Friday, October 31, 2008

Tony Batman's Open Letter to Senator Obama

Today, RealClearMarkets published an open letter from Tony Batman, the CEO of the financial services firm 1st Global, to Senator Obama ("A Letter to Senator Obama"). About seven years ago I had the pleasure of meeting Tony Batman, though I doubt he remembers me. I worked for a start-up that was one of two finalists competing for a contract with his company, and I went to 1st Global's headquarters in Dallas to make our pitch. If memory serves, the other guy won the contract. One thing I remember about Tony was that he had more professional designations listed on his business card than anyone I had ever met. He mentions in his letter that he is a CPA, but as I recall he also holds a CFA, a CFP, and a few other designations.

Batman's letter is, among other things, an impassioned defense of the role business owners play in our economy, and a rant against class warfare and collectivism. Batman also explicates the role his Catholic faith has in his worldview, and throws in an allusion to Atlas Shrugged for good measure. Below are two brief excerpts:

I am a product of public schools, local community college, and state university. I am only marginally educated beyond my intelligence. I was taught to think rigorously.

No job was ever beneath my dignity. I did farm work, drove a tractor to plow fields, operated a combine to harvest summer wheat, cut and stacked hay, navigated a Sunday morning newspaper route, was a fry cook at Kentucky Fried Chicken, cutter in a beef packing plant, roughneck on a drilling rig, night clerk at a liquor store, a bouncer at a discotheque, and I even trapped and killed gophers on a golf course. Yep, I was the original Carl Spackler in “Caddyshack.”

My parents never financially helped me because they could not, despite their desires to do so. They did the best they could in life and they would not have ever considered asking for a handout from anybody. I would never change one thing about my upbringing.


My wife and I started our company in 1992 with an $88,000 investment from our savings, a few untapped credit cards, a month-to-month rental on an executive suite, no customers and no employees. All we had was a dream, the willingness to work very hard and to honor the promises we made to people.

We lived frugally and saved money which allowed us to have options and choices in life like starting a business. For the first thirteen years of marriage, we lived in a 1,200 square foot home with our two young sons with mortgage payments of only $650/month. Frugality ruled the day and it still rules.

For two years after the start of the business, I drew less than a $30,000 salary, living mostly on additional savings. For the ensuing five years, I drew a salary substantially below my market value just to make the business work. This is the price a working class business owner pays for happiness.

Sixteen years later, we have a national payroll of over $125 million and the pride we feel is for the creation of so many good jobs and the opportunity to serve those we love.

A life centered on high and unchanging values is central to the life of a working class business owner. For me, the virtue of personal responsibility is so important that I will not even give a permanent job to my sons. They cannot even apply for a job at my company. They are not entitled to one from me. I love them and I only owe them a good education and an education in those life values essential to their personal joy, significance and meaning. They will be better and happier men for it.

You may not agree with all of what Tony writes, but perhaps you will find it worth reading, as I did.

A Conversation with the CEO of Vaalco Energy

The CEO of Vaalco Energy (NYSE: EGY), Robert L. Gerry III, was kind enough to spend a few minutes on the phone with me today. A few notes from our conversation:

- He estimates that the per-barrel cost of production of any oil produced by Vaalco's current exploration projects will be similar to the cost of the company's current production, i.e., about $10 per barrel.

- No predictions on oil prices, but given Vaalco's low cost of production, Gerry was unconcerned. "We can make money on $20 oil," he mentioned.

- Regarding the political environment in West Africa, he said the government of Gabon had been great to deal with, and Vaalco hasn't had any problems there. He noted that Gabon is one of the more stable countries in Africa (as we mentioned in a previous post, "Vaalco Energy Reports"). Vaalco currently has an office in Angola as well, in support of its exploration there.

- Gerry estimated that the company would be able to maintain daily production rates of about 25,000 barrels through '09, but noted that its FPSO1 would be about maxed-out at these levels. He mentioned that the rates to lease an FPSO currently average about $70,000 per day, but given the current correction in crude, these might start coming down at some point. If they do, he'd consider locking in low rates on one in advance.

1Floating Production, Storage, and Offloading vessel -- see the image above, which comes from Vaalco's website.

Thursday, October 30, 2008

U.S. Energy Corp. and Wyoming

In previous posts on U.S. Energy Corp. (Nasdaq: USEG), e.g., "A Conversation with the CEO of U.S. Energy Corp.", we mentioned the multi-family housing project the company was developing in Gillette, Wyoming, where, as the company notes on its website, "there is a critical housing shortage due to high employment in the energy and mining industries." The graphic above, borrowed from the Economist article we referred to in the previous post (A Tale of Two States: Utah versus Rhode Island") shows that the current unemployment rate in Wyoming is even lower than Utah's, at 3.3%.

A Tale of Two States: Utah versus Rhode Island

An article in last week's Economist (The Mormon work ethic: Why Utah’s economy is soaring above its neighbours") noted that Utah's unemployment rate is 3.5%. A few days later, a New York Times article ("Leading in Job Losses, Rhode Island Struggles On") noted that Rhode Island's unemployment rate is 8.8%. A number of factors contribute to this disparity, but a smart Republican strategist would focus on two of them: energy costs1 and taxes on businesses2. According to The Tax Foundation, among the states, Utah ranks 17th in business tax climate, and Rhode Island ranks 50th. According to the Energy Information Agency, Utah had the 5th cheapest industrial electricity rates in July, with an average cost of 5.26 cents per kilowatt hour, and Rhode Island ranked 47th, with an average cost of 15.53 cents per kilowatt hour.

Neither article mentions the Tax Foundation or EIA data I just cited, but the Economist does mention Utah's low energy costs, noting that "The state has experienced a minor semiconductor boom in part because of its cheap, coal-fired power", and the New York Times article mentions taxes, noting that "Many economic analysts and state officials say Rhode Island has long had a high tax burden for businesses, discouraging them from moving here."

1Energy is one issue the GOP initially had some traction with a couple of months ago (e.g., "Drill here, drill now, pay less"), before the steep correction in oil prices.

2Republican candidates, such as McCain, generally focus on personal income taxes, which doesn't give them much traction anymore, since the federal income tax code is so progressive that most Americans pay little if any net federal income taxes, and Democratic candidates can always promise to make the income tax even more progressive, as Senator Obama is currently doing. Better to focus on business taxes, and explain how high taxes on business discourage job creation.

Wednesday, October 29, 2008

McCain's Base

In the 2000 Republican presidential primary, Senator McCain and his campaign staffers used to joke that "the press is our base". McCain had long had favorable relations with the press, particularly when he bucked his party on various issues, and that continued during his insurgent primary campaign against then-Governor George W. Bush. McCain enjoyed some favorable press during this year's Republican primary as well, but once the general election campaign between McCain and Senator Obama began, McCain's press 'base' largely deserted him. The Pew Research Center study released last week provides some evidence of this (see: "Canvasing Campaign Media: An Analysis of Time, Tone and Topics"; the histogram above comes from this study). According to the Pew study,

In the six weeks following the conventions through the final debate, unfavorable stories about McCain outweighed favorable ones by a factor of more than three-to-one [...]

The Pew Research Center study summary report asks whether media bias has played a role in this negative coverage,

One question likely to be posed is whether these findings provide evidence that the news media are pro-Obama. Is there some element in these numbers that reflects a rooting by journalists for Obama and against McCain, unconscious or otherwise?

Maybe not, says Pew:

The data do not provide conclusive answers. They do offer a strong suggestion that winning in politics begets winning coverage, thanks in part to the relentless tendency of the press to frame its coverage of national elections as running narratives about the relative position of the candidates in the polls and internal tactical maneuvering to alter those positions.

Many conservatives have long complained that since most journalists tend to be Democrats, the mainstream media is inherently biased against conservatives (although they are sometimes more tolerant of liberal Republicans). This week the Washington Post Company's online magazine Slate was open enough to publish a piece detailing who its staff members and contributors were supporting in the upcoming presidential election. The results won't do anything to assuage conservative complaints of media bias: 55 Slate staff members and contributors are supporting Obama, versus 1 (Deputy Managing Editor and Copy Chief Rachel Larimore, who hopefully doesn't have to eat lunch by herself) supporting McCain (you can read their explanations of their votes here, "How we're voting: Obama wins Slate in a landslide").

Tuesday, October 28, 2008

Will the Credit Crisis lead to a Food Crisis?

In a recent post ("Jim Rogers on CNBC Europe Early This Morning") we mentioned that Rogers continues to be bullish on agricultural commodities. Another investor who remains bullish on agriculture is Aaron Edelheit. Today on his blog, Aaron Edelheit writes that low global inventories, continuing demand growth from China, and the credit crisis together are setting the table for food shortages next year ("Looming Food Catastrophe in 2009"). Regarding Chinese demand, Edelheit quotes an article by Jim Lane, editor of Biofuels Digest1 ("It's not food, it's not fuel, it's China: Expanded study of impact of China on global corn market") that argues that demand for corn has been driven primarily by the growing consumption of meat in China (since corn is used to feed livestock):

“Even with all the growth, Chinese meat consumption is still 45 percent less than the average consumption in the US,” Lane warned. “An additional 277 million tonnes of grain would be needed to support China at parity with the US. That would take 68 million acres to grow. There isn’t that kind of arable land available anywhere is the world, whether we grow grains for renewable energy or not.”

Regarding the impact of the credit crisis, Edelheit writes,

The credit crisis is hammering South American farmers, to the extent that they cannot get fertilizer2. No fertilizer, no planting of crops.

Further, suppliers are asking farmers in the U.S. for more upfront money to make sure they aren’t holding delinquent debts, causing farming to be a bit more uncertain this year.

Edelheit bases this on an article by Carlos Caminada, Shruti Singh and Jeff Wilson on Bloomberg yesterday ("Farm-Credit Squeeze May Cut Crops, Spur Food Crisis").3 This raises two questions related to one of Edelheit's holdings, Hemisphere GPS (TSX: HEM.TO): if farmers can't get credit to buy fertilizer, can they get credit to buy Hemisphere's precision agriculture equipment? Do they need credit to buy Hemisphere's equipment? Edelheit doesn't say, as he doesn't discuss his stock positions on his blog.

1I find this sort of primary research -- the kind often done by industry-specific analysts, but occasionally done by money managers such as Edelheit -- impressive. Partly as a result of doing this sort of research, occasional commenter Daniel Wahl (his blog) invested early in some winners in the agricultural space, as I noted in a post last June ("Stress Fractures in Titanium"). Daniel has taken his blog in something of a new direction recently, as he prepares to launch a new blog, and he no longer writes about his trades, but he did note in a recent comment thread on his blog that he is still holds Hemisphere GPS, and calls on the fertilizer company Potash Corp. of Saskatchewan (NYSE: POT).

2This may have been a factor in the recent correction in the prices of fertilizer company stocks.

3Jim Rogers similarly linked the credit crisis and commodities in his CNBC Europe interview last week, noting the difficulty anyone would have in borrowing money to dig a mine today.

Monday, October 27, 2008

"Risk Management and Hooke's Law"

Last week's Investor's Business Daily listed the Hussman Strategic Growth Fund as the best performing growth fund so far this year (with a year-to-date performance of -5%, if memory serves). Dr. Hussman was perhaps too modest to mention that in his weekly commentary, which is (as usual) worth reading, "Risk Management and Hooke's Law". In the excerpt below Hussman refers to Hooke's Law,

There's a general relationship in physics called Hooke's Law, which applies to springs: “as the extension, so the force.” My impression is that the stock market behaves much the same way. When investors are very skittish, the market may behave like a very loose rubber band, generating little tension even as it moves significantly away from fair value. But as risk aversion abates, the tension becomes much more like a stiff spring, and the potential to return forcefully toward normal valuations becomes enormous, particularly when the distance from fair value is large.

[Geek's Note: Adding up the cumulative tension described by Hooke's Law gives you a measure of the “potential energy” stored in the spring, which is proportional not to the distance the spring is pulled, but to the square of that distance. This observation has a nice analogy to finance, in terms of how investors should scale into a falling market. Taking the basic dividend discount model as an example, if the growth rate is 6% and the initial yield is 3%, it takes a 25% drop to increase long-term returns from 9% to 10%. From there it takes another 20% drop (40% cumulative) to increase long-term returns to 11%. From there, it takes a drop of 16.7% (50% cumulative) to increase long-term returns to 12%.]

For those who may not remember, Hooke's Law was named after the the physicist Robert Hooke, who was a contemporary of Isaac Newton. Hussman's mention of Hooke reminds me of a comment a friend of mine made years ago, when we were both students in a philosophy class on Baruch Spinoza. The class was mainly about Spinoza, but also covered the work of other rationalists of the same period, such as Gottfried Leibniz. Newton came up at one point during the class, because of a dispute Leibniz had with the Newtonians (Newton wouldn't correspond with Leibniz directly). My friend mentioned that Newton's famous quote, "If I have seen farther than others it is because I have stood on the shoulders of giants" was actually meant as a dig at Robert Hooke, who happened to be a hunchback. I don't know if that's true, but Hooke and Newton did have a bitter rivalry1.

Back to Hussman's commentary, the paragraph below is consistent with comments made by Jim Rogers on CNBC Europe last week, as we noted in a recent post ("Jim Rogers on CNBC Early This Morning"),

Given the enormous expansion of government liabilities we are observing worldwide, it is unlikely that we will observe a long-term absence of inflation once the recent drop in monetary velocity abates. “Monetary velocity” declines when investors hoard government liabilities as safe havens – this suppresses inflation pressures by supporting the value of government liabilities, including currency. But velocity can also shoot higher once credit fears subside. So one of the casualties of easing credit fears is likely to be weakness in the U.S. dollar, and a concurrent strengthening in commodities – particularly precious metals, which serve as a currency substitute. Given the pricing of precious metals shares here, it would not be unexpected to see the XAU roughly double within the next 12 months from these levels.

1Update: My friend offered me the following elaboration via e-mail,

Here are a couple of links, 'verifying' the claim. 'Course with the Internet, you never know... (this is a long one, but traces the origins of the saying before Newton)

...but, I didn't doubt its veracity, because I heard it from a very reliable source: Dr. Jerry Lettvin, he of 'What the Frog's Eyes Tells the Frog's Brain' fame (a seminal paper that eventually led to the development of modern-day cognitive science studies).

He taught an honors seminar at Rutgers on Leibniz, which a friend of mine was taking at the time. We had tea at Jerry's house in Highland Park once. He is a fascinating character, to say the least:

This'll round out your post-

Sunday, October 26, 2008

Don King Has Lunch with the Financial Times

There probably aren't many Obama supporters with positive things to say about President Bush, but Don King is one of them. From Harry Haman's interview with King in yesterday's Financial Times ("Lunch with the FT: Don King"):

King has been a prominent supporter of George W Bush and has been a regular guest at Bush’s ranch in Texas. “Every black looked at me like I had bubonic plague,” he says, although he is unrepentant, calling Bush “a revolutionary president”. I ask him to explain. “George Walker Bush had the most diverse cabinet of any president in the history of this nation: he had the Latinos, he had the blacks, all those who had been degraded, dehumanised and cast into a ... package of negative associations. He took those [people with] negative associations and he put them to the forefront of the nation.”

King believes Bush prepared the way for an Obama presidency, and compares his willingness to put African-Americans in charge of national security to a defining moment in baseball history, the 1947 decision of Brooklyn Dodgers manager Branch Rickey to sign the black player Jackie Robinson, thus integrating the sport.

Saturday, October 25, 2008

Edelheit on the Effect of the Weaker Canadian Dollar on Two of His Picks

On the Value Investors Club website, Aaron Edelheit commented that the recent decline of the Canadian dollar versus the U.S. dollar is bullish for two of his companies, PhotoChannel (OTC BB: PNWIF.OB) and Destiny Media Technologies (OTC BB: DSNY.OB):

Investors may not be appreciating the tremendous benefit Photochannel (bulletin board: PNWIF) will get from the falling Canadian Dollar (CAD). PNWIF gets paid predominantly in US dollars (USD) and pays all of their expenses in CAD. In the past three weeks the CAD has fallen more than 20%. Now I`m sure at some point it will recover somewhat but it is a huge benefit to some of my companies, most notably Photochannel.


Another company I own Destiny Media Technologies (bulletin board: DSNY) will have the same benefit, but even more so, as all of their revenue are USD, and all expenses CAD.

Friday, October 24, 2008

Vaalco Energy Update

There have been a couple of news items on Vaalco Energy (NYSE: EGY) over the last two weeks that I hadn't gotten around to mentioning. Earlier this week, the company announced that it had hired a new CFO. Previously, Vaalco's president, Russell Scheirman, was also its CFO; as part of it settlement of a proxy fight earlier this year, Vaalco had agreed to split the roles. Last week, Vaalco released an update on its drilling and exploration program. Vaalco expects production of about 4500 barrels per day by January from its development well in the Ebouri field offshore of Gabon. That would raise Vaalco's total production per day about 22%, from 20,500 to 25,000. The company also offered these updates on its exploration program:

  • Three exploratory wells in the Etame block: These wells include an appraisal well (North Ebouri) for possible expansion of the Ebouri field and two wells (North Etame and South East Etame) on newly mapped structures. Due to one of the Company's partners electing to go non-consent, VAALCO has increased its interest in the North Ebouri development well and in the South East Etame well to 44% from 30%. The jack-up drilling rig, Pride Cabinda, is now expected to be on location by November with drilling to commence shortly thereafter. The wells will be drilled back to back and have combined gross reserve potential additions in excess of 60 million barrels.

  • Two exploratory wells onshore Gabon in the Mutamba concession: VAALCO remains on schedule to commence drilling the first of these two exploratory wells in December 2008, as previously announced. VAALCO has a 100% working interest in the onshore Mutamba block. Combined potential reserves for these wells are expected to be in excess of 30 million barrels.

  • One exploratory well in Angola: The Company previously announced that it expected to move forward on the planning for a well on Angola Block 5 during the first half of 2009 depending upon rig availability. Due to rig demand, VAALCO now expects this to occur in the third quarter of 2009. The Company has recommended to the consortium a prospect with three objective zones, both above and below the salt layer on the block. Total potential from all three objectives is 150 million barrels. VAALCO has a 40% working interest in Block 5.

  • Interest in North Sea: VAALCO has a 25% interest in a gas prospect on Block 48/25c in the British North Sea. The Company is participating with Century Exploration on the well, which is an offset to a former Shell gas discovery made in 1987. 3-D seismic data indicates the ability to get higher on the structure than the earlier well, increasing the potential reserves to 60 Bcf. VAALCO continues to expect that drilling will begin in the fourth quarter of 2008.

With about $103 million in net cash, Vaalco ought to be able to continue its exploration program without relying on external financing. Vaalco's share price has declined with the correction in oil: Vaalco closed at $4.59 today; when we last mentioned it here, in August, ("Vaalco Energy Reports"), it was trading at $5.69.

Thursday, October 23, 2008

KSW Update

Earlier this week, KSW, Inc. (Nasdaq: KSW), a New York City-based HVAC contractor we've discussed in previous posts (e.g., "KSW Reports") announced that it had been awarded a new project worth between $24 million and $25 million (Press Release: "KSW, Inc. Awarded Contract for Downtown Luxury Building"). The press release noted that,

With this new project, KSW’s backlog remains at approximately 139 million dollars, which does not include the construction costs on projects where the Company is providing pre-construction services.

I spoke to KSW's general counsel, Jim Oliviero, this morning to clarify why the backlog remained unchanged. He said that KSW hadn't had any cancellations in its backlog, but had worked off some of the backlog since last quarter. Oliviero also reiterated that the company is keeping an eye out for potential acquisitions.

At yesterday's closing price of $4.62 per share, KSW was trading at 7.61x its trailing twelve months' earnings. The company has a market cap of about $29 million with $18 million in cash and no long term debt, and its current backlog is about 1.7x its revenue over the last twelve months. KSW may be adversely affected if the economic slowdown hits the NYC construction market, but its balance sheet and backlog could help it get through a lean period.

The company also could be positioned to benefit if a new economic stimulus package includes funds for local infrastructure projects, since KSW's CEO sits on the Metropolitan Transportation Authority's Blue Ribbon Panel on Construction Excellence which provides "guidance to the MTA as it pursues its ambitious capital construction program" and the New York City Department of Environmental Protection's Blue Ribbon Panel on Construction Costs, which provides "guidance to the DEP on its capital construction program."

Wednesday, October 22, 2008

"Market Downturn Shatters Faith in Stocks"

In a post a few months ago ("A Secular Range-Bound Market?"), we discussed Vitaliy Katsenelson's thesis that we are currently in a secular range-bound market1 that started in 2000 that will likely continue for another ten years or so. The key driver of these secular range-bound markets, in Katsenelson's thesis, is multiple compression, driven by psychology: as investors give up on stocks, stocks gradually start trading at lower multiples. By the end of the last secular range-bound market in 1982, for example, the S&P 500 traded at 9x its trailing twelve months' earnings; at the end of the previous secular range-bound market, in 1950, the S&P traded at 7x its trailing earnings. An article in today's Los Angeles Times, "Market downturn shatters faith in stocks", gives some anecdotal examples of investors giving up on stocks:

Even now, the vast majority of investment advisors would strongly urge people not to give up on stocks, especially when most of the damage to their portfolios arguably has already been inflicted.

Most individual investors are sticking with that advice.


But for many, this time is different.

"What's really scaring investors today is whether this mega-meltdown will take 25 years to get back to even, like it did after the Great Depression," said Sam Stovall, chief investment strategist at Standard & Poor's.

The article goes on to quote a couple of boomer investors; the first quote is from a 55-year old accounting consultant named Don Abbee:

"I feel fairly helpless, and I don't know what I can do to change it," he said. "If you stay in the stock market long enough, it's supposed to come back up, but I'm becoming more skeptical. This market feels different."

Bill Orton, a 46-year-old political consultant, is going through a similar apostasy. His faith in the stock market, merely shaken by the tech crash, is now shattered, he said.

A stock fund he bought a few years ago has plunged in value, while U.S. savings bonds he picked up at the same time have been a rock of stability. Orton now declares himself finished with stocks.

"But I am feeling really good about those savings bonds," he said. "I like bonds."

When enough investors decide that they like bonds too, we'll probably see the average dividend yields on stocks rise until stocks become attractive to them. It's worth remembering that there have been times when the average dividend yield on stocks was higher than the average yield on corporate bonds.

1Secular, Katsenelson's terminology, refers to trends that last for 5 years or longer; cyclical refers to trends that last for less than five years. So the current secular range-bound market has included the cyclical bear market from 2000-2002, the cyclical bull market from 2002-2007, and the current cyclical bear market.

Jim Rogers on CNBC Europe Early This Morning

No kind words from Rogers about the officials who have been handling the financial crisis in the U.S. and elsewhere. To add insult to injury, he mangles NY Federal Reserve Bank president Timothy Geithner's name in the process. Rogers says he's still long commodities (particularly agriculture) and short U.S. Treasury bonds, since he expects higher inflation (and higher interest rates) when the economy recovers.

Technical issues prevent me from embedding the video, but here's a link to it: Jim Rogers on CNBC Europe, 10.22.08

Monday, October 20, 2008

'The Economic Blue Screen of Death'

John Mauldin's latest "Thoughts from the Frontline" column, "The Economic Blue Screen of Death1", includes the above histogram that estimates what U.S. GDP growth would have been from 1996-2006 without the stimulus provided by homeowners cashing equity out of their houses via refinancing. Mauldin writes,

Without US homeowners using their homes as an ATM, the economy would have been very sluggish indeed, averaging much less than 1% for the six years of the Bush presidency. Indeed, as a side observation, without home equity withdrawals the economy would have been so bad it would have been almost impossible for Bush to have won a second term[2].


It is likely that whatever recovery we see will be slow in coming. Without MEWs, the period from 2001-2007 would have seen GDP growth of less than 1%! What has changed for the better? It is going to be a rather serious recession and a slow Muddle Through recovery of several years. Unless Obama, Pelosi, and Reid push through their tax increase. Then it will be a lot longer.

1The title of the column refers to the screen old versions of Microsoft Windows would show when the system crashed.

2Mauldin's assumption is consistent with the research Larry Bartels wrote about, as we discussed in a previous post, "Contingency and Causation".

"Government Sachs"

In Sunday's New York Times, reporters Julie Creswell and Ben White notice the ubiquity of Goldman Sachs alumni in government ("The Guys from 'Government Sachs'"). Does this represent potential conflicts of interest, or are these just the latest examples of selfless public service by Goldman Sachs alumni? The article is more even-handed than is typical for the Times. On the one hand,

“To the extent that they have a portfolio or blind trust that holds Goldman Sachs stock, they have conflicts,” said James K. Galbraith, a professor of government and business relations at the University of Texas. “To the extent that they have ties and alumni loyalty or friendships with people that are still there, they have potential conflicts.”

On the other hand,

For every naysayer, meanwhile, there is also a Goldman defender who says the bank’s alumni are doing what they have done since the days when Sidney Weinberg ran the bank in the 1930s and urged his bankers to give generously to charities and volunteer for public service.

“I give Hank credit for attracting so many talented people. None of these guys need to do this,” said Barry Volpert, a managing director at Crestview Partners and a former co-chief operating officer of Goldman’s private equity business. “They’re not getting paid. They’re killing themselves. They haven’t seen their families for months. The idea that there’s some sort of cabal or conflict here is nonsense.”

On the first hand again,

THIS summer, as he fought for the survival of Lehman Brothers, Richard S. Fuld Jr., its chief executive, made a final plea to regulators to turn his investment bank into a bank holding company, which would allow it to receive constant access to federal funding.

Timothy F. Geithner, the president of the Federal Reserve Bank of New York, told him no, according to a former Lehman executive who requested anonymity because of continuing investigations of the firm’s demise. Its options exhausted, Lehman filed for bankruptcy in mid-September.

One week later, Goldman and Morgan Stanley were designated bank holding companies.

“That was our idea three months ago, and they wouldn’t let us do it,” said a former senior Lehman executive who requested anonymity because he was not authorized to comment publicly. “But when Goldman got in trouble, they did it right away. No one could believe it.”

The article notes that although NY Fed president Geithner isn't a Goldman Sachs alumnus, "Goldman alumni have figured prominently in his ascent", including former Goldman Sachs chief Robert Rubin, who mentored Geithner when Geithner worked in the Treasury Department and Rubin was Treasury Secretary, during the Clinton Administration.

Sunday, October 19, 2008

United Technologies Chairman on China

Jim Cramer, of CNBC's Mad Money, has attributed the current commodity correction to a slowdown in China. On Friday's episode of Mad Money, Cramer interviewed a guest with a different view, George David, the Chairman of United Technologies (NYSE: UTX). In response to Cramer's question about China, David reiterated the point he had made on his company's recent conference call that China was "booming" and, as an example, noted that United Technologies had sold 30% more elevators in China in the third quarter of this year than it had sold in the same period last year. Here is a link to the video of Cramer's interview with David. The discussion about China comes up at about 7:13.

Friday, October 17, 2008

E-Mail from the CEO of Alloy Steel International, Inc.

During the current market downturn, shares of Alloy Steel International, Inc. (OTC BB: AYSI.OB), have sunk recently along with the shares of other companies in the metals sector. I have had a GTC limit order in for a few days to buy a few more shares below $1, but it hasn't been filled yet. I asked the following questions of the company via e-mail early this morning:

Can you provide an update on the construction of your second mill? If memory serves, you expected to have it in operation by September.

Also, have you succeeded in hiring the sales persons you were recruiting over the summer?

Is your planned joint venture in Mongolia still on track?

I received the following response from Alloy Steel's CEO, Gene Kostecki,

Thank you for your continuing Interest in AYSI. We are about to make a press statement on the company, we were just waiting to get the accounts finished for the 3rd Quarter. I think that every one will be in for a pleasant surprise. We have shelved Mongolia for at least 6 Months till this madness subsides. The 2nd mill is a few weeks behind schedule before we start calibrating and software checking. We are continuing to steer a steady course for the company.

At its current price of $1 per share, Alloy Steel is trading at 6.62x its earnings over the trailing twelve months.

Thursday, October 16, 2008

"Sea Change" in the Arctic

In an article in the November Atlantic ("Sea Change") that includes the above graphic, Scott Borgerson describes some of the economic and political implications of the Arctic Ocean becoming navigable due to the melting of the ice cap.

Presumably, a beneficiary of a more navigable Arctic would be Baffinland Iron Mines (TSX: BIM.TO), the speculative Canadian junior iron mining company that had been a pick of Aaron Edelheit (at least until Mitsubishi declined to participate in Baffinland's round of financing last year).

Conversation with the CEO of USEG

U.S. Energy Corp. (Nasdaq: USEG) put out a press release on Monday announcing a deal with a private, Texas-based oil company -- U.S. Energy's third working interest partner in the oil & gas space: "U.S. Energy Corp. Signs Lease Purchase and Drilling Agreement With Private Texas-Based Company".

I spoke to U.S. Energy's CEO Keith Larsen today, and asked him if he was seeing better terms offered on these sorts of working interest deals, with the current correction in oil and natural gas prices. He said he was, and that he was also starting to look at buying proven reserves from other companies, particularly those that overextended themselves with leverage and may now be forced to sell some of their assets.

At its closing price today of $2.29 per share, USEG is trading for about $2.5 million less than its net cash.

Wednesday, October 15, 2008

Financial Times: Gloomy Short-Term Outlook for Metals

This article won't be a surprise to anyone who owns or has been following the share prices of mining companies, Financial Times: "Mining and metals prepare for lean times". Excerpt:

The mining and metal industry is bracing for months of price weakness as slowing demand in the US, Europe, Japan and some emerging markets, including China, is likely to push commodities such as copper into surplus.

At the London Metal Exchange annual dinner last night, the premier gathering of the industry in London, the mood among traders, bankers and mining executives was gloomy, particularly with regard to the short term.

"With the likelihood of a global recession rising, industrial metals prices will face further downward pressure," said a report by Francisco Blanch of Merrill Lynch.


Over the medium-term, some analysts and executives see some bright spots in the market. Leon Westgate, a metal analyst at Standard Bank, said that looking ahead towards the start of the next decade a demand recovery and in some cases the need for restocking by consumers will come into play. "Given the current low price of metals relative to production cost, and the impact of expensive capital, we may see supply retreat further," said Mr Westgate.

Edelheit Echoes Jim Rogers

Aaron Edelheit makes two predictions in a recent post ("Looking Out") on his blog; the second one echoes Jim Rogers:

I see two major sea changes coming due to the current financial crisis.

1) When things normalize in credit land (and it has already started normalizing, albeit very slowly), there is going to be a slew of M&A activity.

2) The next commodity bull run will be mind numbingly explosive.


The second point is based upon the printing of money and debasing of currencies from every major government in the world, combined with the fact that we are still in relatively short supply for most commodities once the world starts to grow again, I think the next run in commodities will be enormous.


The 1970s show us what can happen. Oil went from $1 to $4. Then pulled back to $2, before going to $20. Could $750 oil be in our future by 2015? I think its more likely than $20 oil.

$750 oil in 2015 seems unrealistically high to me -- I haven't heard anyone quote an estimate that high -- but I agree that oil will probably go significantly higher in the next several years. Of course, given the inherent operational leverage in commodity-producing companies, even a much more modest increase in oil prices would lead to large increases in profits. For a simplified example, consider an oil E&P with cost of production of, say, $40 per barrel (this is a lot higher than the cost of production of the E&P I own, Vaalco Energy, but it makes the arithmetic simpler). If oil prices go from $80 to $120, that would be a 50% increase in the price of oil, but that would represent a 100% increase in the (pre-tax) earnings of the E&P (assuming its cost of production and production rates held steady), since its profits per barrel would have doubled from $40 to $80.

Tuesday, October 14, 2008

More from "The Irrational Electorate"

In a recent post ("Contingency and Causation") we posted an excerpt from an article ("The Irrational Electorate") in The Wilson Quarterly by Larry Bartels, the director of the Center for the Study of Democratic Politics in Princeton University’s Woodrow Wilson School of Public and International Affairs. The article is worth reading in full, but here are a couple more excerpts from it.

On the relevance of candidates' policy positions to most voters

Most people seem able to provide cogent-sounding reasons for voting the way they do. However, careful observation suggests that these “reasons” often are merely rationalizations constructed from readily available campaign rhetoric to justify preferences formed on other grounds.17

Consider the role of Social Security privatization in the 2000 presidential election. It was a huge issue, the focus of more than -one-tenth of all campaign-related television news coverage and about 200 ads on a typical television station in a battleground media market in the last week of the campaign. By Election Day, there was a strong statistical relationship between voters’ views about privatization and their presidential choices—just as one would expect if voters were pondering this important issue and casting their ballots accordingly. However, a detailed analysis by political scientist Gabriel Lenz found very little evidence that people actually changed their vote because of the Social Security debate. What happened, mostly, was that people who learned the candidates’ views on privatization from the blizzard of ads and news coverage simply adopted the position of the candidate they already supported for other reasons. The resulting appearance of “issue voting” was almost wholly illusory.18

An example of irrational voting

Voters have great difficulty judging which aspects of their own and the country’s well-being are the responsibility of elected leaders and which are not. In the summer of 1916, for example, a dramatic weeklong series of shark attacks along New Jersey beaches left four people dead. Tourists fled, leaving some resorts with 75 percent vacancy rates in the midst of their high season. Letters poured into congressional offices demanding federal action; but what action would be effective in such circumstances? Voters probably didn’t know, but neither did they care. When President Woodrow Wilson—a former governor of New Jersey with strong local ties—ran for reelection a few months later, he was punished at the polls, losing as much as 10 percent of his expected vote in towns where shark attacks had occurred.

New Jersey voters’ reaction to shark attacks was dramatic, but hardly anomalous. Throughout the 20th century, presidential candidates from incumbent parties suffered substantial vote losses in states afflicted by droughts or wet spells.

Incidentally, according to Wikipedia, the 1916 Jersey Shore shark attacks Bartels refers to inspired Peter Benchley to write Jaws

Monday, October 13, 2008

"Dow'd but not Out"

Just got an e-mail from Seattle restaurant company Chow Foods, advertising the promotion below. I've only been to one of their restaurants, The Five Spot, but it was excellent: great breakfast, and some of the strongest coffee I've ever had.

Dow'd But Not Out

As a token of our appreciation to our loyal customers, on Thursday, October 16th, between 5-10pm, CHOW Foods is executing a short term Main Street bailout plan far more delicious than the one the goofs in congress passed last week.

To make sure the Dow doesn't get you down, on Thursday night only, we're pricing our menu based on the close of the market on the 16th. The lower the Dow closes on Thursday, the less your entrée costs--no food on the menu will be priced more than the Dow. If it closes at 8300 (gulp!) then you won’t pay any more than $8.30 for any item on our food menus.

If Chowin’ on the DOW isn’t enough to whet your appetite, keep in mind that our house red & white wine, draft beers and well drinks will be priced at the NASDAQ close for the day.  If it dips to 1250, then our depression era pricing on these libations will be just a buck twenty five!

Stop by for dinner and drinks between 5 p.m. and 10 p.m. at any of our joints as we match the economy cent for cent. Menu prices will be set according to the markets close, so for one night, forget about the size of your 401k and CHOW down on our nickel.

Get your wallet off your mind and join us on October 16th at your local CHOW restaurant and enjoy a taste of the good life for a little bit less. For a full list of restaurants or to browse our menus see

Sunday, October 12, 2008

"Revenge of the Copy Book Headings"

In his October 6th Bear's Lair column ("Revenge of the Copybook Headings"), Martin Hutchinson, inspired by the Kipling poem, offers his own copy book headings related to the current financial crisis. Here are two of them:

“Whoever makes a loan has responsibility if it goes wrong afterwards.” This Copybook Heading principle of traditional banking was flouted by the securitization market, in which loan originators were able to escape responsibility for poor credit decisions. The result was an orgy of poor housing lending, involving not simply poor credit decisions but outright fraud, connived in by loan originators who collected their fees and passed the fraudulent paper on to Wall Street and international investors. In this disaster, Wall Street was self-deluded, drunk with excessive money supply; the real crooks were the mortgage brokers, mostly a bunch of used-car salesmen who had never been closer to Wall Street than a day trip to the Statue of Liberty. The securitization market will only survive under careful limitations which ensure that, at least to some degree, this God is obeyed1.

“Don’t take risks that you don’t understand.” Flouted openly in most bubbles, this God was drugged during this one by perverted science, the “Value–at-Risk” Risk Management technique, which controlled risk just fine provided that the markets involved were not in fact risky. In Wall Street’s defense, the proof that VAR was a load of codswallop required fairly sophisticated mathematics and so was available to only a few noisy skeptics like myself and Benoit Mandelbrot2, whose previous invention, fractal geometry, was unknown to the intellectually uncurious workaholics of Wall Street.

1Hutchinson is careful here to not blame securitization per se. Securitization makes sense if done properly, e.g., if mortgage originators use rational underwriting standards, if only loans of homogeneous credit quality and terms are packaged together, and if mortgage originators and borrowers both have some skin in the game if a loan goes bad.

2Brooklyn-based musician/geek/Internet phenom Jonathan Coulton wrote a song about Benoit Mandelbrot, "Mandelbrot Set". For more on Coulton, see Clive Thompson's New York Times article on him, "Sex, Drugs, and Updating Your Blog"

Saturday, October 11, 2008

"The Excesses of Pragmatism"

Christopher Caldwell occasionally writes a column that, whether you agree with it or not, will be worth reading years after the news that prompted him to write it is off the front pages. His essay in yesterday's Financial Times, "The Excesses of Pragmatism", looks to be one of these. In it, Caldwell takes aim at those who blame free market dogmatism for the current crisis and argues that the excesses of pragmatism, not dogmatism, have led us here. He goes on to write,

“Bold, persistent experimentation” was Franklin Delano Roosevelt’s formula for getting out of an economic crisis. In fact, bold, persistent experimentation is all we ever have. In the 1930s, FDR brought Americans hope with massive government involvement in the economy. Whether the New Deal’s economic effects were positive or negative is open to debate. But because it was politically popular, it was extended and expanded over the decades. The same pattern was followed throughout the west: sensible, pragmatic help for working-class families was, by popular demand, extended until it turned into a bubble – a benefits bubble, or a wage bubble or a unionisation bubble, or call it what you will1. In the 1970s, that bubble popped, putting the global economy at risk. The result was “bold, persistent experimentation” à la Thatcher and Reagan, the most effective part of which was the idea of an “ownership society”. It has left us here.

Dogmatism is pragmatism that has stood the test of time. Institutions tend to be forged in moments of crisis. Ideas that fail are discarded; ideas that succeed are retained, elaborated and then over-elaborated until they collapse. The problems of 30 years from now will turn out to have been hidden somewhere in the parts of today’s bail-out packages that wind up being most effective. If we are lucky, the most effective parts will be the most morally admirable parts. But that is not inevitable. In politics, correlation often passes for causation2. The recovery of the Russian economy after the rouble crisis of 1998 coincides with the arrival of Vladimir Putin in power. If a strong hand coincides with prosperity, the public sometimes assumes a stronger hand will mean more prosperity. Needless to say, leaders always think like that.

1The higher education bubble I posited in a recent post ("The Next Bubble to Burst in the Deleveraging Process: Higher Education?") seems to be consistent with Caldwell's point here.

2Interesting parallel between Caldwell's point here and role of contingency in politics that Larry Bartels described, as we discussed in a recent post ("Contingency and Causation").

John Mauldin Warns that Another Credit Market Is Starting to Freeze Up

In John Mauldin's latest "Thoughts from the Frontline" letter ("Where Do We Go From Here?"), he writes that the letter of credit market is starting to freeze up, and that if this isn't dealt with, it will hamstring global trade:

Just as the business world is dependent upon commercial paper as its life blood, the world of global trade depends on letters of credit (LOC). Without LOCs, the world of trade quickly freezes up.

If you are a manufacturer of a product and want to sell to someone outside your borders, you typically require a letter of credit from the buyer before you load any cargo at a port. A letter of credit from a prime bank is considered to be proof of your ability to pay. It not only can be a source of ultimate payment, it can be a source of inventory financing while goods are in transit.

And if you are a business which is buying a product, you do not want to release money until you know the product is on the way. There are buyer's and seller's agents who make sure these things happen seamlessly, and world commerce had grown because of it.

Now we are starting to get anecdotal evidence that this extremely vital market is also freezing up. If you think the problems stemming from a meltdown with the commercial paper markets are threatening to the world economy, they are small potatoes when compared to a seizure in the letter of credit markets.

One piece of evidence for the freezing in letters of credit that Mauldin mentions is an anecdote about an shipper unable to get funding from Citibank using his letter of credit from BNP Paribas. Given the uncertainty that surrounds many large banks due to their exposure to distressed assets and opaque derivatives, I wonder if there might be an opening for smaller banks or even non-bank lenders to expand into letters of credit. Maybe not, but I'll bounce the idea off of a client who owns an non-bank lender.

Mauldin's letter covers more ground than this, including his take on the CDS market, the collapse of Lehman, the crisis in Iceland, and Mauldin's proposed solutions. It's worth reading the whole thing as a counterpoint to U. of Chicago Professor Casey Mulligan's more optimistic take on the state of the economy. I suspect the reality is somewhere in between.

Friday, October 10, 2008

Contingency and Causation

On his Atlantic blog yesterday, Ross Douthat posted an excerpt from an article by Princeton professor Larry Bartels in The Wilson Quarterly ("The Irrational Electorate"). In his article, Bartels argues that sea changes in politics are often driven not by changes in ideology or political philosophy but instead are contingent on other factors, e.g., economic conditions. Surveying the political realignments of the Depression era, Bartels writes,

Considering America's Depression-era politics in comparative perspective reinforces the impression that there may have been a good deal less real policy content to "throwing the bums out" than meets the eye. In the U.S., voters replaced Republicans with Democrats and the economy improved. In Britain and Australia, voters replaced Labor governments with conservatives and the economy improved. In Britain and Australia, voters replaced Labor governments with conservatives and the economy improved. In Sweden, voters replaced Conservatives with Liberals, then with Social Democrats, and the economy improved. In the Canadian agricultural province of Saskatchewan, voters replaced Conservatives with Socialists and the economy improved. In the adjacent agricultural province of Alberta, voters replaced a socialist party with a right-leaning funny-money party created from scratch by a charismatic radio preacher, and the economy improved. In Weimar Germany, where economic distress was deeper and longer-lasting, voters rejected all of the mainstream parties, the Nazis seized power, and the economy improved. In every case, the party that happened to be in power when the Depression eased dominated politics for a decade or more thereafter. It seems farfetched to imagine that all these contradictory shifts represented well-considered ideological conversions. A more parsimonious interpretation is that voters simply--and simple-mindedly--rewarded whoever happened to be in power when things got better.

U. of Chicago Economist: The Real Economy is in Good Shape

In an op/ed in the New York Times today ("An Economy You Can Bank On"), University of Chicago economics professor Casey Mulligan challenges claims that the financial crisis threatens to lead to a crisis of similar proportions in the real economy. Below is an excerpt, but it's worth reading the whole thing.

We’re in a financial crisis, not an economic crisis. We’re not entering a second Great Depression.

How do we know? Well, the economy outside the financial sector is healthier than it seems.

One important indicator is the profitability of non-financial capital, what economists call the marginal product of capital. It’s a measure of how much profit that each dollar of capital invested in the economy is producing during, say, a year. Some investments earn more than others, of course, but the marginal product of capital is a composite of all of them — a macroeconomic version of the price-to-earnings ratio followed in the financial markets.

When the profit per dollar of capital invested in the economy is higher than average, future rates of economic growth also tend to be above average. The same cannot be said about rates of return on the S.& P. 500, or any another measurement that commands attention on Wall Street.

Since World War II, the marginal product of capital, after taxes, has averaged 7 percent to 8 percent per year. (In other words, each dollar of capital invested in the economy earns, on average, 7 cents to 8 cents annually.) And what happened during 2007 and the first half of 2008, when the financial markets were already spooked by oil price spikes and housing price crashes? The marginal product was more than 10 percent per year, far above the historical average. The third-quarter earnings reports from some companies already suggest that America’s non-financial companies are still making plenty of money.

Thursday, October 9, 2008

Mark Cuban: "I'm Going Long Right Now"

In his post yesterday on Wall Street Pit, Cuban mentioned he was starting to go long on some dividend paying stocks while continuing to hedge himself by holding puts on Dow Diamonds (AMEX: DIA). Here are a few excerpts:

On the macro view

When I look at the credit markets. The Fed and Treasury and even international agencies are signalling that they will be the lender of the first and last resort. We see short term treasuries trading as if traders are starting to get comfortable with credit and liquidity. I think that although banks dont fully trust lending to each other yet, they are working to put together the scenarios under which they will trade. They are gearing up.

I have no idea what the economy will do other than the fact that it wont be good. How bad it will get, I dont know. But I can look at a company, discount what the projections are, then discount them some more, and come up with what I think is a fair price.

On the importance of dividends:

What is a fair price to me? Well I start with the Dividend first. No dividend, no buy.


My first stomping grounds are MLPs. They have been getting killed. KILLED. They build pipelines, ships, whatever, and they do contracts to provide service via those assets. The assets are very long term, and the cash flows are very consistent. I am putting together a big porfolio that will pay me more than 10pct yield. The nice thing about 10pct yield, is that its 10pct yield. As long as I watch them and make sure nothing changes in their business to impact that yield (and hopefully it improves and they increase the payout), then I dont have to mark to market on a daily basis. I just get paid.

On the importance of dividends some more

I’m also looking at stocks in industries that I know very well that yield 6pct or more. Dividends that I think are safe in companies that I think are very strong. This wont be a big part of my portfolio. Just a tasting.

Why? Because there are some good companies, in good businesses where I think the dividend is safe, and 6pct , plust hopefully future dividend increases is a good thing. Notice I didnt say a word about the price going up. It doesnt matter if the price goes up. It matters if the dividend goes up. The best stock to buy is the one you never have to sell. It just pays you forever. The concept that you own your share of the discounted cash flow of a company is the biggest lie ever sold by brokers in the history of financial markets. You dont own shit. The CEOs, you know the ones that pay themselves, but dont manage to pay dividends, they control and effectively own those future cash flows. So dont kid yourself. Buy stocks that pay dividends and get paid. Even then there is the risk they can go to zero. So always be aware.

On why you should be skeptical of anyone's advice, including his:

All that said. The stock market can humble me or anyone in a nano second. It could go a lot lower. I DO NOT SEE IT GOING DRAMATICALLY HIGHER. NO CHANCE IT GETS BACK TO 11k anytime soon.

But, Do not take advice from me. In fact, do not take advice from anyone. If your advisor was so smart, they wouldnt be giving you advice on what to buy. They would be sitting on their yacht, being taken to port, to hop on their helicopter, to go to the airport, to jump on their GV, to go to their house on an island you have never heard of. Not sitting in an office, on the phone talking to you about to go nuclear over the market ass.

Unless you know a company and industry as well as anyone, PUT YOUR MONEY IN A CD.

Wednesday, October 8, 2008

From Mark Cuban to Chris Rock

Mark Cuban's description of his first year in business from his "Success & Motivation" series of posts reminded me of a bit about jobs versus careers from Chris Rock's recent HBO special. Here's Mark Cuban writing about his first year in business:

That first year in business was incredible. I remember sitting in that little office till 10pm and then still being so pumped up, I would drive over to the gym I belonged to and run 5 to 10 miles on the treadmill going through that day, and the next in my head. Other days I would get so involved with learning a new piece of software that I would forget to eat and look up at the clock thinking it was 6 or 7pm and see that it was 1am or 2am. Time would fly by.

And here's a clip of Chris Rock's bit about jobs versus careers:

Mark Cuban on the Importance of Having an Information Advantage

On Christmas Eve last year, Mark Cuban republished on his blog a series of posts about how he got his start in business ("Success & Motivation"). There's a lot of great stuff in this series of posts, but one theme that comes up repeatedly is Cuban's emphasis on having an information advantage. Here are a couple of examples, excerpted from this long (but entertaining) series of posts.

On the importance of having an information advantage in the technology business

I would continuously search for new ideas. I read every book and magazine I could. Heck, 3 bucks for a magazine, 20 bucks for a book. One good idea that lead to a customer or solution and it paid for itself many times over. Some of the ideas i read were good, some not. In doing all the reading I learned a valuable lesson.

Everything I read was public. Anyone could buy the same books and magazines. The same information was available to anyone who wanted it. Turns out most people didn’t want it.

I remember going into customers or talking to people in the industry and tossing out tidbits about software or hardware. Features that worked, bugs in the software. All things I had read. I expected the ongoing response of “Oh yeah, I read that too in such-and-such.” That’s not what happened. They hadn’t read it then, and they haven’t started reading yet.

Most people won’t put in the time to get a knowledge advantage. Sure, there were folks that worked hard at picking up every bit of information that they could, but we were few and far between. To this day, I feel like if I put in enough time consuming all the information available, particularly with the net making it so readily available, I can get an advantage in any technology business.

On the importance of having an information advantage in investing (from an interview with Young Money magazine)

YM: Do you have any general saving and investing advice for young people?

CUBAN: Put it in the bank. The idiots that tell you to put your money in the market because eventually it will go up need to tell you that because they are trying to sell you something. The stock market is probably the worst investment vehicle out there. If you won’t put your money in the bank, NEVER put your money in something where you don’t have an information advantage. Why invest your money in something because a broker told you to? If the broker had a clue, he/she wouldn’t be a broker, they would be on a beach somewhere.

Monday, October 6, 2008

Aaron Edelheit Calls the Bottom

From his rather infrequently updated blog:

I’m calling it now. Jim Cramer, CNBC and commentator and former hedge fund manager, has officially called the bottom.


I recommend that anyone waiting to invest, do so now. You rarely get a bell ringing for the sound of a bottom than as you did today.

Incidentally, for any prospective bargain hunters, the three Edelheit picks that I bought are well below the prices Edelheit recommended them: Destiny Media (OTC BB: DSNY.OB), PhotoChannel (OTC BB: PNWIF.OB), and Hemisphere GPS (TSX: HEM.TO1).

1Hemisphere is below the price where Edelheit recommended it in June of '07 on the Value Investors Club website, but it's still above the price where he recommended its predecessor company, CSI Wireless.

Sunday, October 5, 2008

Fannie Mae Exposé

Today's New York Times features a long cover article by Charles Duhigg on the fiasco at Fannie Mae, "Pressured to Take More Risk, Fannie Reached Tipping Point". The broad strokes of this have been covered before, but the Times article fills in some of the sordid details.

The article notes how former Fannie Mae CEO Franklin Raines and his CFO J. Timothy Howard expanded Fannie's share of the mortgage market by having the company increase its purchases of risky mortgages. Those two were of course forced to resign in 2004, after the accounting scandal at Fannie came to light, and Daniel Mudd took over as CEO then. Mudd was shown the door last month, after the federal government took over Fannie Mae. The Times article concludes by describing what Raines, Howard, and Mudd are up to today:

Mr. Raines and Mr. Howard, who kept most of their millions, are living well. Mr. Raines has improved his golf game. Mr. Howard divides his time between large homes outside Washington and Cancun, Mexico, where his staff is learning how to cook American meals.

But Mr. Mudd, who lost millions of dollars as the company’s stock declined and had his severance revoked after the company was seized, often travels to New York for job interviews.

Incidentally, at first I wondered why McCain didn't push back in the first debate when Obama blamed the credit crisis solely on "failed Republican policies", by noting Obama's receipt of campaign contributions from the GSEs, and his association with Franklin Raines. Then I read that McCain's campaign manager, Rick Davis, had been a lobbyist for Freddie Mac.

Saturday, October 4, 2008

Letter to Congress from the CEO of BBT

Hat tip to commenter DB for posting a link to this letter from Branch Banking & Trust Co. (NYSE: BBT) CEO John Allison to Members of Congress. Below is an excerpt. Mr. Allison's second point is consistent with the view of the contrarians quoted in an earlier post ("Is the Credit Crisis hurting the Real Economy").

Key Points on “Rescue” Plan From A Healthy Bank’s Perspective

  1. Freddie Mac and Fannie Mae are the primary cause of the mortgage crisis. These government supported enterprises distorted normal market risk mechanisms. While individual private financial institutions have made serious mistakes, the problems in the financial system have been caused by government policies including, affordable housing (now sub-prime), combined with the market disruptions caused by the Federal Reserve holding interest rates too low and then raising interest rates too high.

  2. There is no panic on Main Street and in sound financial institutions. The problems are in high-risk financial institutions and on Wall Street.

  3. While all financial intermediaries are being impacted by liquidity issues, this is primarily a bailout of poorly run financial institutions. It is extremely important that the bailout not damage well run companies.

  4. Corrections are not all bad. The market correction process eliminates irrational competitors. There were a number of poorly managed institutions and poorly made financial decisions during the real estate boom. It is important that any rules post “rescue” punish the poorly run institutions and not punish the well run companies.

  5. A significant and immediate tax credit for purchasing homes would be a far less expensive and more effective cure for the mortgage market and financial system than the proposed “rescue” plan.

  6. This is a housing value crisis. It does not make economic sense to purchase credit card loans, automobile loans, etc. The government should directly purchase housing assets, not real estate bonds. This would include lots and houses under construction.

  7. The guaranty of money funds by the U.S. Treasury creates enormous risk for the banking industry. Banks have been paying into the FDIC insurance fund since 1933. The fund has a limit of $100,000 per client. An arbitrary, “out of the blue” guarantee of money funds creates risk for the taxpayers and significantly distorts financial markets.

  8. Protecting the banking system, which is fundamentally controlled by the Federal Reserve, is an established government function. It is completely unclear why the government needs to or should bailout insurance companies, investment banks, hedge funds and foreign companies.

  9. It is extremely unclear how the government will price the problem real estate assets. Priced too low, the real estate markets will be worse off than if the bail out did not exist. Priced too high, the taxpayers will take huge losses. Without a market price, how can you rationally determine value?

  10. The proposed bankruptcy “cram down” will severely negatively impact mortgage markets and will damage well run institutions. This will provide an incentive for homeowners who are able to pay their mortgages, but have a loss in their house, to take bankruptcy and force losses on banks. (Banks would not have received the gains had the houses appreciated.) This will substantially increase the risk in mortgage lending and make mortgage pricing much higher in the future.

  11. Fair Value accounting should be changed immediately. It does not work when there are no market prices. If we had Fair Value accounting, as interpreted today, in the early 1990’s the United States financial system would have crashed. Accounting should not drive economic activity, it should reflect it.

  12. The proposed new merger accounting rules should be deferred for at least five years. The new merger accounting rules are creating uncertainty for high quality companies who might potentially purchase weaker companies.

  13. The primary beneficiaries of the proposed rescue are Goldman Sachs and Morgan Stanley. The Treasury has a number of smart individuals, including Hank Paulson. However, Treasury is totally dominated by Wall Street investment bankers. They do not have knowledge of the commercial banking industry. Therefore, they can not be relied on to objectively assess all the implications of government policy on all financial intermediaries. The decision to protect the money funds is a clear example of a material lack of insight into the risk to the total financial system.

  14. Arbitrary limits on executive compensation will be self defeating. With these limits, only the failing financial institutions will participate in the “rescue,” effectively making this plan a massive subsidy for incompetence. Also, how will companies attract the leadership talent to manage their business effectively with irrational compensation limits?

Friday, October 3, 2008

The Commodity Correction

The commodity correction over the last few months has been brutal, across all market caps. For example, my micro cap holding Alloy Steel International1 (OTC BB: AYSI.OB) closed at $1.16 per share today, down from its June high of about $2.80; mid cap U.S. Steel (NYSE: X) closed at $63.50 today, down from its June high of nearly $192 per share; and large cap Arcelor Mittal (NYSE: MT) closed at $44.62 today, down from its June high of $104.25. Share prices of agricultural commodity companies have posted similar drops.

A question this raises is whether this is a cyclical correction in the continuing secular bull market in commodities, or the end of that secular bull market. My view is that this is a cyclical correction and could be a great buying opportunity (for anyone who has some dry powder left). It's worth revisiting some comments Jim Rogers made to Bloomberg's Carol Massar in July ("Jim Rogers Speaks"):

[Carol Massar:]...What about this commodity boom? I think recently we talked to you and or I was reading something and it said that we are in the fourth inning of a baseball game. Still there, in your view?

ROGERS: Probably around the fourth inning, that sounds good enough. Maybe the fourth and a half, maybe the top or the bottom of the fifth, something like that. The commodities bull market has a long way to go.

There are going to be corrections along the way, Carol, there always are, but no, nobody has discovered any major oil field in over 40 years. There just aren't any supplies of anything.

MASSAR: Jim, what do you make though of the arguments out there about demand destruction, about a weakening global economy and that is going to start to bring down commodities. I know you talk about some near-term corrections.

So, anything out there though that will substantially drag down commodities, in your view?

ROGERS: Well, recession, if the world goes into recession, of course it is going to drag down the demand. But remember, Carol, in the 1970s we had one of the worst decades in a long time for the economy. And oil went up ten times, the oil commodity, we had one of the great bull markets of all time in commodities because supply went down faster than demand and that is what is happening now too.

Oil can go down - you know the bull market in oil started in 1999. Three times since 1999, oil has gone down over 40 percent. It wasn't the end of the bull market. It just scared the socks off everybody, including me. That can happen again, but it is not the end of the bull market.

MASSAR: So, any pullbacks for a buying opportunity, in your view, whether it is oil, whether it is grains, whether it is base metals?

ROGERS: Yes, of course. Everything. Base metals have already corrected a lot. Wheat has corrected a lot. Sugar has corrected a lot. Get yourself some sugar, take it home, take it home from your Bloomberg.


MASSAR: 30 seconds left here. I know you mentioned you are kind of looking, eyeing at base metals. Anything else you think investors should be looking at, just kind of keeping on their radar, just quickly if you could?

ROGERS: Agriculture, agriculture. You should be buying agriculture. I am buying agriculture.

Update: Rogers reiterated his view that the secular bull market in commodities hasn't ended in an interview with New Delhi Television over the weekend, "Commodity bull run not over yet: Jim Rogers". Excerpt:

NDTV: Do you believe in the theory of commodity cycle cooling off?
Jim Rogers: There is no question that commodity prices have cooled off, but that is the way the market works. You always have consolidation and correction. Three times in the last nine years, oil prices have gone down by 50 per cent, and each time it was not the end of the bull market. If suddenly someone discovers huge oil reserves then the bull market is still on.

NDTV: But how long the bear market in the current commodity space will continue?
Jim Rogers: In the 1970s, gold went down 50 per cent, but after two years it turned around and went up 850 per cent. So I don’t know how long this correction is going to last. If the worldwide economic problem continues for a while then it can last for a longer period.

NDTV: But everybody is talking about global slowdown, so if there is no demand then how will commodity price rise?
Jim Rogers: They will have a consolidation but if you are suggesting the world in a perpetual economic decline, then we will never have any bull market.

1Alloy Steel occupies a different niche than traditional steel companies: it manufactures alloy steel wear plates for mining equipment.

USEG Update

U.S. Energy Corp. (Nasdaq: USEG) announced the spudding of the second of the three planned wells with PetroQuest Energy (NYSE: PQ). Excerpt from the press release:

``With drilling completed at the Bluffs prospect, our oil and gas program continues to expand as our partner, PetroQuest, has redeployed the rig to begin drilling at the second of three projects where we have an interest,'' stated Keith Larsen, CEO of U.S. Energy Corp. ``As we advance our oil and gas program through the balance of 2008, we expect to report initial production rates at the Bluffs and additional drilling at our other prospects. With approximately $70 million held in U.S. Treasuries and cash, we are well positioned to take advantage of any additional opportunities identified in the year ahead,'' he added.

According to Yahoo! Finance, USEG currently has a market cap of about $60 million and, after adding in its debt and subtracting its cash, an enterprise value of about $1.5 million.

Gerard Baker Tries to Calm the Cassandras

In his Times of London column ("That rubbish they talk about the credit crunch"), Gerard Baker addresses some of the more hyperbolic reactions to the credit crisis and the rescue package passed today, including the claims that the rescue represents an inexorable turn from capitalism to socialism. Worth reading in full, but here is an excerpt:

[The financial crisis is] a vast drama, with consequences that will ripple steadily from immediate economic hardship to changes in short-term political fortune to a broad recasting of the way our economies and societies work.

But that's not enough, apparently, for the drama queens and kings of our political and media establishments. Hastily, they've constructed a grand historical narrative in the last couple of weeks, composed largely of overarching myths that are in danger of hardening into conventional wisdom.

So at the risk of being accused of missing the historical boat, let me try to take a few of them on.

Capitalism has failed and the US has embraced socialism

This one has adherents, surprisingly, on both sides of the Atlantic. In Europe, the birthplace, etymologically speaking, of Schadenfreude, the Germans and French have been eagerly stamping on the grave of Anglo-Saxon capitalism. In America they've found unlikely allies among a bunch of hardline conservative Republican politicians and commentators. These latter-day Bourbons claim the Bush Administration's $700 billion bailout plan for banks will rank with the October Revolution and Mao's Long March as seminal events in the history of human serfdom.

Let's take the latter claim first. Seven hundred billion dollars certainly sounds like a big chunk of the economy to be placed in the hands of the Government. It could, spent wisely, get you some way to the top of the commanding heights of America's $14 trillion economy.

But I doubt the Hank Paulson plan would win him plaudits with Marx and Engels. For starters, acquiring the financial equivalent of a junkyard is not quite what socialists have in mind when they urge nationalisation.

In any case the actual outlay will not be anything like $700 billion. The Government is merely proposing to use that money to buy the putrid assets that now clog the balance sheets of banks. When the frozen credit markets thaw, it will sell them back. It's unlikely the whole exercise will cost more than a couple of hundred billion dollars, which represents about 1.5 per cent of the US economy.

Capitalism's Cassandras might also want to consider that the crisis the current mess most closely resembles is the Swedish banking collapse of 1991-92. I don't remember Sweden being reviled in those days as a model of heartless capitalism.

The unpleasant truth is that financial excesses occur quite frequently in the capitalist system and always require modifications to it, not its abolition.

One hundred years ago, John Pierpont Morgan singlehandedly rescued a financial system near collapse. The experience led directly a few years later to the creation of the Federal Reserve, America's central bank (greeted then, by the way, by the same sort of extremists, as a harbinger of socialism). In the 1930s the Depression resulted in reforms that changed but did not destroy the free market. In the early 1990s the Government spent a couple of hundred billion dollars bailing out the savings and loans industry. That didn't noticeably undermine capitalism.

Thursday, October 2, 2008

Why the Popular Opposition to the Paulson Plan?

The simplest explanation is that, like the contrarians I quoted in the previous post ("Is the Credit Crisis Hurting the Real Economy?"), most Americans don't see how the crisis on Wall Street affects Main Street, and so they're not interesting in helping out Wall Street firms.

Another explanation, proposed by Salon's Walter Shapiro ("The Voters are Angry -- And Don't Know Why"), is that the folks on Main Street don't understand the issue. Shapiro notes that both presidential campaigns have avoided discussing the credit crisis in their ads and writes,

Both campaigns are basing their TV ads on non sequiturs, presumably because they believe that most voters cannot handle a serious discussion of the liquidity crisis on Wall Street.

Sadly, this cynicism may be justified. A Pew Research Center poll released Wednesday found that 43 percent of all voters admitted that they feel "confused" by the proposed plan to stabilize the financial markets. At the same time, voters grasp that something important is happening -- 54 percent say, in response to another question, that they are paying "a lot" of attention to the bailout debate in Washington. Pollster Andy Kohut, the director of the Pew Research Center, said that it was virtually "unparalleled" to have this simultaneous level of interest and confusion in a policy debate. "It's a tough one to get into the nitty-gritty of," said Kohut. "It is not like gay marriage that is easy to grasp no matter what your point of view is."

Is the Credit Crisis hurting the Real Economy?

That is, after all, the political rationale for enacting the Paulson plan: that the credit crisis on Wall Street is, or will cause significant harm on Main Street. That was also the subject of many of the questions Congressmen asked of Secretary Paulson during his testimony last week. Doubts that the problems on Wall Street will effect Main Street are one explanation proposed for the popular opposition to the Paulson Plan. Although the conventional wisdom among pundits seems to be that, if unchecked, the credit crisis on Wall Street will have dire consequences on Main Street, there are some skeptics. Below are a few examples.

- Binyamin Appelbaum, writing in the Washington Post last week ("Smaller Banks Thrive out of the Fray of Crisis"):

Banks throughout the United States carried on with the business of making loans yesterday even as federal officials warned again that their industry is on the verge of collapse, suggesting that the overheated language on Capitol Hill may not reflect the reality on many Main Streets.


"We collect money from local savers, and we lend it in the local community," said William Dunkelberg, chairman of Liberty Bell Bank in Cherry Hill, N.J. "We're doing fine. There are 9,000 financial institutions out there, and most of them are small and most of them are doing fine."

- Alex Tabarrok, writing on his blog Marginal Revolution last week ("Where is the Credit Crisis"?):

[H]ere we are in September and bank credit continues to look very robust.  As Robert Higgs points out consumer loans are up, commercial and industrial loans are up, even real estate loans are up.  Overall, total  bank credit is up with just a slight sign of leveling off in recent weeks.  So where is the credit crunch?


I wonder how much real lending was actually being generated by asset backed securities. Could it not be that most of the funds generated were used to buy more asset backed securities? (The growth in these securities is certainly suggestive of that possibility). If that is the case then it explains why the real economy has been remarkably resilient to the "credit crunch."

- Alan Reynolds, writing in Forbes yesterday ("Bank Loans Have Not 'Dried Up'):

Contrary to many comments, consumer and industrial loans actually increased in the latest week. Troubled giant banks have cut back on lending, but smaller banks have picked up the slack. Consumer and real estate loans dipped insignificantly through Sept. 17, remaining much higher than they were a year earlier.

If all the recent hysterical chatter about lending being "frozen" or "shut down" refers to anything real, it is not about banks loans (through Sept. 17) but about such arcane financial markets as asset-backed commercial paper or loans between banks. But this too is mainly about financial firms, not Main Street. Non-financial commercial paper increased from $156 billion at the start of the year to more than $204 billion from Sept. 3 to Sept. 17, dipping only modestly since then."

Wednesday, October 1, 2008

The Next Bubble to Burst in the Deleveraging Process: Higher Education?

Like housing, spending on higher education has been fueled by cheap credit facilitated by a government sponsored enterprise (Sallie Mae, in the case of higher ed). As with housing (up until the burst of that bubble), all this cheap credit has led to higher prices (interestingly, politicians who call for increased spending on higher ed every election year never seem to consider that this increased spending may have helped drive up tuition costs). Now, the common sense observation that, for many, college is a waste of money and time has started to seep into the mainstream. A few recent examples come to mind: Charles Murray's op/ed in the Wall Street Journal in August ("For Most People, College Is a Waste of Time"), "Professor X"'s essay in the June Atlantic ("In the Basement of the Ivory Tower"), and James Altucher's February column in the Financial Times, ("College a waste of time and money for kids").

How long until a clear-eyed consideration of the return on investment (of time and money) of college educations becomes part of the conventional wisdom? Given the increase in household debt over the last few decades (see the top left chart in the graphic above1), and the current, inevitable process of deleveraging, it would make sense for the federal government to throttle back on its policy of throwing money at student loans and grants. The best American universities -- public and private -- probably have enough money to provide scholarships for the most talented high school grads whose families don't have the resources to pay for college. If they don't, a leaner education policy more narrowly focused on providing merit scholarships to worthy applicants would make more sense from an economic perspective. From a political perspective though, the higher education industry is a reliable Democratic constituency, so I would be surprised if a Democratic-majority Congress decided to cut back on education funding.

1Graphic borrowed from Martin Wolf's September 23rd Financial Times column