Sunday, September 28, 2008

Who's next?

Is Wachovia at risk? I gave my opinion on GM earlier. Is Ford a bailout candidate? What criteria is being used to determine whether a bailout is warranted? Taxpayers are already strapped. Can they afford a bigger tax hit? I like the concept of taxpayer-funded bailouts enabling taxpayers to enjoy any upside via warrants, but even if that best-case scenario plays out 5 years from now, will the funds actually trickle down to the taxpayers? Or will the government continue to be poor stewards of said funds?

Washington Mutual...what's next?

I posted this last week on WaMu:

Well, another shoe just dropped--the biggest bank failure ever. Washington Mutual was just seized over night, so good luck to any depositors with over $100,000 in their accounts. I'm going to guess there are many Californians, Floridians, New Yorkers, and Washingtonians who lost millions.

Hate to be the bearer of bad news, but this is getting ridiculous. I saw this coming a couple years ago, and adjusted accordingly, but my friends thought I was a doom and gloomer, when in hindsight, I wasn't gloomy enough.

So what's next? More bank failures, I assure you. Berkshire Hathaway's Warren Buffett (only the wealthiest man in the world), just mandated that one of their portfolio companies stop insuring any assets above the FDIC limit of $100,000. That should tell you something--get any amount over that limit out of there--now! Bank deposits, money markets, etc. are NOT the safe haven you thought they were. Check the capital reserves of your bank (banks are required to have reserve requirements to cover bad loans) to measure how healthy they are. I predict hundreds, if not thousands of banks will fail going forward. Heck, the biggest ones are failing before our eyes--expect this to cascade to other major money centers, as well as smaller regional banks. The Federal bailout programs may save some, but if they let big commercial banks like WaMu go under, and big investment banks like Lehman fail, should we have confidence that the local bank around the corner will be saved?

I hate to be an alarmist, but I can't in my conscious NOT give my opinions. As always, seek professional investment and tax advice from your investment advisor and tax advisor. But please, do your own research as well, because they are human and not infallible.

Looking further out, I predict General Motors will be insolvent within 18 months. Shareholders will be slaughtered. Their manufacturing costs are too high relative to their nimble competitors, and their obligations to fund the pension fund and healthcare will drive them to bankruptcy. Instead of building hybrids in the face of $5 a gallon gas, they continued to build gas-guzzling SUVs.

In between banks failing and American industry icons going under, everything else is Jim Dandy. :-) The economy will recover, but it's going to be a long time before things get better. I'm thinking we bottom out in 2010, which means we've got a few more years of pain.

Keep a cool head, stay the course, and tell your loved ones how much they mean to you.


Even the most optimistic have conceded that the Chinese will be the next superpower within a decade. It's inevitable. But they will have huge growing pains as well (witness the recent precipitous decline in the Chinese equity market), much like America did when we became a superpower. Look at their human rights and how they deal with social injustice and civil unrest, as well as their deliberate flogging of environmental issues (although America has no right to point fingers, given our track record of polluting). I just don't want America to be the next UK--a financial center with little else. The UK experienced a huge brain drain to the US because of our manufacturing and economic might. There could be a mass exodus of smarts out of the US this time--actually there already is.

My opinion of Sarbanes Oxley is that it has driven entrepreneurial spirit under or overseas. Instead of developing next-generation technology, entrepreneurs have become bean counters and lawyers, dealing with compliance instead of focusing on their core competence. London is now underwriting more IPO's than New York. Legislators rant about the evils of the outsourcing of jobs overseas--yet they misguidedly enact laws which encourage it. We don't need more regulation--we need enforcement of existing laws on fraud.

I've been engaged with venture capitalists and serial entrepreneurs focusing on China, the next great frontier for not just making Nike shoes, but also highly intellectual property-intensive semiconductor technologies. I used to be a vendor selling enabling tools to these semiconductor companies (I now manage money), and I was lucky enough to participate in the tech boom in silicon valley in the late 90's. These people are replicating that business model in China. Some VC's ONLY invest in Chinese startups--serial entrepreneurs (Chinese natives) who had success in the States, and aim to replicate it in their return to China. They are creating another silicon valley in China--lots of them. The brain drain is already occurring.

For instance, those from San Diego are well aware of Qualcomm, the developer of the 3G wireless standard. They double dip because they make money on the semiconductor hardware as well as through royalties from their intellectual property (3G technology). Broadcom (socal) and Marvell (norcal) are also semiconductor icons which have had very successful IPO exits in the last decade. They are industry leaders in networking and storage, as they developed the silicon content enabling many technologies. The intellectual property in these leading edge technologies resides in the silicon, much like Intel's Pentium controls your computer.

Hence, the Chinese are getting tired of paying royalties on technologies and standards US companies developed. The domestic Chinese market is big enough to support development of their own standards--they're basically saying "screw the US--we can do it better and more pervasively--and we're tired of paying you royalties". And while there are challenges--this stuff ain't easy--they will get there.

And don't pooh pooh these efforts. Some of you recall the last big downturn in the economy, the housing markets, and the thing called the S & L crisis--during the early 90's. We had the riots, the closing of naval bases, debilitating earthquakes, the defense industry downturn, etc. as well. You could have bought a home on a 1/2 acre lot in Beverly Hills (north of Wilshire) for half a million, and a 12 unit apartment building in Long Beach for $350,000 via foreclosures.

Sounds awfully similar, doesn't it? Low-end homes have tanked first this time, and it's just a matter of time before higher-end markets take a dump, too.

But here's the silver lining: do you also remember when the internet was spawned (no, Al Gore did not invent the internet)? It happened many years ago, then known as DARPA, part of the Defense department communications network. Companies like Netscape and Yahoo rolled out the internet to the masses during these dark economic times, thereby enriching thousands of shareholders and employees. They went public in the teeth of that recession--I would argue they helped end the recession and catalyzed the start of the great tech boom.

I can assure you innovation in labs is still occurring today, what techies geeks affectionately coin "disruptive technology". These soothsayers can see around corners and will develop the next "new thing". My concern is that the next wave of value and wealth creation in the US will be dampened because much of this technological innovation is occurring overseas. The wealth generated by these startups won't be as widely distributed in the States. In other words, we need more Google's and fewer's. Long-term, I shouldn't be so cynical, because it is not a zero sum game. We should encourage innovation abroad as well as domestically. But my fear is that the US will not be playing at the adult table--and relegated to the kiddie table.

I've been a doom and gloomer for 2 years, and people thought I was heretical. Well, the manure did really hit the fan, and it turned out I understated the magnitude of this crisis. We'll climb out of it, and I have a feeling I'll be fine by staying close to the next wave of faster bandwidth, Moore's Law, and bio-entrepreneurship, but I'm afraid the deep end of the pool is going to be more treacherous this time. More people will lose their homes and jobs, and more realtors and loan officers will be waiters and waitresses. It's disheartening, but we are paying penance for our excesses.

Until our schools seed more engineers, scientists, and computer scientists, we will lose more high-intellectual, high-paying jobs overseas. It's got nothing to do with outsourcing--capital flows where it gets more bang for its buck. It's got everything to do with upgrading our skill sets, because the market will determine where the next good jobs will be.

Wednesday, September 24, 2008

Bailout or No Bailout?

I'm from the school of let 'em die. If you and I make poor investment decisions, we have to suffer the consequences. These executives applied far too much leverage, took on way too much risk, and after plundering their firms, they get golden parachutes. Where's the accountability factor?

I'm all for the founders of Google earnings billions because they have created a lot of value for consumers, business, shareholders, and employees. But when executives run their firms to the ground, they should not profit from said disasters, whether their firms get bailed out or not. A meritocracy rewards those who add value, not those who detract from it.

As much as I hate that the taxpayers bear the brunt of rescuing an AIG, I reluctantly agree they should probably be bailed out, because if they implode, the cascading illiquidity would essentially freeze up markets worldwide, as the sovereign funds, hedge funds, pension funds, mutual funds, private equity firms, and every financial institution would suffer a loss of confidence in the US financial markets, which would bring about a dark age analogous to the Great Depression. No one wins in that scenario, save the few bottom fishers with cash and balls to step up and play in the deep end of the pool.

But make no mistake: the intended recipients of these bail outs are the big institutions--not necessarily the common man, altho we all are in the same boat.

Having said that, there is a downside to this massive injection of liquidty--re-inflation. Interest rates should be favorable short-term, but when oil approaches $150 a barrel, when gold flirts with $1500/oz, the Fed will have no choice but to raise rates. Again, the lesser of two evils, but still an evil...Eventually, the economic shocks worldwide and the domestic slowdown will eventually dampen demand and cost of living increases, but until then, gold seems more stable than the US Dollar.

You know the world is turned upside down when there is more concern about the USD than the Brazilian currency, Russia has a flat tax, and the US has the 2nd highest tax brackets in the western world. Our leaders have forgotten what has made this country (and California) great.

Tuesday, September 23, 2008

The massive bailout and how it affects us...

Berkshire just injected $5 Billion into Goldman Sachs, while the Fed and Treasury announces a $700 Billion bailout. Despite the market turmoil, I'm going to guess this signals we're closer to a bottom than a cataclysmic meltdown in equities and real estate. We'll still have to endure a couple more years of pain before the economy and the housing market recovers. I think we'll have a couple more big legs down and more bank failures, but bottom fishers should eventually do well by investing in companies with strong balance sheets. Having said that, Christmas will be subdued this year.

The big risk is that more financial institutions become victimized by the cascading insolvency, as many are linked due to naked derivatives. which encourages high-risk speculation without accountability, which got us into this mess in the first place. Leverage works both ways--it's great for maximizing returns in a healthy economy, but it's lethal when markets are unwinding. Right now, we are experiencing a de-leveraging process not seen since the Great Depression. If more big banks start going under, buy more ammo--it's going to get uglier.

Hopefully, the worst is behind us, but I'm not jumping in just yet--I need more proof this tanker is going to turn around. The thought of buying into a fire-sale is enticing, but I'm not going to try to catch a falling knife--it can cut you. I want to see more blood in the streets, and the whites of people's eyes before I dive into the deep end of the pool. For now, I'm happy to be wading in the kiddie pool.

Good luck people--it's going to be a wild ride. This downturn will be a doozie--the worst in our generation, but eventually we will recover, I assure you.

Hunker down, work the extra overtime, use generic instead of designer labels, and ride this sucker out. Don't wait for the other shoe to drop--even if you are currently employed, be prepared for impending layoffs. Work you network, stay in touch with your influencers, and plan for the worst, while hoping for the best. Save for a rainy day, because this is that rainy day. And remember: equity is not cash. Cash is cash. Stay liquid.

Monday, September 15, 2008

Lehman and Merill Lynch this morning....

I wrote this in response to a concerned client:

XXXXX, on the contrary. These firms (investment banks, commercial banks, and insurance companies) invested in mortgage-backed securities, thinking they were safe. Little did they know it was just another asset bubble bursting.

Life insurance companies are more conservative by nature, investing premium payments in short- and long-term bonds, and in the case of indexed products, are linked to stock indexes like the S & P 500. With your contracts, if the S & P tanks, you are still guaranteed a 1% floor--which isn't much, but it's better than losing 15% or more, which is what your current stock portfolio is doing. They are able to guarantee the 1% due to options trading, much like they cap you at 15%.

Expect a big loss in the stock market this morning, as this is really, really bad news, but not something I didn't warn you all about several months and years ago. I predicted the real estate bubble, and it's coming to fruition as well. While the more expensive neighborhoods of the bay area are holding up, expect high-end prices to start declining. Manhattanites continue to brag their real estate market has held up, but do you really think that will continue, now that hundreds of billions of dollars are vanishing? Not only are Wall Street bonuses going to disappear at the end of this year, but many investment bankers will be lucky to have jobs. Having a consortium of banks to band together to raise money to prevent the next disaster is akin to gathering 10 cancer victims into a leaky boat--a few will get tossed over the side. First Bear Stearns, Countrywide, now Lehman and Merrill Lynch. Don't forget insolvent Freddie Mac and Fannie Mae, who only hold trillions of dollars of mortgages (70% of all US mortgages). Check out their share prices--they've lost over 90% of their market cap, which makes the tech bubble look like Disneyland.

Expect more big losses and layoffs--it is going to be a bloodbath--the biggest since the Great Depression. Insurance companies were the only ones standing in the aftermath of the Depression, as thousands of banks failed. They set premiums based on actuarial data, not based on speculative lending practices. Banks use 10:1 leverage, which works great in a growing economy, but is terrible in a downturn, as bad loans mount. Expect Washington Mutual to fold, too--unless they get bailed out. It amazes me that people still think banks are safe, despite pervasive evidence to the contrary. How many more banks have to fail before people get it? In any case, insurance companies are forbidden by law to implement that type of leverage.

The VC market has dried up as well--last quarter was the first time ever that there were no IPOs. The liquidity crisis is spreading up and down the food chain--couples with high FICO scores and sizeable assets are having trouble getting financing. Cash is more important than ever, so curb your spending and hoard it. Don't mess around this time, this ride is going to be hell.

In summary, this is EXACTLY what should be doing in a severe downturn, where every asset you turn to is dropping like a Thai thunderstorm downpour. The next 2 (or more years) will be very difficult, and when the last bulls finally turn bearish, basically giving up all hope and expecting the world to end. hopefully we will reach a bottom. Real estate agents and stock brokers have been preaching to me their respective markets will turn around for the last two years, and given their polyannish outlook, I know this hellstorm is going to last longer. They're like Colonel Klink in Hogan's Heroes--whatever they say will happen, do the exact opposite.

If you had to pin me down, the meltdown recovers in 2010, which means you can expect a climactic abyss in stock markets late 2009. THAT will be the time to nibble at good companies who got thrown out with the baby wash--the companies themselves are solid, but the financial hurricane took them down unfairly Pick the winners of each struggling group: Goldman Sachs will be a screaming buy in a couple years, but don't try to catch a falling knife--it'lll cut you. Wait till they bottom and bounce off the bottom a couple times. It's better to be late when bottom-fishing (buying), and it's better to be early when selling.

Of course, I could be wrong and too optimistic on the recovery time, at which point, all bets are off. Just to give you an idea of how bad it is, Warren Buffett of Berkshire Hathaway just sent a directive to one of his portfolio companies, a reinsurer who guarantees funds above the FDIC limit of $100,000 for banks. They lost a mint in guaranteeing losses when IndyMac went under recently, so the reinsurer just notified thousands of banks they are no longer guaranteeing accounts above $100,000! Do you think wealthy depositors are going to react to that?

As an aside, the formerly venerable Lehman firm was the preemiment fixed-income (bond) banker who got themselves in trouble with junk offerings years ago. Buffett actually stepped in and helped bail them out at the time. Obviously, he's not bailing them out this time. These subprime mortgages are the latest cyanide, only this time the Kool-Aid is a lot more toxic. You thought I was a doom and gloomer earlier, and it turns out I understated the magnitude. And unfortunately, it's going to get even worse.