Archive for January, 2008
January 30, 2008 3:03PM
By Elizabeth MacDonald
In a prior blog, I told you I asked Sageworks, a financial research firm, to find companies that are not drunk on debt.
The idea being that, I wanted to find stocks that won’t be hurt by the credit crisis and won’t need to hoard cash to pay down debt in future periods. Which means they can use the money to grow their businesses, profits and your stock portfolios. Want proof that avoiding companies that are drowning in debt is one good way to approach stock picking? Shares in plenty of debt-aholic companies have flatlined over the years. Think Time Warner and the U.S. carmakers.
I also asked Sageworks to find the companies that are so waterlogged with high levels of debt that their earnings will likely be submarined and won’t resurface until after the downturn blows over.
Tim Keogh, a top analyst at Sageworks, crunched the numbers. Check out the stock ideas below.
- Low Debt Stocks Worth a Look-See
- High Debt-aholic Stocks to Avoid
Investors are now taking a closer look at companies’ balance sheets to see if they have over-stretched and whether the Federal Reserve’s 125-basis-point rate cut since last Tuesday will make it easier for them to pay down their debt. Even with the rate cuts, economists, mostly from Wall Street, are saying that the U.S. economy still may be headed into a recession.
The sub prime meltdown and the ensuing credit crunch has U.S. GDP growth stalling out, with growth at 0.6%. What’s hurting growth too is that debt is at record levels, and not just in our spendthrift government.
As of September 30, 2007, U.S. household debt was $13.6 trillion versus non financial business debt of $9.8 trillion, Reuters points out.
Fiscal stimulus footnote: George Cloutier, founder, chairman and chief executive of American Management Services, has some very good insights about how the government’s fiscal stimulus plan really won’t help small businesses.
For one small businesses won’t see the tax break on buying equipment take effect until they file 2009 taxes, at least 12 months away, Cloutier notes. He adds too that most small businesses earn less than $100,000 a year and won’t qualify for any meaningful tax breaks.
January 30, 2008 4:53AM
By Elizabeth MacDonald
I know I promised you stock ideas in my last blog, “The Leave No Consumer Behind Act.” I still plan to give you them once I’m done reviewing the data from Sageworks, a financial research outfit.
I asked Sageworks to crunch the numbers on 6,000 companies to find the cheapest, most stable value plays with little debt and sizable cash kitties, the idea being they can best avoid the credit crunch, grow profits and bolster your portfolios. I want to get this right for you, so bear with me, they are forthcoming.
But in the meantime, I had to write to you again.
With all the talk of the Fed potentially cutting rates again, I’m reminded of what a dear friend of our family once advised me about relationships. I had just endured a breakup.
She said, “Lizzy, relationships are like hailing a taxi. One goes by, you hail the next one. The next one goes by, you hail another one.”
So with the market hollering for another rate cut, are we just hailing another asset bubble?
Cutting rates weakens the dollar which causes commodities priced and traded in dollars to spike higher. You see asset bubbles already forming in oil and gold. “Many already feel that the Fed’s behavior over recent years has resulted in a series of global asset price problems,” says Andrew Clare, a professor of finance at London’s Cass Business School and a former economist with the Bank of England. I would add that market bubbles are often caused by structural problems intrinsic to each home country (China), but yes overall gunning the printing presses doesn’t help.
Set aside the lemming-like flight that’s causing bubbles to develop in emerging markets. And yes it’s true that a weak dollar on top of the credit crisis has caused a fire sale in America’s assets, which is why foreign money is cherry picking now. It also makes investors think twice about investing in our government paper—why invest when the returns will be microscopic? Has the U.S. replaced Japan in the carry trade, borrow low here and invest long elsewhere?
Cutting rates will not solve all of the problems in the housing market or at the financials.
That’s because a rate cut can’t turn a sick mortgage into a healthy loan. Plus the Fed can only control the price of credit—it can’t force the banks to make credit available.
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January 28, 2008 1:21PM
By Elizabeth MacDonald
Ok we’ve been in a heated debate here at Fox Business over the government stimulus plan and whether we’re headed into a recession or not. We’ve been kicking these issues around on Money for Breakfast, myself, Alexis Glick, Peter Barnes, Charles Payne and Jenna Lee.
Alexis just got back from the World Economic Forum in Davos, Switzerland where she made a valiant effort trying to pin down executives to get candid, straight answers for you on all of these problems.
Yes Davos sounds sweet, but it isn’t Hawaii. It’s a pain in the neck to get to, the security clearances can drive you batty, and covering it can be grinding work. Pinning executives down for interviews is as easy as trying to chase a gnat in a hurricane. It’s one reason why I chew Tums round the clock.
But Alexis, God Bless her, delivers a fresh look on these important issues you’ll get no where else, to get the full story, go to Alexis’s blog, it’s worth reading.
Peter and Charles have been doing a smart job going toe to toe with our crew of financial experts, we’re trying to get a clearer read on the picture, with Jenna telling us when our reality check has bounced with breaking news. God Bless her too (can you tell by now I’m a Catholic girl? Yup, Elizabeth Mary Regina, I still say the Rosary, God Bless me, 12 years of Catholic school plus 12 years of therapy).
I don’t know about you, but my head is spinning. Tax rebates, good idea or no? More government debt-funded stimulus, good or bad? More debt for our children and grandchildren to deal with? Inflation or no? Recession or no? Yikety yikes!
I have something to say. Not because I am a t.v. gasbag doing my part to add to global warming (there should be a new Kyoto treaty covering t.v. gasbags).
But tell me if I’m wrong here. I want to hear what you have to say. Do we really think tossing money at the problem is going to fix what’s wrong? Do we really think a $150 billion dollar stimulus package loaded with tax rebate checks will fix the problems? Aren’t the rebate checks just a quick steroid boost so consumers can go out and help out, well, the retail stocks I guess, as well as China, which makes most of those goods?
Then there’s more talk of yet another Fed rate cut. Do we think a rate cut can stop a recession, can it prevent the economy and the markets from going south faster than geese fly in winter? Shouldn’t we just let the free market fix the mess? What do you think?
I get it, a Fed rate cut plus pumping liquidity via term auctions could help thaw out a frozen solid bank sector, as banks hoard cash to deal with potential writedowns and won’t use it to lend. We need banks to lend to small businesses so they can hire workers who will spend, that’s understood.
But is tossing money at the problem by, well, printing money really the way to fix the current mess we’re in? Won’t it simply create inflation (too much money chasing too few good assets)? Is printing money really the way to prosperity? “Printing money cannot create wealth if it could counterfeiting would be legal,” economist Brian Wesbury has rightfully said.
As I’ve noted in prior blogs, this is far from over. Alexis, Peter, Charles, Jenna and I have all been talking about how the financials still face massive write-downs, beyond the $107 billion already reported. Especially with the bond insurers in trouble—they’re the backstop to the financials, having guaranteed payment on the debt instruments the financials sell in the event of defaults (I kind of think the bond insurers have no reason to exist, really—sort of like the credit rating agencies. They sell big promises but in reality deliver a whole lot of nothing.)
Some bond insurers may go bellyup, which means deeper write downs at the financials. Royal Bank of Scotland esimates that the bond insurers have guaranteed $305 billion of these collateralized debt obligations at U.S. banks, and $88 billion overseas. Again, yikety yikes!
But recession? Yes, profit results are backward looking, but still it’s worth noting that earnings are coming in ok. Of the 160 companies in the S&P 500 that have reported, 59% beat estimates (vs. the usual 60%), about 14% matched and about 28% missed forecasts (vs. the usual 20%).
As you know I’m an accounting geek. I’ve covered accounting, quality of earnings and taxes for the two decades I’ve been a business journalist (yes 20 years, I’m dating myself, but that’s okay because, as Dick Cavett once joked, I can date whomever I want ha).
I like to closely eyeball companies’ balance sheets to see if they are drunk on debt and whether the credit crunch will hurt them more, whether they’ll need to hoard a lot of cash to pay down debt in future periods. Which means they can’t use the money to grow their businesses, profits and your stock portfolios.
So which sectors to avoid? Financial information firm Sageworks of Research Triangle Park, N.C., has crunched the numbers from more than 6,000 publicly traded, nonfinancial U.S. companies. Sageworks found that, outside banking, real estate, and retail, most sectors are pretty ok with their debt levels. Reuters looked at the same data and arrived at the same conclusion.
Sageworks found that the ratio between short-term assets and short-term liabilities of U.S. companies was 1.8-to-1. Banks, real estate and retailers ended 2007 with ratios well below 1-to-1. A ratio above 1-to-1 is considered healthy.
The high ratio for many companies may help explain why, when the National Association for Business Economics recently surveyed U.S. businesses, two-thirds of respondents said tightening credit conditions had not affected them, Reuters says.
And research company Credit Sights found that Cummins, Deere & Co and CNH Global NV have improved their credit profile, while Eaton Corp, Brunswick Corp and Ingersoll-Rand Co Ltd for having gone the opposite direction, Reuters found.
I’ve got some defensive stocks for you to consider if we do face a downturn—these companies have not gotten drunk on debt, a rarity in these times, so they’re pretty decently positioned. And I’ve got the debtaholics to avoid. Stay tuned.
January 22, 2008 1:43PM
By Elizabeth MacDonald
I heard a top-notch market analyst say recently that she is a big believer in not trying to anticipate the end of the world. I am in that camp.
The markets are pretty cheap now. The 1,953 stocks in the MSCI World index are now valued at 14 times profits, the lowest since at least 1995, according to a data review by Bloomberg. Europe’s Stoxx 600 has a price-to-earnings ratio of 10.7, the cheapest since at least 2002.
We are just on the cusp of true globalization. Once we clean out the excesses, the markets will be poised for the next leg of a strong market run. We’ll likely have to wait for that run for a bit, but it will happen.
Before I tell you the ideas for the stocks to consider retreating too, a broad-zoom perspective is in order. The U.S. spent only 16 months of the last 25 years in recession. That’s a significant improvement over prior periods. Many analysts say we are in a recession right now, but even figuring out whether we are or not will take a few quarters. If we are, the typical recession since World War II has lasted 10 months on average, according to the National Bureau of Economic Research. Given the massive size of the housing and subsequent credit bubble, it will likely last longer than ten months. How long is anyone’s guess.
A look at the stock market performance during 11 recessions dating back to 1945 by Sam Stovall, chief investment strategist at Standard & Poor’s, found that the S&P 500 fell 26%, on average, from the months leading up to a recession to the recession lows. The S&P study found that when 10 of the last 11 recessions were over, in the ensuing six months stocks rose on average 12.1%.
The fear of course is that the Federal Reserve has guided the market from one asset bubble to another, from the tech bubble to the housing bubble to now the credit-market bubble. And that cutting rates again keeps the asset inflation party going. The fear is legitimate.
The recession of 2001 was over by November of that year, but still the Fed cut rates down to zero and held them there for three years, in a now unsubstantiated fear of deflation. The real fear was asset inflation which is what we’re dealing with now.
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January 22, 2008 11:14AM
By Elizabeth MacDonald
The bears are red in the claw and they are having their day. The Dow hasn’t closed below 12000 since November 3, 2006, Fox Business’s stats pro Charles Brady informs us, and it hasn’t fallen below 12000 since March 14, 2007 on an intraday basis.
Some armchair cranks now claim they saw it coming. They say they saw the weakness move from the homebuilders in 2005 to the community and regional banks in 2006 into 2007, to the consumer this past holiday season, and now to a weakening labor market.
Yes, 20-20 hindsight is a beautiful thing. And yes if you call a recession long enough you can call yourself a seer. Because for me, I like to say that the epitaph on my tombstone will read, “I’m in it for the long-term.” There are a lot of value plays still out there, more on that in ensuing blogs (I gotta get you to come back and visit me, right?).
First the uglies. We’re in a credit crisis like no other, different from the S&L crunch of 1989-1992, though with some similarities. That crisis started with a pullback in lending for commercial real estate that then spread to business lending. Back then commercial loans that went bellyup were not too opaque.
Right now we’re dealing with a credit crisis fueled by Frankenstein mortgage derivatives spun out from the housing crisis, securities that have both Ben Bernanke and Alan Greenspan scratching their heads. What happened? When Freddie Mac and Fannie Mae were limited in the dollar amount of mortgages they could buy and securitize, to $417,000, Wall Street stepped in to securitize these loans. Wall Street, in case you didn’t know it, is in manufacturing too.
It manufactured all sorts of subprime paper, paid the credit ratings agencies more money than the usual fees paid on corporate bonds to get rosy ratings, sold this paper to all sorts of unwitting investors here, including pension funds and local governments, and started exporting this bad paper to any takers overseas. Wall Street firms then kept a sizable slug of this bad paper off their balance sheets to keep financial results rosy, and then wrote themselves sweet bonus checks off the goosed-up numbers.
Any bear worth his or her claws knows that as far back as 1987 the accounting monks of Norwalk, Conn. at the Financial Accounting Standards Board warned there was no adequate way to value these things, and now Frankenstein derivatives are sluicing financial poison through the system. Citi’s chief financial officer, Gary Crittenden has said that price-tagging CDOs “all gets extremely complex” and that “it is very difficult to forecast exactly where all this is going.”
It’s that uncertainty over how to value these securities and over when housing will find its bottom that’s fueling the jitters. Remember, we’ve seen uncertainty exact damage before. Students of the 1987 crash—painful to cite but it does hold lessons—remember that what really triggered the panic selling that awful day in October was uncertainty that led to panic selling, triggered by a breakdown in the basically paper system used to place stock trades. The system cracked under the weight of requested trades that were three times the level on any ordinary day. A government-backed commission later found that orders for 112 million shares were never executed—more than one-fourth of the total value of trades that day. The shutdown triggered a stampede for the exits.
It’s uncertainty that’s hurting us now. What investors need now is evidence that the write-offs in the financial-services sector are behind us, that housing has seen its bottom. Merrill Lynch says housing will decline 30% over the next three years, still nothing versus the 130% runup in prices from 2003 and 2006. Phew.
We may see some daylight about writedowns in the second quarter, around when the auditors are done scrubbing the books (and they’re being extra tough, what with the Arthur Andersen debacle still fresh on their minds). We’ve already seen $107 billion in writedowns at the financials. With further drops in housing values, writedowns could be with us for some time.
Plus the downgrade of bond insurers is surely helping fuel the rocky markets now. When a bond insurer gets downgraded, the value of the insured debt securities at the financials also drop in value too, so they have to hoard even more cash beyond the capital they’re grabbing to plug the holes in their leaky balance sheets (and remember, some like Citi are bringing back onto the books off-balance sheet debt they didn’t reserve for, making that hole bigger). On top of all this, credit cards and home equity loans are creating problems, too.
But consider this: Some of the uncertainty over what these credit-backed securities are worth may be exaggerated. Much of the downward suction of uncertainty arises from a self-fulfilling prophecy intrinsic to how Wall Street values the Frankenstein securities it breathed life into. The G-forces of uncertainty over what these mortgage securities are really worth are exerting a Black hole-like force now.
Remember that there is no standard way to value these hard-to-read securities down on Wall Street, something I’ve already said the Securities & Exchange Commission must address now. The fire-engine red alarms should be ringing at SEC headquarters in Washington, D.C.
So watch what happens. Many banks rely heavily on something called the ABX index to mark to market (or value) many of these illiquid assets. The credit ratings agencies use the ABX too. The ABX is an index largely based–now this is important to remember–investor sentiment. The ABX is a thinly traded, volatile index invented just two years or so ago and is a series of credit-default swaps based on 20 bonds that consist of subprime mortgages. ABX contracts are commonly used by investors to speculate on or to hedge against the risk that the underling mortgage securities are not repaid as anticipated. The ABX swaps offer protection if the securities are not repaid as expected, in return for regular insurance-like premiums. A drop in the ABX Index indicates investor sentiment that subprime mortgage holders will suffer increased losses from those securities. Similarly, an increase in the ABX Index signifies investor sentiment that subprime securities will improve in value.
Some critics rightfully argue that the ABX is a very narrow window on the mortgage market and, because it is so thinly traded, is highly vulnerable to a few large trades to the downside. About $3 billion to $4 billion of trades take place in the ABX each day. That’s versus $179 billion in average daily trading volume in S&P 500 index futures and options contracts on the Chicago Mercantile Exchange.
But the Wall Streeters who post the trades affecting the ABX try to anticipate what the credit ratings agencies will do rating these asset-backed securities and place bets in the ABX accordingly. However, the credit ratings agencies watch what the ABX is doing to decide whether to downgrade securities. The banks in turn watch the credit ratings agencies and what the ABX is doing.
The echo chamber is amplifying at dangerously loud levels, as everyone is watching each other.
Wachovia Capital Markets has already said that the price of the ABX that tracks AAA-rated mortgage debt has implied losses of around 49% among pools of subprime mortgages issued in 2006. You only get to a cumulative loss of 49% if all, count them, all of the 2006 subprime mortgages issued that year were to go bellyup, and only half of their value after foreclosing on the homes were recovered. Or if half were to default and recover nothing. That’s what we’re looking at. Sounds a bit out there, but unfortunately. we’ll have to wait and see.
January 16, 2008 1:05PM
By Elizabeth MacDonald
With the unremitting negative headlines, it sure sounds like we should all be slamming our doors shut and getting out the nail guns. Here though are some points to ponder as we move from what economists call the Great Moderation (a period of low inflation) to the Great Unwind (the housing meltdown).
1. Learn from history: To get a read for how long we may be stuck wandering around in this Stygian gloom, check out this interesting study of 18 past banking crises co-authored by a professor at Harvard University and a professor at the University of Maryland that was released at a recent meeting of the American Economics Association. The study, which included analysis of the meltdown in Japan’s banking system in the ‘90s, sheds some light. The report found that in 18 prior banking-led crises, it took an average two years for economic growth to stabilize. The average drop in the growth of gross domestic product was two percentage points. For the five worst crises, GDP growth tumbled on average five percentage points from the top, and it took more than three years to unwind the mess. Other studies found housing-led crises last twice as long as equity busts—five years versus two, with output losses twice as large, 8% of GDP. The academics’ study also found a swift monetary policy response helps limit the pain—Fed chair Ben Bernanke is well aware of this fact, being a student of the severe monetary contraction that was partly to blame, along with the disastrous Smoot Hawley tariffs, for the Great Depression.
2. But how badly will the banks suffer?: To date banks, brokerages and financial services firms have written off $107.8 billion from their balance sheets, writedowns that have carved the same sum out of their net worth and vaporized assets that won’t deliver cash in the future. Say all of the $1.3 trillion in subprime mortgages defaults, and just half is recovered, amounting to $650 billion in losses. To be sure, a number of banks and bond insurers would be taken out. The professors’ study found that losses would amount to about 5% of GDP. Compare that to the 8% of GDP noted above in other housing-led downturns. That 5% is somewhat on a par with the five big crises, they aver. By way of comparison, the total losses from the S&L crisis as well as the related commercial lending mess from 1986 to 1995 amounted to about $189 billion, or 3.2% of GDP in that period. But here’s the figure to grab onto: Economists and housing pros are buzzing that home prices will have to fall 20% to 30% to come down to reality. That could amount to a loss of wealth in the U.S. of–deep breath–$4 trillion to $6 trillion, some estimates show.
3. No bull market without the financials: History shows there is no strong market without a strong financial sector, with the financials making up about 25% of the S&P 500. So keep an eye on still ugly numbers at big banks like Citigroup, now scrambling to shore up its capital reserves. The writedowns are likely far from over. John Thain, head of Merrill Lynch, told analysts that subprime securities won’t likely ever recover–meaning they’re dead money. Citigroup faces $37.3 billion in exposures to toxic waste from securitized subprime assets still on its books. A big $14.3 billion of its massive $18.1 billion pre-tax writedown came from this toxic junk (ironic that the name of the now moribund Superfund that the big banks wanted to launch to take care of off-balance sheet subprime waste echoed the name of the EPA’s toxic clean up fund). Citi isn’t alone. UBS, now cheekily called the Union Bank of Singapore thanks to Singapore’s cash infusion, faces a gross exposure of $28.9 billion, and Merrill Lynch, $7.5 billion to subprime loans and securitized mortgages, down from $21.5 billion at the end of the third quarter.
4. The problem is spreading beyond subprime: We already see the weak consumer creating credit card problems at American Express, and credit card and consumer loan problems at Bank of America and Capital One. Just take Citi alone. Meredith Whitney, executive director in equity research at Oppenheimer who was way out in front calling the problems at the financials, finds a “disturbing trend” in the rapid rise in consumer losses at Citi. Consumer credit costs at Citi increased by $4.1 billion, which included a net charge of $3.31 billion to increase consumer loan loss reserves. That $3.31 billion compares to a net reserve release of $127 million a year ago. Yikety yikes. Whitney warns “we believe this is simply not enough against a portfolio that is deteriorating so rapidly.”
5. The operative term is ‘Spread the Pain’: Dilution to existing investors is the order of the day at the financials caught in the housing quicksand, which has investors at places like UBS in an uproar. Citi alone is raising $14.5 billion through convertible preferred securities, with a sweet 7% coupon. Ouch. It also delivered a 41% cut in its quarterly dividend to 32 cents per share from 54 cents per share–raising debate about why it’s raising capital from foreign and domestic investors if the money is just going out the door toward the dividend. Whitney, who advocates deeper cuts to Citi’s dividend, estimates Citi faces close to 20% dilution on forward earnings.
6. Downgrades have picked up: In December alone, Standard & Poor’s, Moody’s and Fitch downgraded $314.9 billion worth of subprime and mortgage related securities, according to Bloomberg. That’s up from $110.8 billion in November and $165.1 billion in October. December was the single highest month for downgrades in the past five years. Also, no corporate defaults yet, though Moody’s expects that to happen this year. Another reason there’s panic in the bond insurance sector at places like MBIA and Ambac.
UP NEXT: Will the political fixes work?
January 16, 2008 1:04PM
By Elizabeth MacDonald
Ok now on to cleaning up the housing mess on Wall Street:
1. More mortgage cops: To be sure, we can’t afford to spend taxpayer money on having a Federal Reserve sheriff sitting in the lap of every mortgage broker. What with Moody’s threatening to downgrade the entire United States of America due to our oceanliner of debt (and if a downgrade happens, you can forget about national health care, we can’t afford the increased borrowing costs to fund it). But the states are just not doing enough to stop reckless brokers. In some states dry cleaners and nail salons are more regulated than mortgage brokers, who are regulated by the states. Extend the Office of Federal Housing Enterprise Oversight to the mortgage brokerage industry as well—OFHEO did a good job cracking down on Fannie Mae and Freddie Mac’s shoddy accounting, in the face of an avalanche of protest from these quasi-government agencies and their political backers.
2. The Street’s reality check has clearly bounced: I’m loving this quote from Dan Fuss, vice chairman of Boston-based Loomis Sayles. He’s taken a pass on all sorts of valuation software used to value mortgage-backed securities, and he refused to include these securities among the $22 billion he manages. He told Bloomberg: “It’s like teenagers: You sort of know what’s going on but not really,” adding, “we spent a fortune on software, $75,000 a month. And what do we end up with? A bunch of zip codes.” What’s going on? Unlike the corporate bond market, which gained price transparency in 2002 when the SEC required dealers to report their trades on a computer system called Trace, the asset-backed debt market has no centralized computer network for disclosing prices. Why? Because investment banks want it that way so they can cook up their own valuations. They objected to Trace when it was introduced for corporate bonds in 1998, and fought hard and got the NASD to back down on any attempt to put prices of asset-backed securities on a shared computer system. Leaving Wall Street alone to their own mark-to-make-believe devices let the banks collect tens of billions of dollars in fees from underwriting and trading asset-backed securities. Enough is enough.The Securities and Exchange Commission must jam a new computer valuation network for asset-backed securities down Wall Street’s throat if it has to. Investors have suffered enough—federal regulators should see it as an embarrassment that we are exporting our subprime pain to places as far afield as the Arctic, Iceland, Norway and Australia. The SEC supposedly has opened about a dozen investigations into how investment houses value their subprime assets. But this after-the-fact refereeing must end—regulators need to grow a spine or investors will continue to suffer.
3. Stop mark to make believe: For too long the market watchdogs let Wall Street get away with using any fantasy model it wanted to price its mortgage-backed securities, with the models now cheekily being called “mark to myth” or “mark to make believe.” It is inexcusable to leave Wall Street to its own devices. Here’s what happened: When Congress opted not to lift the dollar amount of the mortgages that Fannie and Freddie Mac can buy on the secondary market, Wall Street gladly dove in. Wall Street players bought those loans, sliced them up into all sorts of concoctions, and sold them as mortgage-backed securities to investors. In turn, Wall Streeters willy-nilly assigned values to this $2 trillion of asset-backed debt based on their own models, in turn cooking up the earnings it could book off of these assets. It then shoved a lot of this junk off its balance sheet into structured investment vehicles, or SIVs, and then wrote itself big fat bonus checks off these goosed-up earnings. That has led to an estimated $100 billion in losses for banks and brokerages and the ousters of executives at Merrill Lynch, Citigroup, UBS, Bear Stearns and Morgan Stanley. So don’t listen to the calls now to let Fannie and Freddie buy mortgages north of $417,000. Why should American taxpayers provide an implicit guarantee to mortgages of up to $1 million when lenders have made such a hash of it, and when the average sale price of a home is now less than $250,000?
4. More independent credit ratings agencies. Now.: To say that the credit rating agencies were slow off the mark is a thunderous understatement. We saw that happen 10 years ago in the Asian flu and the dotcom crisis in 2000 to 2001. But today’s mess reveals how startling blind they were. Less than 20 publicly traded companies have Triple A credit ratings. But somehow Moody’s, S&P and Fitch handed out triple A ratings like Kleenex to subprime securitizations that are quickly turning toxic. What happened? The credit rating agencies get paid by the investment houses to rate their securitizations and other debt offerings—a huge conflict of interest. Wall Streeters say that such securitizations reap more fees, sometimes double, for the credit rating agencies than plain vanilla bonds.
So the markets need more independent ratings agencies like Egan-Jones. It is now the first credit ratings agency not paid by Wall Street whose instruments it rates to be included by the SEC in a new oversight system. Last June, the SEC introduced a system of registration for credit rating agencies, requiring them to apply for status as Nationally Recognized Statistical Rating Organization (NRSRO). Now, the agencies must disclose their procedures and methodologies for assigning ratings, and the investment houses must use ratings by an NRSRO when they calculate the value of securities on their books (prior to this, brokerages could use any agency they wanted). Seven credit agencies are now NRSROs, including Moody’s Investor Services, Standard & Poor’s and Fitch–the three largest. But they still get paid by the issuers to rate securities. Not good. Sean Egan, managing director of Egan Jones, told the Financial Times that winning its regulatory stamp of approval was significant because it “addresses the primary concern [in the market], which is the alignment of investor interest with rating firm interest.” He added: “It’s lunacy to have investment guidelines geared to ratings from conflicted firms. It exposes fiduciaries to significant lawsuits along with substantial losses.”
January 16, 2008 12:28PM
By Elizabeth MacDonald
With the U.S. facing a recession, according to a growing chorus of economists, the government is getting set to launch a $150 billion stimulus plan. The debate now is whether the plan is loaded with gimmicks, acting as one congressman put it like a temporary vitamin B12 shot, or serious fiscal restructuring should take place. Here are some thoughts to consider:
1. The deficit hawks are getting trampled: Bernanke warned Congress in his testimony to exhibit fiscal discipline with tax cuts and spending, as he said the U.S. faces an explosive problem with the federal deficit. The costs for government spending, plus unfunded liabilities for Medicare and Social Security now easily amounts to four and a half times the size of the U.S. gross domestic product. That ought to make you spit your cornflakes across the room. And to say that the deficit doesn’t matter is like saying ketchup is a vegetable or trees cause pollution. Taxpayers msut foot the bill for interest on all the treasury securities investors buy–among our biggest buyers is of course China ($2 trillion is held by foreign investors, China has about half that). On just the $9 trillion in debt for government spending alone, the amounts that are separate from Social Security and Medicare, the U.S. pays $405 billion in interest annually–well north of the GDP of Saudi Arabia or Belgium. Some argue that, well, a big chunk of that $9 trillion went toward hard assets like land, cars, trucks, bullion at Fort Knox, which can be liquidated if there’s a problem. But as the housing crisis now proves, try unloading assets in a downturn–firesale prices prevail. The guardrails are totally off when it comes to how Congress now wants to blow out the deficit to save the economy with new fiscal stimulus plans. Watch this twist on Joseph Schumpeter, the economist famous for his line that the economy goes through creative destruction. When it comes to how it spends willy nilly our tax dollars, the government is about “all creation and no destruction.” Rember this: It took the country from George Washington until Ronald Reagan to reach the first $1 trillion in debt.
2. Cut taxes: Honestly, I would just as soon listen to politicians trying to score points on the backs of a housing crisis as I’d listen to Evil Knievel’s safe driving tips. Because politicians can fit what they know about economics up the left nostril of a very small bumble bee. Just witness their stubborn opposition to tax cuts, which has record federal revenues pouring in, has drained them of all common sense. We need a stable tax policy that is all about low rates. That’s the best fiscal stimulus you can have now. It would put more money into taxpayers’ pockets longer-term. Our unstable tax system is horribly unproductive and sucks a huge amount out of our economic growth. Hard as he tried to remain circumspect, Federal Reserve Chairman Ben Bernanke, whose purview is monetary not fiscal policy, did say an eye-brow raising comment. He said tax cuts “don’t pay for themselves,” sending fear into the hearts of Wall Streeters that the world’s most powerful central banker gave cover to those who want to raise taxes, notably on capital gains and dividends. A debate worth having, whether tax cuts add to federal revenues or whether inflation, population growth, and just long-run economic growth do. What the tax hikers ignore is that tax cuts do unlock economic growth–capital gains taxes, for instance, are voluntarily paid. Taxpayers often hold off on selling an asset, like a house, so they can pay at the lower long-term capital gains rate. Cut capital gains taxes and you unlock that asset–raising capital gains will help keep the housing market iced over, frozen solid, as no one will sell.
3. Consider a flat tax: Ok, I confess, I am a flat-taxer, having covered the IRS for about a decade and having testified before Congress about IRS abuses of taxpayers (a weird position for a journalist to be put in, for sure, so I based my testimony on a government report about the agency). I saw first-hand how “America’s museum of mass confusion” as the Heritage Foundation rightfully calls it, severely abused taxpayers. A flat tax would ignite the economy, would bring in record revenues, and it would detonate the IRS as well as the Gucci Gulch, still thriving (it’s no wonder that the tax writing committees get the most visits from lobbyists as well as the most political donations.Just witness the back story to Europe’s 2.7% GDP growth last year. Yes that sounds teeny tiny, but hey they broke out the hats and horns over there in the land of the welfare state. Europe’s GDP growth is due to the adoption of a flat tax in former Soviet satellite states, now part of Eastern Europe. Russia passed the flat tax in 2001, and immediately revenue jumped 26% in the first year, says SageWorks, a financial advisory and research house in Triangle Park, N.C. Estonia went to a flat tax in 1994, and from 1997 to 2005 saw an annual GDP growth of 6%. Lithuania implemented the flat tax a year later, in 1995. Tax revenues grew substantially and Lithuania saw an average GDP growth rate of 7% for the next five years. Latvia passed a flat tax in 1997 and saw GDP grow 11% over five years while government revenues rose 13%. Ironic, isn’t it, because a flat tax runs contrary to the ideals of Marxism, “from each according to his ability, to each according to his needs,” Karl Marx once said about the progressive tax system. So the first former communist nations to implement the flat tax are now the richest of the group.
4. Cut corporate taxes: Companies don’t pay taxes—instead, customers, investors and employees do. In fact, a growing chorus of academics are saying it’s likely workers who actually get it in the neck first from high corporate taxes—evidence for why wage growth has stagnated. Another piece of info: although Iceland does not have a pure flat tax, when it lowered corporate taxes, corporate tax revenues increased. Same for, get this, Egypt. Rudy Giuliani, now running for the Republican presidential nomination, has this one right. So does Treasury Secretary Henry Paulson. Today the United States’ corporate tax rate ranks among the highest among the 30 nations in the Organisation of Economic Cooperation and Development (OECD), a Paris-based group which encompasses the world’s industrialized nations. “We now have, on average, the second-highest statutory corporate tax rate (including state corporate taxes), 39 percent, compared with an average rate of 31 percent for our top competitors,” Paulson says. “A study by Treasury economists estimated that a country with a tax rate one percentage point lower than another country’s attracts 3 percent more capital.”
Ok those are my thoughts on fiscal stimulus. Now on to cleaning up Wall Street’s housing mess.
