NOTES FROM THE FRONT

SAILING WITH TEDDY

PETER R. MACK & CO. INC.

MEMBER FINRA/SIPC

19 EAST 71^ST STREET, SUITE 3

NEW YORK, NY 10021

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NOTES FROM THE FRONT

September 3, 2009

 

SAILING WITH TEDDY

 

Just about 16 years ago in August of 1993, early in the days of Peter R. Mack & Co., Inc. I published Notes From the Front about my expectations of the then new Clinton administration and their proposed new health care reform legislation.

 

It seems like 1993 redux. Barack Obama was inaugurated in January of this year and is vacationing at Cape Cod. Bill Clinton had been inaugurated in January of 1993 and was also vacationing at the Cape. Just like Bill, who faced a determined Republican party opposed to health care reform, portrayed in the fictional TV characters Harry and Louise, Barack is also mired in an endless and confusing debate about reforming health care, meeting tremendous opposition from the traditional forces of status quo, as well as from renegade Senatorial and House members of his own party. The Republican Senator DeMint of South Carolina has led the charge with his statement that if they can defeat Obama on health care, they will bring down his Presidency, just as Newt Gingrich in the spring of 1991 declared “the need for hard-line Republicans to begin positioning themselves now to keep Democrats from winning in the future.”(PBS.org) 

 

Some believe that because of the failure of the Clintons’ initiative, the subject of health care reform became a political deathtrap for the Democratic Party, dooming the subject from consideration for sixteen years.

 

I remember quite distinctly, and now with great sadness, the widely-published news photo of Bill and Hillary sailing with Teddy Kennedy and his wife Vickie, and Jackie O., on the calm waters of Nantucket Sound. Teddy, it was known, loved sailing, finding calm in the silent power of the wind and traveling by compass. It gave me a thrill back then to see them all together, with so much optimism invested in Bill and Hillary and the promise of change, and the iconic photo of the passing of the torch from one leading political family to another. One could not see or especially hear Teddy’s voice without arousing the good, though painful, memories of Jack or Bobby.

 

 In the intervening years, I don’t recall seeing any photos of George and Laura sailing with Teddy. They had their own dynastic political family but preferred the speed and bustle of motorboats, rather than sailboats, to ply the waters off the coast of Maine.

 

Barack and Michelle did not get their chance to sail with Teddy and have an iconic photo taken, or even get to visit with him in his last few days as they vacationed on his turf. For so many years, the Kennedy compound at Hyannis was the scene of some joy but mostly sadness, and that aura and era has now passed. But if there was one political figure in America for these last 16 years and even pre-Clinton who championed and worked for health care even to his very end, it was Teddy.

 

In my own mind, I see Teddy not as the troubled soul of his earlier years, with his personal transgressions ‘so out there,’ but as a champion of the weak and powerless, who through his strength, heroism, faith and dedication to public life helped me and the country to survive the assassinations of his brothers and Martin Luther King and the destruction of our innocence and dreams. In Puccini’s Madam Butterfly, Butterfly sings “even a mighty oak can be felled in a storm” but Teddy proved otherwise. Knocked down and almost out in 1968 with Bobby’s untimely death, and after Chappaquiddick in 1969, Teddy rose from the ashes to lead the Kennedy family out of grief back to life. He died as a grandfather – something none of his brothers could claim – and a beloved husband, father, uncle, friend and American legend. I and many of my generation and political beliefs will certainly miss him.

 

Some now believe that his passing will unite the divergent voices of health care in a broad, sentimental reconciliation leading to compromise. In spite of differences, there were many in the Republican Party such as an Orrin Hatch who were known to be Teddy’s dear personal friends. I am convinced that there will be a health care reform bill enacted into law, and it may be called the Kennedy bill, but whatever is coming, it will be devoid of soul and likely missing the key elements of change that a healthy, tireless politician like Teddy Kennedy might have accomplished with his oratory and political gifts and passion.

 

I think that the debate over health care has become confused, with most average citizens including me having little understanding of what’s being discussed. To me, there is just one main issue: Health care in America is too expensive for average people to afford. Those individuals who work for corporations or government are provided health care through a variety of insurers and plans and generally contribute some portion of salary towards the overall cost. For many, even that partial payment is barely affordable. The cost to employers is also very substantial and punishing.

 

In my own small company, we have a small group plan through Oxford Health Plans, a division of United Health Group. Premiums have risen in every year since we started in 1991, and in the plan year that began on May 1, 2009, premiums rose by 17% over the previous year, while the level of coverage including deductibles, co-pays, and freedom of choice decreased. The premium for a single person in the current year is approximately $600 per month, over $7,000 per year. The cost for family coverage is approximately $20,000 per year, an amount that is clearly unaffordable for most wage-earners.

 

I am certain that because of their size and negotiating strength, large corporations have plans that cost considerably less than our own, but it is virtually impossible to get a good plan for family coverage for less than around $12-15,000. Unemployed people or even self-employed people can’t afford any insurance at all, and that includes people who leave the security of the large corporation or government job and have to pick up insurance under COBRA. Two income families generally are affording health insurance but at a great cost and sacrifice.

 

In recent years, we have seen corporations shed full time employees in favor of outside consultants, not only with global outsourcing, but in the domestic US as well, in order to avoid adding new employees to the health cost roster. As insurance costs continue to escalate, this trend will grow and employment numbers will worsen, leaving more people without health insurance. General Motors was forced to declare bankruptcy in large part because of employee health care costs.

 

As we listen to the public debate, the implication seems to be that the uninsured are mainly members of the “illegal immigrant class”, rather than actually often being students, young workers and working class citizens. At the rate costs are increasing, growing numbers of ordinary, working people and their children outside of Medicare and Medicaid will be without health insurance because they just can’t afford it.

 

In my opinion, the only solution to controlling costs and providing health care to most people, would be to include every citizen under Medicare even if they are below 65 years of age, or Medicaid if their income levels fall below the “Federal Poverty Level”, which   is currently around $23,000 of annual income for a family of four including two children. I assume that these programs come under the “universal health insurance “or “public option” nomenclature that everyone is talking about. 

 

As one who participates in Medicare and a supplementary private insurance program, I feel that my wife and I have the best medical care available in today’s world at a highly affordable price. All those in the media and on the political right, and people selected for TV news seen screaming at town hall meetings to “keep the government out of my Medicare” don’t know what they’re talking about. Even “the money honey”, Maria Bartiromo on CNBC doesn’t seem to understand that Medicare is a voluntary program open only to older people. (In an interview, she stridently demanded to know of Rep. Wiener of New York why he wasn’t in Medicare rather than the Congressional plan. Wiener appears to be in his early 40’s. She had no clue!)

 

In fact, none of the CNBC broadcasters seem to know much about the subject at all, even though they lead a daily debate actively seeking to preserve the status quo. They, of course, are covered by General Electric’s health care insurance. (GE owns CNBC). I’m certain that they have no idea what it costs or any details. For those of my readers who might not be familiar as well, I will explain. Under the present Medicare system open only to people over 65, those of us who are eligible pay premiums to the government for our basic health insurance which is a very generous program, and for those who wish to expand the basic coverage of Medicare, private insurers such as Blue Cross/Blue Shield, and United Healthcare (through AARP) provide different plans at variable rates to get coverage in excess of Medicare’s. These plans are known as “Medigap.” In my own personal experience, the cost for my wife and me is less than half of that of the plan available under my company, and the coverage includes everything. Adopting Medicare for all would allow for private insurers to stay in the game and to compete with each other to gain “Medigap” business. Medicare premiums are also adjusted by incomes, so that there is some needs-based adjustment, which seems very fair.

 

There are those who say that the Government can’t run a health care program, but from my own experience, I see that Medicare claims are processed quickly and seamlessly integrate with the private insurance companies. I think even Doctors I talk to share the same feelings. From my own experience with Oxford and other private insurance companies in the past, I would have to say that the U.S Government does a better job.  

 

This seems like such a simple solution that I remind myself of Ross Perot who ran for President in 1992, and probably cost George H.W. Bush his re-election and brought us the Clinton Presidency. Perot would stand before the camera in front of an easel displaying charts, and in his Texas twang would say “it’s simple” and then go on to explain his own simplistic solutions to pretty complex problems.

 

Well, to me, it is simple. The best way to control costs is to have individuals involved in the purchase of their own health insurance, rather than having to deal with insurers through their employers’ corporate benefits’ departments,  under plans and coverage chosen for them by others. It should be obvious to everyone that publicly held corporations are in business to make money for shareholders, so when conflict and tension arises between profits and management compensation on the one hand, and medical costs for Mr. Jones’s illness on the other, Mr. Jones loses. Contrary to the odds of flipping a coin, Mr. Jones will lose every single time. It always comes up tails.

 

Anyone who feels that insurance medical board personnel, who work for a for-profit corporation and whose own compensation and advancement within the insurance company depends on increasing profits - i.e. being a good employee - will look out for patients’ interests first, is badly mistaken. Government medical boards acting under properly proscribed legislation, however, would carefully adhere to the law, and if compassion and discretion is written into the law, those government appointees will administer the law properly and fairly (unlike those imagined “death panels” of Sarah Palin’s nightmares which are more likely to be located in the private sector rather than Washington). As much as I like my solution, however, I am pretty certain it won’t be the plan that gets passed by Congress and signed into law later this year. Incremental change is less threatening in this confused, difficult time.

 

President Obama has announced a speech to a joint session of Congress on Wednesday, the 9^th of September, in which he will presumably lay out a new strategy to regain control of the debate and the initiative. I hope for the market and the country that we can get some meaningful change and that the struggle does not diminish the Obama Presidency. I believe that improved and less costly health coverage is a very important element in stimulating economic recovery and employment growth and will satisfy the markets. On the other hand, an inability to make any meaningful progress on a health reform plan and a rebuke to President Obama will undoubtedly stun the markets. Now that Congress is coming back into session, events will unfold very rapidly.

 

 

Peter R. Mack

September 3, 2009

Peter R. Mack & Co.,Inc. and any of its principals including Peter R. Mack may have an investment position, long or short, in any security mentioned herein. Furthermore, although the information contained herein is believed to be accurate, neither the author nor the author's firm makes any representation as to its accuracy and the reader should not rely on the statements contained herein for any purposes. Opinions mentioned are subject to change without notification. Material contained herein is for educational purposes only.

 

A Plan of Action to Chairman Bernanke

Copy of letter sent to Chairman Bernanke - March 2, 2009

PETER R. MACK

 

 

March 2, 2009

 

Chairman Ben. S. Bernanke

Federal Reserve Board

Constitution Ave & 20^th St.

Washington, DC 20551

 

Dear Chairman Bernanke:

SUMMARY:

The economic recovery depends on 1) stimulating the economy and 2) repairing psychology and restoring confidence. The Fed and Treasury have been working on stimulating the economy but restoring confidence against a barrage of bad news is proving elusive. In order to repair psychology and restore confidence to the markets, and to provide a better future rate-of-return to all American citizens than an investment in Treasury Bills, I suggest that the Federal Reserve Bank invest $1 Trillion into the domestic equity markets through periodic purchases of large, mid and small cap index funds through the leading fund distributors. 

 

RATIONALE:

 

The markets decline almost daily, setting new multi-year lows. Fears are being stoked by rampant rumors about troubled banks and nationalization, putting stocks into free fall. In recent days, rumors and speculation in the media about nationalization of Citicorp and Bank of America have driven shares of those stocks to low single digits, putting the value of their preferred shares and the continuance of the enterprise in great jeopardy. Managements of both institutions have publicly tried to assure shareholders about their long term viability but the markets are disbelieving. President Obama and Secretary Geithner have publicly stated their opposition to nationalization but again, the markets aren’t listening. Your own recent testimony to Congress, which I thought was a powerful affirmation, failed to stabilize the markets.

 

As a small and quite recent stockholder of Citigroup, in particular, but many other  industrial companies as well, and as an executive in the brokerage industry for 45 years, I

am fearful that shareholders of common and preferred stocks in these institutions are about to get wiped out. It is my strong belief that a nationalization of the

two large institutions most commonly mentioned, together with the prior catastrophic and ill conceived bankruptcy of Lehman Brothers and collapse of AIG, Wachovia, WaMu, GM and the like of our widely held corporations, will sound a death knell for the equity markets until long in the future. Individuals will flee common stocks and equity mutual funds. Today, GE broke the $8 level – a grim omen.

George Soros has long held and publicized his view that markets drive fundamentals, rather than the other way around, producing bubbles and crashes – a dynamic he calls reflexivity. In my view, stabilizing the markets is the key to recovering household wealth and creation of economic recovery. Following is my idea about how this can be accomplished while the world waits for Government action to take effect.

 

THE PLAN:

 

The Federal Reserve must become an equity investor by deploying $1 trillion into the equity markets through periodic purchases of broad-based large, mid and small cap index funds through the leading fund distributors. The Fed can operate under its normal procedures to minimize impact on the markets. Because of the market sensitivity of prospective Fed actions, leakers and leakees of Fed market actions under this program should be dealt with under criminal rather than civil statutes, under Justice Department rather than SEC jurisdiction. The public is sick of front running and other abuses done by insiders and hearing rumors in the financial media that turn out to be true.

 

These operations should be conducted on behalf of the account of the Social Security Trust Fund. For those who believe that privatization of Social Security into self-directed accounts was, and continues to be, a good idea, this plan should get their support. For those who feel that current aid to banks and financial institutions is a bailout for “fat cats” and incompetent and spendthrift financial executives, this plan is inclusive and benefits all citizens equally. If the US economy ever is able to emerge from its current squalor, these investments should become quite profitable. Purchases of equities for the Social Security account will also provide a hedge against inflation, which many fear as inevitable following the current period of money creation and growing deficits. There is no reason why equities should not co-exist with low interest T Bills in the Social Security account and no more appropriate time than now. Over the past weekend, in his letter to Berkshire shareholders, Warren Buffett described the market in US Treasuries as an investment bubble.

 

Were the Fed to conduct these open market equity operations, the playing field would be more leveled in the equity markets. Bear markets occur when there is an excess of fear over greed, when sellers overwhelm buyers, in this case, because of a weak economy. Because of relaxed rules regulating short selling and other market changes such as decimalization and the growth of leveraged short ETFs, short sellers and hedge funds have had relative free rein, as normal buy side investors such as mutual funds, pension plans and individual households have had much of their ammunition taken by deflation,de-leveraging, and low confidence caused by the weak global economy. In addition, as the markets continue to decline and further, as the hedge fund industry is rocked by recent scandals, additional deleveraging by hedge funds is expected as investors withdraw funds. Weakness in the markets has driven fundamentals lower. It is not coincidence that as household wealth and investment portfolios have declined, economic fundamentals have deteriorated as consumers stop spending.

 

As you are known as a scholar of The Great Depression, you know far better than I how,   on Black Thursday during The Crash of 1929, Richard Whitney, J.P. Morgan’s broker came to the floor of the Exchange and placed sizable orders in blue chip stocks for Morgan’s account. As word spread of Morgan’s intervention, prices firmed, effectively stemming the crash. Several months ago, legendary value investor Warren Buffett emulated Morgan by stepping in to snap up shares in Goldman Sachs and General Electric, hoping to set a confident example as well, but he was far too early and has lost enormous amounts of money, an experience shared by many.

 

Fed participation in influencing equity markets is nothing new, having that ability through its authority in setting margin requirements. Although I can’t recall any Fed action since at least the early 1970s, margin requirements were a tool used to encourage or discourage equity investments. Aside from just quaintly complaining about “irrational exuberance” a number of years ago, Chairman Greenspan could have used the Fed’s authority to try and curtail speculation if he thought it important enough to do something other than to comment, but he did nothing. If this were a normal recession, now might be an appropriate time to lower margin requirements, but with the volatility and illiquidity in the markets, and the fact that this is more a depression than recession, lower margin requirements would probably accomplish little at this time.  

 

Again, I believe it’s time for the Fed to act - to be the Morgan of today and buy stocks on behalf of the people - to do what I and so many others would do if we had any money left and weren’t so fearful of losing everything. If we as a nation have any economic future at all, these purchases will turn out to be great investments.       

 

Thank you for your attention.

 

 

 

 

 

 

 

 

 

Letter to SEC Chairwoman Schapiro

PETER R. MACK & CO., INC.

19 EAST 71^ST STREET, SUITE 3

NEW YORK, N.Y. 10021

TEL: (212) 744-3939     FAX: (212) 744-8484     EMAIL: PRMCO@AOL.COM

MEMBER FINRA & SIPC

 

SENT BY E-MAIL

February 27, 2009

 

Chairwoman Mary Schapiro

The Securities and Exchange Commission

 

Dear Chairwoman Schapiro:

 

In looking at the pre-market trading in Citigroup (C-NYSE) and seeing its descent by over 60% or so from its previous close on the NYSE on high volume in response to the Treasury department’s news, it would seem a safe assumption that much of the pre-market trading involved high amounts of short sales done electronically without pre-borrow or other stock loan arrangements, which, if I understand the SEC rules correctly, would be a violation of those rules.

 

Extraordinarily high short selling, whether in pre-market or during regular trading hours, causes extreme  volatility in a market where individual investors, pension funds and mutual funds have had their portfolios devalued and available funds depleted, The weakness in the economy and equity markets and decline in consumer confidence, down to 25% at last reading, has created an un-level playing field and enabled a condition of extreme volatility, allowing the markets to be easily manipulated. In my view, the Commission has a responsibility to ensure orderly markets.

 

Late last year, I wrote to the Commission regarding re-institution of the uptick rule and received a response explaining that, with decimalization and price increments commonly one cent a share, the judgment was that the uptick rule would be inconsequential and hard to implement. The solution, then, in my opinion would be to limit decimalization to identifiable units of perhaps five cents a share, or in any amount that would once again permit the effective implementation of the uptick rule and permit the Commission to regulate markets.

 

Moreover, although I personally have very little knowledge of how leveraged “ultra” short index funds work, there must be some contribution to extreme downside market volatility from these vehicles as well, perhaps involving short selling, and if so, they should be subject to regulations and not exempted. But, again, I really am ignorant about that product and how it works.

 

I have worked in the financial markets for almost 46 years and I lament the fact that I and my clients and the majority of the population now believe that the equity markets are a giant casino, that they are manipulated and that they are too risky for responsible allocation of assets. The markets need prompt and effective regulation to insure their stability and viability in these troubled times.

 

Thank you for your attention.

 

Sincerely yours,

Peter Mack

Secretary Geithner Speaks

Just checking in with some comments on Secretary Geithner’s plan.

The popular narrative is that the market was so unhappy with the lack of specifics in the plan that it sold off 5%. I understand that the public and the media want everything spelled out, even though reality dictates that solutions to the economic plan have to be dynamic.

I think the major take away from the plan is that big banks are not going to be permitted to fail, that the government will not nationalize and will not own and operate banks. They have been saying this under Paulson, but no one seems to believe, necessitating its constant repetition.

I think the plan is ok. First, it uses existing $350 million left in TARP to partner with investment groups to acquire what everyone calls “toxic assets.” There has been a deafening din about valuation under the good bank/bad bank debate in Congress, television, on blogs, etc. Nobody wants the government to pay too much and reward those rotten bankers. Everybody, including Nobel Prize winning economists Krugman and Stieglitz blithely demand that the valuation be based on market price, but it seems that only Geithner and the bankers (and me) know that there is no market, that there is no one to trade with, no one to put up capital. By partnering with private capital and guaranteeing a valuation based on long-term returns rather than fire-sale prices, the Treasury can revive a moribund market. I think this will succeed and put a floor under these assets and trading will resume.

Secondly, under the plan, TALF sets aside $100 billion of Treasury money which creates $1 trillion of money available to buy credit card, auto and student loans. This is really significant and will start soon.

Thirdly, a “stress test” for banks to see if they can be restored to health, if they are curable. Who can complain about that?

Finally, a promise to set aside $50 billion for foreclosure relief to homeowners – ok to have no specifics – because Congress is involved in the formulation of the plan, not Treasury alone.

There’s a tremendous amount of national anger and ignorance. Legislators themselves are unable to process the amount of information required to understand this very complex problem, and all are quoting constituents who are angry but have absolutely no understanding of what’s going on. They rail about corporate jets, and bonuses etc. – legitimate perhaps – but representative of a greater societal problem which has gone on for a long time.

The Geithner plan is a middle-way solution that deserves much more credit than it has received but it will require time to be implemented and to work out. As you know, the markets generally want instant gratification which they didn’t get yesterday, but things should stabilize as people learn more about it and as it kicks in.

The key takeaway: The large banks will not be allowed to fail! Taxpayers will be protected, somewhat.

 

Pfizer + Wyeth?

NEW YORK (MarketWatch) -- Pfizer Inc. is negotiating to acquire rival drug maker Wyeth in a blockbuster deal potentially worth more than $60 billion that could alter the global drug industry, the Wall Street Journal reported Friday.

News of the possible deal sent shares of Wyeth up 13% in premarket trading Friday, while shares of Pfizer slipped about 2.7%.

Positions: Long Wyeth & Pfizer

GERON CORP. - HUMAN STEM CELL TEST

GERN 5.21, -0.08, -1.5%) said Friday that the U.S. Food and Drug Administration has granted clearance for it to begin trials for what it said was the world's first study of a human embryonic stem cell-based therapy for people. Geron said it will begin a Phase I multicenter trial designed to establish the safety of its treatment, currently referred to as "GRNOPC1," in patients with complete Grade A subacute thoracic spinal cord injuries.

Positions: Long Geron Stock

FIGHTING BACK

PETER R. MACK & CO., INC.

19 EAST 71^ST STREET, SUITE 3

NEW YORK, N.Y. 10021

TEL: (212) 744-3939     FAX: (212) 744-8484     EMAIL: PRMCO@AOL.COM

MEMBER FINRA & SIPC

 

 

 

January 18, 2009

 

 

FIGHTING BACK

 

 

On October 28^th, in Restoring Trust, I wrote of the need for trust to be restored in many facets of our life and society including the economy, the markets, financial institutions, political systems, our fiduciaries and advisors, and lastly, our own self-confidence.

 

Now, less than three months later, the need to do so is even greater. We had then just seen completed a first round of bank bailouts and government forced corporate mergers and suddenly last week witnessed the unraveling of the Bank of America/Merrill Lynch combination so confidently put together in September, and now requiring another major infusion of aid from the Treasury Department. Bank stocks which had recovered and rallied upon the passage of the TARP (Troubled Asset Relief Program) are once again at record lows.

 

In December we learned that the three domestic manufacturers of automobiles were likely to imminently file bankruptcy if they did not receive direct and quick aid from the government, and lest we believe that the phenomenon was restricted to the much-reviled big three, the foreign companies manufacturing in the US such as Toyota and Honda (known as transplants) were also seeing sales and profits plummet.

 

And finally, giving authenticity to the loss of trust in financial advisors and institutions, came the December revelation about the widespread swindle by Bernard Madoff purportedly estimated (by him) to be around $50 billion. Since then, other Ponzi schemes have been reported, and just yesterday came a news report of a Florida money manager disappearing and an estimated $350 million of customer funds missing.

 

Economic statistics being reported for the fourth quarter are truly dismal. Retail sales were sharply lower, housing prices continue to sink, and foreclosures rise. On the jobs front, unemployment rose to 7.2 per cent and is widely expected to continue for some months well into 2009. It should be noted that corporations and organizations make budgets and plans at the end of the prior year based on expectations for the coming year, and generally stick to the plan. The recently-announced layoffs have been in the planning for quite some time and are both a manifestation of the current state of business as well aspart of strategic decisions as corporations restructure and redirect activities. The economic climate in the fourth quarter was quite negative and budgets going forward

were fashioned to be quite austere. Just at the end of last week, GE Capital announced cuts of 11,000; Pfizer by 2,400, Conoco Philips 1,500 and the liquidation of Circuit City will cut another 30,000 jobs.

 

These numbers are almost certain to keep ratcheting upward until the “official” unemployment rate exceeds 9 per cent or more from its present level. To those without jobs and with dim prospects in the market, despair will set in. To the 90 per cent of people still employed, caution and fear will abound and for most of those people, from the self-employed to corporate titans, salaries and compensation will be lower in 2009 than 2008. The mood of conservatism will be entrenched. Yet, a 90 per cent employment rate is still a powerful economic force that can keep the economy from entering a depression, as so many doomsayers suggest.

 

According to recent CNN polls, only about 27% of American people believe that President Bush did a good job in his eight years in office. Aside from most Democrats, that polling figure suggests that more than half of Republicans voted thumbs down. Hendrik Hertzberg writes in The New Yorker (January 19, 2009) that during the last eight years, “the unemployment rate went from 4.2 per cent to 7.2 per cent and climbing; consumer confidence dropped to an all-time low; a budget surplus of two hundred billion dollars became a deficit of that plus a trillion; more than a million families fell into poverty; the ranks of those without health insurance rose by six million; and the fruits of the nation’s economic growth went almost entirely to the rich, while family incomes in the middle and below declined.”

 

That’s the past, but there can be little question that ultimately, the negative mood has to change and the inauguration of Barack Obama and a new team on Tuesday, January 20^th will go a long way to starting us on the way back. The election of Obama was an affirmation of the country’s will to restore trust and demonstrated the ability of the people to overcome centuries of inherent racism and, to a lesser degree, partisan politics.  The nation continues to evolve.

 

On the positive side, many factors are in play that can turn things around. The government, through the Federal Reserve and Treasury Department has unleashed a torrent of funds through the $700 billion TARP program and through Fed lending that has backstopped the banks and financial services. Interest rates on Treasury bonds are at record lows, and have worked through the system, bringing about the lowest mortgage rates in 30 years or more.  Rate cuts are not just in the US. We have seen The Bank of England just reduce interest rates to the lowest levels in 300 years, a lower rate than even George Washington might have borrowed at when he was a farmer in Virginia and an English subject. The ECU is lowering rates as well. Skeptics of the interest rate moves

point to Japan where low, almost negative interest rates, failed to provide any stimulation to the economy over a decade and suggest it could happen here – that Americans will change their habits from consumers to savers – basically a new trick for an old dog. 

It just doesn’t seem likely.

Energy costs have dropped dramatically, with gasoline, home heating oil and natural gas prices far below (over 25 per cent) the levels of a year ago. This drop represents the equivalent of a sizable tax cut for consumers.

 

Finally, President Obama and the Democratic Congress will pass a stimulus package probably in the area of $1 trillion to help move the economy and advance aid to states and municipalities for infrastructure projects. China has recently announced its own stimulus with an additional $600 billion in infrastructure projects to augment their already significant budget.

 

Money will certainly begin to flow with the inauguration of a new administration.

 

More than money, the change in government should bring about effective changes in leadership. I have been a severe critic of Chairman Christopher Cox at the SEC. I hold him personally responsible for changes in market regulations that have harmed – maybe permanently – the workings of markets as we have known them. The Bernard Madoff scheme appears to have been conducted in spite of “whistle blowing” evidence provided to the agency many years ago. As the story unfolds, more evidence of regulatory failure will be revealed and histories will chronicle the collapse of the financial industry under Cox’s watch.

 

 The incoming Chair of the SEC, Mary Schapiro, is an honest, dedicated, non-political public servant and fiduciary. She has been the Chairman of FINRA (Financial Industry Regulatory Authority) the agency that regulates the brokerage industry and our firm. Under Ms. Schapiro, I expect that certain significant remedial actions will be initiated, I hope soon after taking office. I expect her to reinstate the uptick rule regulating short selling, to strengthen and enforce rules prohibiting naked short selling, to  revise certain requirements of FAS 157, and, over time, to put CDSs (Credit Default Swaps) and hedge funds under new regulatory authority.  I think these actions, if taken, will go a long way to restoring trust in the markets and reducing chaotic volatility.

 

With new leadership, I expect a new tone at the FDA (Food and Drug Administration) that will revive an almost-moribund agency and place a premium on science and health for all Americans rather than an agency that has been transformed into one that advanced and promoted the religious ideologies of conservatives. This will encourage the biotech and pharmaceutical industries to rev up their search for new treatments for our major diseases.

 

I foresee an economic revitalization, and an expansion of domestic manufacturing after years of disinvestment and job export to foreign shores.

 

On the other hand, while I am optimistic, nonetheless we are a country at war with an economy that is dangerously weak and depleted. The road to recovery is bound to take a longer time than most would hope for, and the shape of the new economy will look somewhat different from what has gone before.

 

But I certainly wouldn’t sell the economy short – to bet on failure - especially with all the positive forces arrayed against it. In short order, someone will refinance a house and go to Home Depot and buy some paint and a new sink. Someone else will finance a new car.

Money will begin to flow, one transaction at a time, until the cumulative effect changes the statistics and produces better reading and better news, thus giving others the courage to act as well. And so it goes.

 

Hope is on the way and no one should be so cynical as to not share in some optimism. Maybe it will work, maybe not, but it’s what we’ll see kick in very soon, thought out by some of the best minds that America has to offer. One year ago today, I was in the ICU at Yale - New Haven hospital and here I am today, still among you.

 

I will close by adding a poem that I particularly like by the Welsh poet, Sheenagh Pugh, which I think sums it up better than my text.

 

 

SOMETIMES

 

Sometimes things don’t go, after all

from bad to worse. Some years, muscadel

faces down frost, green thrives, the crops don’t fail,

sometimes a man aims high, and all goes well.

A people sometimes will step back from war,

elect an honest man, decide they care

enough, that they can’t leave some stranger poor.

Some men become what they were born for.

Sometimes our best efforts do not go

amiss; sometimes we do as we meant to.

The sun will sometimes melt a field of sorrow

that seemed hard frozen; may it happen for you.

 

-Sheenagh Pugh, “Sometimes”

 

 

 

Peter R. Mack

January 18, 2009

 Peter R. Mack & Co., Inc. and any of its principals including Peter R. Mack may have an investment position, either long or short, in any securities mentioned herein.Furthermore, although the information contained herein is believed to be accurate, neither the firm not its principals make any representation as to its accuracy and the reader should not rely on this information for any purpose. Opinions mentioned herein are subject to change without notification. Material contained herein is for informational and educational purposes only. 

China Stimulus Package

China today announced a stimulus package worth some $586 billion, equal to approximately 16.7% of the roughly $3.5 trillion economy. The US has previously announced a $700 billion rescue package which while large is equal to some 5% of the $14 trillion US economy. China's package which will concentrate on infrastructure and capital improvement is huge and is consistent with global efforts to forestall the creeping deep global recession.

This is big news.

Bank of England cuts rates

BOE cuts rates aggressively to 3.0% from 4.5% signaling growing recession numbers in UK. Hopefully, we can expect the same from Federal Reserve and central bankers around the world in attempts to stimulate business activity and bring liquidity to debt markets. Somewhere, the ball has to start rolling by virtue of increased lending and availability of credit for housing, automobile sales, capital spending and even the most rudimentary functions. Troubled banks have siphoned capital and must and ought to begin their business of lending responsibility, otherwise, they have no function in society and saving them is a waste of money. Can the economy last waiting for the new team?

Restoring Trust

PETER R. MACK & CO., INC.

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TEL: (212) 744-3939     FAX: (212) 744-8484     EMAIL: PRMCO@AOL.COM

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October 28, 2008

RESTORING TRUST

 

This is a time when nothing is as important as restoring trust. People around the world must restore trust in their governments and leaders; financial institutions have to restore depositors’ trust and their own faith in competing institutions; markets have to restore trust in liquidity and the historical system of capital flows; and regulators and legislators need to restore trust in their own integrity and expertise.

 

Most importantly, clients have to restore trust in their own financial advisers and money managers, and, in turn, those investment professionals have to rebuild faith and confidence in their own abilities and judgments.

 

It will be a very difficult struggle for everyone.

 

Personally, I’m having a difficult time understanding how the global crisis developed into the panic we’re currently in. I felt that I and my clients were positioned to maintain some defense against the events. Beginning around 2004, I had become quite wary of the financial sector after reading a number of research papers about leverage in the financial markets and institutions from off-balance sheet exposure to derivatives including credit default swaps (CDSs), collateralized mortgage obligations (CMOs), etc. and coming to further understand the fixed income markets.

 

In 2004, the size of the derivative market was already astonishing to me, although it was then probably less than one fourth or so of the size it was prior to the onset of the crisis, and 2004 was even before the explosion of mortgage debt in housing and the emergence of the sub-prime problem.

 

In July 2007, I posted a piece on my blog Notes From The Front quoting Warren Buffet on the hazards of derivatives in the credit markets. His concern proved to be quite prescient.

 

My own concerns were sufficient to keep us out of financial stocks. We had no or minimal exposure to the brokers, banks or the hot names such as Washington Mutual, Fannie Mae, Freddie Mac, AIG or others that have subsequently been taken over or closed at great loss to shareholders.

 

At the height of their popularity, financial stocks represented 21% of the value of the S&P 500, at a time, for example when energy was somewhere around 6%, and commodity and materials were at 3%. The large financial names that descended into dust were the core holdings, the mainstays of most of the portfolios run by large brokers and advisers. The under-weighting of our portfolios cost us some points in relative performance at that time, but spared our clients the massive losses endured by others in 2008, and I am proud of that fact. 

 

FINANCIAL CRISIS - PART 1:

 

The Global Financial Crisis has gone through two, or possibly, three stages. In my view, stage one began in early 2007 with growing concern about housing, mortgages and the revelation of trouble at two Bear Stearns’ hedge funds. In the early summer of 2007, those funds were closed at great loss to their investors, but the markets shrugged off the trouble as isolated and manageable. 

In July 2007, the SEC under Chairman Cox committed the first gross blunder in the crisis by removing the “uptick rule” regulating short sales. Under the rule, any short sales of stock had to be executed at a price higher (or the same) as the previous sale. The purpose of the rule was to give stocks breathing room on the downside and prevent sellers from essentially throwing fuel on a raging fire and driving stocks lower without interruption. The uptick rule had been in effect for many, many years and, in my opinion, had served to soften the downdraft of stocks subject to heavy short selling and prevent “bear raids” on targeted stocks, by permitting buyers to buy while scaling down. Many have defended the SEC’s action by claiming that stocks that go down would go down whether there was an uptick rule or not, a view I totally disagree with. The uptick rule brings order and time in place of chaos. This blunder by Cox seemed to me to be just the start of a pattern of non-performance during his hyper-political administration at the SEC.

For those who may not understand selling short, the process is to sell stock  (that you do not own) first, and hope to buy the shares back later at a lower price. It is simply the reversal of the buy low/sell high practice; it is sell high/buy low.

 

Additionally, also with respect to short selling, the SEC continuously failed to enforce the rules regarding “naked” short selling, a rule that requires short sellers to borrow stock for delivery to the buyer before it is sold short. By its suspension and non-enforcement of these rules, the SEC permitted chaos to enter the markets at a very delicate and sensitive time in the global economy.

 

In November of 2007, FASB (Financial Accounting Standards Board), an independent organization that establishes accounting standards and interpretations of accounting rules, passed Rule 157 which regulated mark-to-market valuation methods for financial institutions. It is too complicated to fully explain it in few words, but the rule forced financial institutions to adjust the value of certain assets on its books – generally infrequently traded derivative instruments - based on actual last sales in the marketplace. These assets don’t trade on any exchange and actual market prices are not readily available. The net result was that forced and troubled sales at fire-sale prices made by capital-impaired institutions became the standard for all institutions and forced all those other institutions to then mark down the value of the assets on their own books. This constant downward revaluation created a new round of capital shortage and book entry losses which then forced more sales to meet regulatory capital requirements, lower values for those assets and created a vicious downward spiral. In my opinion, the passage and implementation of 157 in November 2007 was the second, if not one of the greatest bureaucratic blunders of all time, and represented a major cause of Financial Crisis 1.

 

I should note that the minutes of the October 2007 board meeting of FASB clearly describe that the professional staff of FASB had recommended a one year delay in implementation of Rule 157 but was overruled by the members of the Board in a 4-3 split vote after a very brief debate. This was a huge mistake and in a perfect world the four board members who forced the implementation of this rule would answer to Robespierre, rather than be permitted to remain in the background, preserving their relative anonymity and cupidity.

 

The process of mark-to-market accounting would be similar to houses sold in foreclosure. Hypothetically, you and your neighbor live in a gated community and have identical houses valued at $750,000. Your neighbor has fallen on hard times and needs to sell to raise cash by the end of the week. A buyer offers $450,000, all cash, which is accepted. Under mark-to-market, if you were a financial institution you would be obligated to value your house at the $450,000 of the last sale without regard to any extenuating circumstances or the fact that you don’t have to sell and expect to hold for years. Extending the analogy, your lender would then call you and demand that you put up the $300,000 marked down forcing you to sell at the discount price or even lower. Frankly, it’s an insane process.

 

Once FASB 157 went into effect, banks and investment firms started to announce and take markdowns, yet there was still sufficient capital and liquidity to maintain regulatory requirements. The level of concern began to rise as institutions began to report growing losses. In January 2008, while I was a patient in Yale New Haven Hospital, a trader at Societe Generale, a large French bank, stunned the global markets by recording a trading loss in derivatives of hundreds of millions, causing the market to have a then huge selloff.

 

On March 14, 2008, after Bear Stearns’ common stock had been relentlessly driven down through rumor and intense short selling, the company was facing bankruptcy as customers pulled funds and wouldn’t trade with them. The US Treasury was forced to intervene and arranged a takeover of Bear Stearns by JP Morgan at $2 per share, with the Treasury positioned to guarantee all debt obligations on Bear’s books. (Subsequently, Bear shareholders managed to increase the stock purchase price to $10.) To everyone, this signaled a realization by the Treasury to intervene to preserve the liquidity of the financial system in saving those firms considered “too big to fail” and was seen by most as an ongoing policy commitment by the government.

 

I view this action and this date as the effective end of the viral portion of Financial Crisis 1, although it was very clear that mortgage woes and housing problems would continue to create economic problems in the future. However, the Treasury’s actions generated a firm commitment to restore trust and liquidity in the system and bought the time needed to work out the problems without a global crisis. In England, the saga of Northern Rock was playing out as well, aided by commitments and support from the Bank of England and government.

 

On March 14, 2008, just prior to the rescue of Bear Stearns, the Dow Jones average closed at 11,951. On September 8^th, immediately after the rescue of Fannie Mae and Freddie Mac but before the Lehman bankruptcy, the Dow Jones Average closed at 11, 510, representing a decline of just 3.7% during a period when the mortgage and housing news continued to worsen. Some people believe that this was a case of mistaken complacency in the markets. In my view, however, it represented the global consensus that the United States had formulated a consistent policy of intervention which restored trust in the stability and strength of the financial system and its institutions. I view this as a clear demonstration of the end of Financial Crisis 1.

 

FINANCIAL CRISIS – PART 2:

 

On Monday, September 15, 2008, Lehman Brothers filed for bankruptcy, after the US Treasury and the Federal Reserve failed to provide or facilitate a rescue plan in spite of having provided implicit assurances to investors that the system would be preserved and stabilized. Within hours, the markets began to experience devastating effects. Money market funds which had provided and held short term loans and commercial paper in Lehman now had essentially worthless debt and had to write down the debt, pushing net asset values below the $1.00 level, a condition known as “breaking the buck.” This caused an immediate run on the money market funds as investors pulled trillions out of these funds as well as from deposit accounts in banks and brokerage houses. It soon worsened as the global panic spread around the world. Equity, bond and commodity markets began to crash, causing margin calls and additional forced liquidation, which in term caused more selling and another vicious circle of selling, a process known as deleveraging.

 

Money market funds are a main source of lending and liquidity in the short-term lending market to banks and industrial corporations through commercial paper. In general, money market funds have an average maturity life ranging from 30 – 50 days, depending on their experience and management decisions, which allows for historically expected immediate cash needs. With the run on the funds and need for cash, the industry was thrown into upheaval and has yet to recover.

 

Since the bankruptcy of Lehman Brothers, the Dow Jones Average has dropped from 11,510 on September 8^th to 8,379 on October 24^th, a decline of some 28%.

 

The government’s failure to backstop Lehman, thus breaking the trust that the markets had placed in it, in my opinion stands as the single cause (or at least the major contributing factor) in the global financial crisis that has devastated every single market in the world.

 

It was most likely Secretary of the Treasury Paulson, or perhaps Timothy Geithner, the President of the New York Federal Reserve bank, or the two of them who single-handedly made the fateful and stupid decision that caused individuals, governments and institutions trillions of dollars in losses.

 

Secretary Paulson has been less than candid about why he shifted policy. At a recent press conference, he was asked whether he would admit that it was a mistake. Defensively, and seemingly pleading for understanding, he answered that “there were no buyers for Lehman” as if this was sufficiently exculpatory, and immediately changed the subject.  Of course there were no normal buyers for Lehman without the government guarantee, just as there were no buyers for Bear Stearns other than JP Morgan back in March without Treasury’s guarantee.

 

We don’t know now and maybe we’ll never know the reason, but it seems likely that Paulson and Geithner wanted to teach Richard Fuld, the CEO of Lehman Brothers, a lesson he’d never forget, without understanding the consequences.

 

For months prior to the bankruptcy it was reported that Paulson, Geithner and other officials had “urged” Fuld to find a buyer and sell Lehman. For whatever reason, he didn’t do it.  These people knew each other well, as power players in the industry. Obviously, I wasn’t in the room and nothing has been reported, but I think what this comes down to is simply a personality conflict, a fit of pique, a power play. “We told you to sell and you didn’t, and we’re going to teach you a lesson you’ll never forget. Don’t mess with us!”

 

Wouldn’t it be shocking and surprising if my take on the development of Financial Crisis Part 2 turned out to be true: a global financial catastrophe, man-made and perhaps caused mainly by arrogance and egotistical human error!

 

LOOKING AHEAD:

 

Since the Lehman bankruptcy, markets around the world have crashed; credit has frozen; economic forecasts which just a month ago were cautious on the question of recession, now question whether we can just stop at recession before moving to depression. Our government has jumped into action, rescuing or causing to be merged such institutions as AIG, Washington Mutual, Wachovia, Merrill Lynch, all on the brink of failure; creating numerous plans with acronyms such as TARP intended to shore up lending and borrowing among banks and generally making available the resources of the US Government to keep the financial system liquid and fluid. All the facilities are in place and hopefully the expanded activity will be felt soon and credit restored.

 

Congress has passed a broad rescue plan for mortgages and housing and another stimulus plan for the economy is likely very soon should Obama win and the Democrats hold or expand their control in the House and Senate.

 

In Europe, the G7 and EU have met and developed concerted interventions to backstop the European banking system, and England has done the same as economies weaken and drop into recession. Iceland teeters on the brink of bankruptcy. The Russian market is down 70% on the collapse of oil and overextended lending. The Russian oligarchs, many among the richest men in the world, have seen their industrial empires collapse amid losses in the billions of dollars.

 

In this country, some of the largest and well respected hedge funds are down by 35-40%, and investors are pulling funds, thus causing serious selling. Just last week, SAC Capital, a hedge fund run by Stevie Cohen said that they had sold 50% of their holdings – probably over $20 billion – to raise money, while Calpers, the State of California Pension Plan, was actively selling at these prices to raise money for payouts to retirees.

 

Today’s news carries a convoluted tale about Volkswagen, and enormous losses being taken by hedge funds caught in a short squeeze in a trade gone exceedingly bad. Goldman Sachs and Morgan Stanley are off by considerable amounts as they are rumored to be caught in the maelstrom.

 

The price of oil has dropped from $145 a barrel just a few months ago down to about $60 a barrel today, on commodity futures liquidation. Other commodities from the metals to fertilizer plummeted with amazing speed. At the beginning of the summer, I wrote about oil speculation and low margin requirements being the only reason why oil had risen to excessive highs and destabilized world economies. At the same time, George Soros and the former head of the CFTC (Commodities Future Trading Commission) both testified before congress that speculation by futures traders including hedge funds, had corrupted the system and led to a catastrophic price increase. Their testimony was ridiculed by CNBC and the free-market advocates, and ideological anti-regulation forces grabbed the media’s attention.

     

Just over a week ago, Aubrey McClendon the CEO of Chesapeake Energy (CHK), a listed natural gas company, was forced to liquidate his entire holdings of Chesapeake, the company he founded, selling over 31 million shares to meet a margin call. His holdings, worth more than $2 billion at the stock’s high of $74 in July, were worth a mere $42 million when sold.

 

Recently, Warren Buffett, the legendary value investor, took significant investment positions in General Electric and Goldman Sachs, demonstrating his willingness to bet on the future. As of this writing, he has significant losses on those two holdings, just like everyone else. Given his time frame, I have little doubt that he will once again demonstrate why he is so esteemed. On the other hand, just a few days ago, Alan Greenspan confessed that his philosophical, ideological belief in free markets was flawed, a much belated mea culpa.

 

The consolation to all of us is that governments, including our own, central banks and legislators have given signs that they are scared, as well, and will do anything and everything to sustain the safety and functionality of the global economy. Initially, this means pumping money and liquidity into the respective systems. It means lowering interest rates. It means working in cooperation and coordination with each other. It also means balancing the needs of the people with the needs of the institutions.

 

We have endured a brutal period. We are all shocked at the destruction of our personal wealth and many of us find the machinations of the financial system and the markets beyond any comprehension. We are asked to have faith in our fiduciaries – the regulators and legislators – and many of us feel that while we don’t know much, they know even less. We can all be consoled, however, by knowing and recognizing that every effort is being made to restore trust in the markets, to provide liquidity and stability to the economy. I believe, or in moments of weakness just hope, that these efforts will succeed.

 

I am angry and regret very much that Secretary Paulson, or his associates, made such a catastrophic error in judgment in spilling the Lehman Brothers poison into our well. No matter how great their effort in trying to clean it up after the fact, the reality is that the well has been tainted and only through time and additional filtration can it be restored. The poison is causing a panic; the markets are asking the question whether some chain of inexorable or irreversible events are in place to dictate our future destiny, to bring about a new depression. I believe not. I believe that the depth of the crisis has passed and that the patient will soon begin to heal.

Peter Mack, October 28, 2008

 

Peter R. Mack & Co., Inc .and any of its principals including Peter R. Mack may have an investment position, either long or short, in any securities mentioned herein. Furthermore, although the information contained herein is believed to be accurate, neither the Firm nor its principals make any representation as to the accuracy of any information contained herein and the reader should not rely on the statements contained herein for any purposes. Opinions mentioned herein are subject to change without notification. Material contained herein is for information and educational purposes only.