear the terms “collateralized debt obligations” and “credit default swaps.” These are the real doozies in today’s market slide.

However, the most important term in today’s financially-minded world is “mortgage-backed securities.” You see, it’s not the mortgages that caused the system to fail. It was the mortgage-backed securities, or MBS. These securities are not a new development in the financial world. In fact, they’ve been around longer than most of the “too-big-to-fail” banks Washington is bailing out.

During the last Depression, in 1938, President F.D. Roosevelt helped create the National Mortgage Association. Later, the word “federal” was added to the beginning. This organization, now called Fannie Mae, was created to bundle mortgages together and resell them as – you guessed it – mortgage-backed securities.

Wall Street’s further perversion of this already perverted “asset class” is a story for another day. But these “securities” are important today because the actions of the last 9 months of government intervention combined with plenty of MBS ridiculousness created an enormous opportunity for income investors.

You see, 2008 was a tough year for Fannie and her brother, Freddie Mac. Both companies’ shares lost about 98% of their value. The highly incompetent and worryingly scared Bush Administration took them over. In a very important piece of legislation, these two government-sponsored enterprises (GSE) were placed under the authority of the brand-new Federal Housing Finance Agency (FHFA).

In September, the FHFA took extraordinary action by placing Fannie and Freddie into a federal conservatorship. This conservatorship, backed by the U.S. Treasury, was designed to guarantee all GSE-backed securities. This September announcement means that the U.S. Treasury is obligated to pay anyone holding a Fannie- or Freddie-backed MBS. That’s a 100% guarantee by the U.S. Treasury. In a moment, I’ll tell you why this is important…

The Pseudo-Bank Loophole

The financial industry is full of penniless banks, uninsured insurance companies, and toxic assets. But it also includes about five pseudo banks that are in the perfect spot to take advantage of the collapsing market and the U.S. government’s desperate attempts to save it.

These companies are called mortgage real estate investment trusts, or REITs. If someone would’ve come up to me and asked me what I thought about a mortgage REIT a few weeks ago, I’d have laughed at them. But after I did some research, I found a bailout loophole that this small sector uses to make a few people very rich.

These mortgage REITs buy mortgage-backed securities from Fannie, Freddie, and occasionally Ginnie Mae (Government National Mortgage Association) at about a 5% yield. Until Bush’s ridiculous Fannie/Freddie bailout, the only government-backed securities came from Ginnie. Now, after the September conservatorship announcement, Fannie- and Freddie-backed securities are backstopped by the U.S. Treasury. That means whoever holds securities originally bundled by Fannie, Freddie, or Ginnie will get paid.

I can’t stress this enough… Until the U.S. government declares bankruptcy or the Chinese army overtakes Fort Knox, these securities are as safe as Treasury Notes. But here’s where it gets interesting…

Multiplying the Spread for Government-Guaranteed Income

The five (or so) pseudo banks that receive this “government-guaranteed” income from mortgage securities are still financial companies. And what do financial companies do? They leverage the hell out of any debt they can grab.

Here’s how it works:

Mortgage REIT A buys a bunch of government-backed MBS from Fannie. In turn, he receives a AAA+ credit rating because his portfolio is 100% backed by the U.S. government. He takes his credit rating to Lending Banks X, Y and Z. These banks give REIT A a bunch of 90-day, $100 million loans at 2% interest to buy more mortgage securities from Fannie. And we repeat, again and again.

When all is said and done, REIT A is leveraged 6-to-1. Its income comes from the 3% spread between its borrowing rate and the yield on the MBS. Multiply that by its leverage ratio, and REIT A grosses 18%.

Because of an obscure law that publicly traded realty companies cut decades ago, REITs aren’t taxed (so long as they pay shareholders all of their earnings through dividends). Therefore, with everything else equal, REIT A’s shareholders receive an 18% dividend yield.

With interest rates artificially held down by the Fed, and government-supported mortgage yields artificially held high to promote more MBS buying, we get a spread (and thus, income) that’s extremely large. And with these companies required to pay shareholders all of their earnings, we get an extraordinarily large dividend yield.

Finally, because of the mortgage mess, shares of these companies are undervalued. While most financial companies deserve their shares driven into the ground, these mortgage REITs don’t.

Investors with big cojones have already taken advantage of this. The spreads are even larger and safer now. If this is new to you, I suggest you check it out before investors jack shares back up – deflating the dividends’ effect.

Sincerely,
Jim Nelson

April 6, 2009

Fannie Mae and Freddy Mac for Safe Income was originally featured on Whiskey and Gunpowder