Dollar Bubble

At last, all you naysayers who never thought the impossible was possible have been proven wrong. And only long after the fact that a humble man came storming through your living room with flabbergasting truth and an iron cast torch burning honesty freed your simple brainwashed minds do you finally concede to reality.

Ron Paul just Rick Rolled you all! He smashed your jaws with his 50 ton torch and now you want an Advil. Well the good doctor isn't prescribing anymore since all you boneheads picked a legion infested robot with no economic reasoning.

But at least he still cracks skulls with an over sized torch fit for slaughtering neocons of all varieties. You see Keynes is eating large creamy 'meat pies' and throwing leftovers at the homeless. Don't suspect for a second that the your back won't be as bruised as Ike on Tina once "Hanky P With Big Ben & The Co." are through with all of you.

Anyway, Ron Paul on Glenn Beck and the Dollar Bubble (sorry, no new video):

...

CONGRESSMAN PAUL: Well, I've been concerned for a long time but more so than ever and my main thoughts are financial, but they're related to everything that we do, whether it's spending domestic or internationally, that our deficits are exploding. And everything puts weight on the dollar. So if you need to bail out the housing industry, where do they get the money. They don't have the money. But they, you know, start buying up hundreds of billions of dollars worth of mortgages. Just last week, for instance, a small nod, but it added up to $48 billion. Out of the generosity of the congressman's heart, they voted to send $48 billion to take care of AIDS victims in Africa. Well, may be well intentioned but if it destroys our country and destroys our dollar and destroys our economy, what good is it going to do. And I think we're at the beginning stages of an unraveling financially of a bubble that's been developing maybe for three decades, and it's going to be very serious.

MWS: Well that AIDS money is well intentioned, but this is Africa and I suspect that this money is improperly channeled within its political sphere aka corruption.

CONGRESSMAN PAUL: I'd say a dollar bubble. We've been able to create money out of thin air and we've had the privilege of it being the reserve currency of the world. So it's almost like we can print gold, that we don't have to work. And that's one of the reasons our jobs go overseas is because they'll take our dollars and we don't have to work for our dollars. We print them. So it's been our economic and military power that allows people to believe our currency is good as gold. But now they're coming to believe that it maybe isn't so good and they have been systematically behind dollars in these last couple of years. Our dollars go down and interest rates go up basically when you look at credit cards and mortgages and our economy keeps getting weaker and the banking system is in danger. And it's not going to be easy because if you allow the liquidation of debt, it's rather painful. But that's what I advocate because continuing to do this is going to literally undermine our whole economic system and our political system.

MWS: This is especially evident in commercial paper rates, in which spreads refuse to slim on what is usually considered safe paper used to fuel capital investment and short term liquidity needs because it is so easy to raise (less regulation).

GLENN: Don't you think that this is?--?I mean, there are people that say, "Well, they're too big to fail." I think that if you are a bank that you aren't smart enough to figure out that, you know, Tom at the auto parts store shouldn't be owning a $3 million house, I don't think you're smart enough to be a global bank. You should fail. And in the short run, very painful. Long run, the only way to cure the financial cancer.

CONGRESSMAN PAUL: That's right. You have to liquidate the debt. The debt always gets liquidated. We're liquidating debt now by paying off debt with cheap money. So if you get a dollar back and it's only worth 50 cents, half your debt was liquidated and that's what they opt for. But the real liquidation of debt ought to be people who bank bad investments and can't afford it, they should have that debt liquidated and people suffer the consequences. But the people who are screaming for the housing bailout are the people who got their houses for free. You know, they didn't have to put any money down. The house went up in value. They even borrowed more money. Then they spent it. Now they want you and I to bail them out so that they can keep their homes.

MWS: I actually disagree with Ron here, debt is not being paid off, it's being written off, or in the case of Merrill Lynch, practically given away at huge losses and dilution, though it is debatable as to whether even the fire sale price of those assets were a bargain or not. This is deflation not inflation. In fact the Fed is utterly powerless to print because they're vehicle for printing money (money center banks) are drying wells. If one looks at the massive amount of credit created since 1980, it is actually simple to see that a sharp reversion to the mean is logical.

This is quite a long interview, but I'll give the link again here just because it is an impressive argument from Ron Paul and I advise you read the entire interview.

United States...Now In Socialism

Few may understand the meaning of the name of my blog, but the 'HD' stands for high definition. Why HD? Because there is much more than meets the eye in the headlines of our mass media and this is one writer who deems to not be fooled all of the time. So I give you Capitalism in high definition, defining the blurry headlines.

In my absence of writing as I draft plans for my investment advisory firm there has been all kinds of unappealing policies from our government, namely Hank Paulson. Hank has come to define the new system of Socialistic Capitalism where too big to fail has become his implicit motto, along with crush the dollar! In fact, Paulson's initial statements might be considered a contrarian signal of his actual intentions. One such example was his commentary that institutions must be allowed to fail, but then shortly after pleading that Fannie and Freddie must be guaranteed by government support. US Citizens will bare a freakish slouch for many decades in carrying this weight.

Now Paulson is pushing his agenda again, this time in promoting covered bonds.

"Covered bonds, issued by banks and secured by pools of assets like home loans, are widely used in Europe but have only become attractive in the United States since the segment of the mortgage securitization market driven by investment banks dried up last year amid a wave of home foreclosures.

Unlike mortgage securities, which pass all the risk to investors, covered bonds collateralized with mortgages would continue to perform even if the mortgages backing them default -- as long as the bank remains solvent.

"The key to the U.S. economy making a major improvement will be turning the corner on housing finance and on the housing correction," Treasury Secretary Henry Paulson told a news conference. "We're not going to be able to do that unless we have availability of mortgage financing, and this is an attractive resource for mortgage financing."

...Federal Reserve Governor Kevin Warsh told the news conference the U.S. central bank was willing to consider highly rated, high-quality covered bonds as collateral for banks seeking emergency funds from the Fed. "A covered bond framework may attract investor interest and facilitate greater access to mortgage credit," he said."

Don't let this one fool you either, it is just another useless scheme. The idea of Covered bonds allows the pooled security to be separated if an institution goes insolvent to the benefit of the bondholders. In other words, the crappy assets in the bond are separated from the quality assets. Covered bonds must be kept on the books though, unlike their MBS counterparts and in default interest payments go straight to the creditors.

In retrospect, this policy makes no sense for our capital impaired banking system right now. Capital raising efforts are still not over, there will be no market for these securities. While I do believe that these kinds of securities are more attractive for investors (creditors) than MBS, it doesn't solve the underlying problem; underwriting standards for home buyers were far too lax, relying on cash now at favorable teaser rates, believing in the fallacy that home prices would rise forever.

The market is already solving this problem, no need for policies like these. Mortgages are tough to obtain, and when they are the rates are much higher than what the Fed suggests. This is natural. There exists a massive oversupply of homes and banks are broke.

The "ownership society" of the past decade is now as dead. Now we face a much larger problem; a government and central bank that refuses to concede that problems exist beyond their control. A strange breed of socialism is now in place. It is defined by capitalistic hubris while the bulls run, but sweeping socialistic reform when bears wake up, with mainly the tax payers paying the piper.

Re TD Ameritrade

This is a quick follow up to my previous post on AMTD, a 1 year chart:

This companies growth has impressed me, but despite the volatility in its stock price, it has remained relatively unmoved from 1 year ago. This suggests a couple scenarios;

1. 1 year ago the company was very overvalued relative to earnings and equity and the stagnation in its stock price has now made it more fairly valued.
   
2. AMTD is undervalued now, even at a P/E of 15 because of the enormous growth over the past year and long term potential growth.
   

Without a much more in depth analysis of its financials and a full blown valuation, this is hard to determine. Examining its competitors and determining if the competitive advantage I believe exists is verifiable is also another crucial hypothesis that must be proved for the second assumption to be true.

Any thoughts or suggestions?

TD Ameritrade - Recession Proof?

To begin, a few highlights from AMTD's June transcript, courtesy of Seeking Alpha:

"With the completion of the June quarter and with that under our belt, we have already earned about as much this year in three quarters as we did the entire year in 2007."

It is this statement that inspired my article headline. And the proof:

"I think you can see the operating leverage probably most clearly when you look at the year-over-year change with regards to both revenue percent versus our expenses which are up about 3% and certainly our pre-tax margin as well has improved about six percentage points from where we were a year ago. Now to take a closer look at our revenues, our revenues overall are up around 15% but we always break down for you what the drivers behind those, revenues that are driven by transactions came in at about $259 million, which is up 25%. And revenues that are driven by assets came in up about 9%."

However, one point that concerns me:

"The break down between revenues driven by assets versus transactions is about 60/40 and remember to put that in perspective a few years ago that same ratio would have been 30/70."

This is a break away from their core business, a transaction based business, or at least it appears that way from looking at that ratio:

"Now with regards to trades per day, we continue to be the market leader with regards to trades. Year-over-year for the quarter we were up about 22% at a number for the quarter of almost 300,000 per day. Now if you take a look at where we are right now as far as July goes, through either yesterday or it was the day before yesterday, for July we’re averaging 321,000 trades a day."

Management does emphasize that the chances of that average will most likely not persist at that level and are mostly results from certain days in July that were big up days in the market. But as noted above, asset based fee business has become the bread and butter of this corporation:

"Revenue earning assets are up around 12%, that’s excluding Fiserv. Now that’s driven by our fee based balances which are up around 20%. To remind you that would be mutual funds, money market funds, Amerivest, AdvisorDirect."

Considering the shift in revenue generation, here is the part that really blows me away:

• Year over year, revenue generating assets are up 122%
• Year to date, revenue generating assets are up 108% compared to the same quarter last year

Holy Shnikes, that's strong performance. Also for your consideration:

"Revenues up 15% but earnings per share up 31%."

Another caveat, the CEO, Joe Moglia, eats his own cooking. The man has over 80% of his families' net worth in TD Ameritrade's stock and he intends to keep at least 80%. I wish institutional investors had the same sentiment, they've shed 2.7% of the outstanding common in the past quarter. On second thought, nah, they can keep selling and lower that cost basis.

Another jewel in this business I see is TD Institutional. Since I am myself in the process of registering my own investment advisory firm (more on this within the next month), I've learned a bit about the environment. The scoop is that traditional full service broker/dealers are escaping their own platform. It's no longer as attractive as it once was to rely on representatives using commision based platforms. Investment advisors are gaining popularity and market share and the B/D's are now accomodating and have dual registration.

This is where TD Institutional peaks my interest. For starters, among the discount brokers, they are the top dogs. Secondly, their commision charges are superior compared to full service brokers, I mean usually drastically less. As far as services offered and soft dollar arrangements, it's really hard to see where the full service B/D's have a competitive advantage, it's just not there in my opinion to merit the excessive clearing costs.

I see plenty of growth potential in this segment as more securities proffessionals become independant investment advisers or investment adviser representatives. AMTD has their own RIA subsidiary to plan for investors as well, which makes them stand out among the crowd because it is aimed towards the long term investors, attracting them to the discount platform.

Looking at the companies financials, their cash and equivalents of $1,769,383,000 less their long term debt and capital lease obligations of $1,464,735,000 = $304,648. This is plenty reassuring in terms of financial soundness. Add to that an above 35% ROE and pretax margins of around 50%. AMTD is trading at around 15 times earnings. With guidance being raised, but overall nervousness in the financial service sector, I wouldn't be surprised to see this contract by the end of 2008, and as readers know full well I have forecasted pain in the economy.

Overall, the firm has a great brand and seems to be growing well, a bit of patience and an investor might find a clearance on this firm at some point this year. They don't pay a dividend currently, but it may be in the cards one day when growth potential reverts to the mean. Of course, a more rigorous analysis of the companies financials is advised and I have not done a valuation forecast.

*I do not own any position in AMTD. This is not intended as investment advice and should be considered general information only. This is not an offer to buy or sell. Please consult an investment proffessional if you are considering buying AMTD as a result of this information.

Getting Real With Reporting

An article from Mish ignited an idea I have about listed securities and their reporting. The inciting entry is as follows:

"So far banks have miraculously come through on their end of things. Wells Fargo (WFC) and JPMorgan (JPM) reported better than expected beaten down earnings. Things must be getting better just as the companies need capital.

What a coincidence.

But if you look at how the banks “beat” their earnings the coincidence becomes clear. WFC took the unprecedented step of extending charge-off acknowledgment from 120 days to 160 days. And JPM was even more aggressive. It actually lowered its loan loss reserves quarter to quarter."

I have two proposals as a result of this information:

1. Terminate quarterly reporting to the SEC; or
2. Require quarterly reports be audited
   

This shenanigan in question is known as income shifting. The above change in provisions of how income is recognized can have a big impact on reported earnings. In this case, not income, but a loss, is shifted to a later reporting period so as to boost earnings for the current period. Whether or not this violates GAAP principles is uncertain in this particular case, and it certainly calls into question an examination of revenue recognition. More specifically, the losses from delinquencies being matched to revenue from the loans, in which an extension on the realization of the loss has been made here. Investors should be aware nonetheless.

Had those new provisions mentioned above been audited, like they are in annual reporting, they may never have been changed at all. An astute auditor may have caught it and mentioned it in his audit reporting on the filing, forewarning investors of the affects it may have on valuations and projections. Now the information was properly disclosed, but a headline from an auditor would have a much greater impact on disseminating knowledge to investors.

It's these kinds of 'adjustments' that are a consequence of quarterly earnings reporting. Management sacrifices long term credibility and focus at the expense of 'beating expectations'. In fact, the phrase 'better than expected' makes me projectile vomit every time I hear this abomination. Not to say that beating expectations is bad, but the reaction is always the same.

Honestly, I would not like to see quarterly filings terminated, but a bit more honesty in their reporting would shed light on information that may not leak until its awareness during the annual audited report. Investors rely on earnings, and much to their dismay, many do not investigate the quality of earnings as intuitively as they should.

This is not to say that auditors are perfect. Like rating agencies, auditors are for profit and must earn business. Issuing negative audits for a firm might impact future business. After all, if firms can find a different auditor that is more generous in its analysis, it will most likely throw its money in that direction instead (if the firm is engaged in suspect accounting that is). However, with more frequently audited reports, lax auditors have a higher probability of being exposed when suspect accounting finally surfaces.

The idea here being, that audited reports will effect quarterly reports to be more honest, but for the preceding reasons that may not be the outcome. Also a huge consideration is the cost, which can really add up for audits at that frequency.

So what option does this leave investors with? Since quarterly audits are almost certain to not come to fruition, the responsibilities fall on shareholders and investors themselves to be more diligent in their analysis. Gimmicks like extending the recognition of delinquencies on loan losses are a perfect example.

Holy Kudlow!

Ron Paul citing on Kudlow earlier today, major bonus points for Kudlow! Great show, check it out (click on image for video):

Risk Is Widely Misunderstood

Not too long ago, the market believed that in the face of the worst economic disaster since the great depression, that the Fed would actually begin to raise rates by the end of the year as food and energy crisis fears grew, as indicated by the Fed Funds Futures:


Seriously? Are there any traders out there that actually understand economics? Apparently not since that trend completely reversed. In fact, I wouldn't be surprised to see a pricing of a rate drop some time.

It seems 'the market' has a misunderstanding of what inflation is. Now even though I disagree and give no credibility to the CPI, I do not believe there is true monetary inflation occurring in this environment. The egregious rise in prices of food and energy have more to do with the following factors:

• Simply stated, supply vs. demand; even with US drivers cutting back significantly in their driving habits, oil prices persist higher. It appears we are no longer the only users on the block anymore (China & India)
• Food production has been skewed against market forces. Thanks to ridiculous ethanol subsidies and mandates, barriers against other ethanol markets, and outrageous agricultural subsidies, corn is taking up a much larger acreage of crop production, leading to higher prices of corn and all other crops as a result of less production. There are many more factors to this, but I'll leave it to factors the US mostly has control over in it's policies
• Speculation (I am not a large proponent of speculators being a major factor in the rise in oil prices and I will not make them out to be the scapegoat, but I will recognize that there is some contribution from it in the price of oil, which is difficult to estimate accurately)
  
• Thanks to low interest rates, pervasive and growing deficits and climbing future obligations of the US not just to creditors, but it's own citizens, the dollar will remain a weak currency. The effect is a reduction in purchasing power, which includes oil even though oil is denominated in dollars

I could go on, but that is sufficient. The last point is important and has not received much attention lately. The Fed can't raise interest rates, period!

Aside from the obvious consequences of the effect on US homeowners who are already underwater, our financial system has massive capital shortfalls and are in between Hell and a hard place themselves. Spreads on lending are juicy right now, but with such huge obligations, deteriorating market conditions and limited capital, the banks can't take advantage of it. Write downs will continue to persist far longer than most expect and banks have largely unknown special purpose entities off their books that pose serious threats to their financial soundness and they know it. Access to raising capital is drying up, we saw this with IndyMac.

Where I'm going with this is that it would not make sense for the Fed to raise rates because of such large scale credit deterioration, which contributes to deflation, not inflation. Don't confuse the two just because commodities are upward bound with no apparent light at the end of the tunnel. Also a fact to consider is the steps our government is taking ie. 'the bailout' process. The US government already has unfathomable obligations outstanding, raising rates raises the cost to borrow, which the US is desperate to keep up.

In summary, traders must have been eating paint chips when they uniformly decided food and energy inflation were our largest economic threats. A nation is only as safe as its financial institutions soundness since cash rules everything around me, but ours is in complete disarray.

Corporate Earnings, A Short View

John Authers runs a wonderful market segment known as the Short View and adds an interesting, and in my opinion correct interpretation of corporate earnings in economic downturns.

From his commentary Authers notes that earnings generally don't stop falling until they've declined about 20%, keep falling for 2 yrs and that so far earnings are only down about 3%, and that there is every reason to believe that the earnings declines will be much greater and more protracted.



He also goes on to note the exceptional rise in earnings over the past decade.

It appears obvious from this graph, even with the historic plummet in the bursting of the dot com bubble, P/E's are still historically high, though with the most recent declines have come down a bit. It also appears obvious that earnings are at unsustainable levels and with a landfill of nuclear waste in our financial markets, this downward trend can be expected to continue for an extended period of time. Why?

The answer is simple; credit deterioration and capital shortfalls discourage lending, which has dramatic effects on either stagnating or decreasing the money supply, which will take time to have noticeable effects in the economy. Add in near $150 oil, rising unemployment and a fearful consumer and you have the cliche perfect storm.

Steinhardt, This Time Is Different

Ah, those fabled words 'this time is different' that often come back to bite you in the arse. Usually I hear this phrase and run for the hills on whatever advice is being given, but after watching this very intelligent interview with Michael Steinhardt and considering his extensive track record, I'll concede just this once:

"as a contrarian, one sees so many reasons, technically, stock market wise to be bullish"

but....

"I think that this time it really is different, that there are really genuine, solid, fearful reasons for a bear market here, and we're in the midst of it"

I highly recommend watching the rest of the interview.

Dimon Gives Warning

Absence makes the heart grow fonder, eh? It has been over a week since my last entry, and unfortunately expect this infrequent writing going forward for the next 1 - 3 months.

Two big queries I left unanswered:

Banks Low on Blood, Need Capital Transfusion, my interest in the Fed's intention to allow commercial and investment banks commingle and my promise to investigate the candidates in Presidential Run 2008. I will not let the obligations go unfulfilled.

Moving forward, and interesting quote caught my eye from none other than JP Morgan's CEO Jamie Dimon as he says the credit crisis could worsen:

""I do think we have some very serious issues to face," Dimon said at a mortgage lending forum sponsored by the Federal Deposit Insurance Corp. "Things could actually get worse."

Wall Street investment banks should not be considered too big to fail, he said, adding the U.S. regulatory response to the credit crisis has been appropriate.

Dimon, whose bank is widely expected to acquire a regional bank, said an accounting rule requiring banks to mark assets to their current market value is a deterrent to mergers.

FAS 157, as the rule is known, would force an acquirer to write down the value of assets from a target bank -- even if the loans and securities were sound -- to reflect current depressed market values. In some cases, Dimon said, a target bank could emerge with negative value under this mark-to-market accounting, forcing an acquirer to raise more capital."

Dimon attacks this issue from an accounting and capital raising perspective. The rules that govern M&A give disincentive to partake in any activities, easily spotted by the anemic M&A market so far in 08'. The prospects of capital raising are drying up, for example IndyMac Bank has been unable to find a market for common new issues or debt issues and and is unable to shrink assets because it would incur losses. Thus it has discontinued extending any new loans.

The capital inadequecy extends further than that since the Fed is overextended on its own balance sheets, limiting its ability to step in and procure a Bear Stearns like bail out. This is why Bernanke is now pushing to change laws governing regulation of private quity and investment banks taking controlling interests in commercial banks (more on this in the future), the situation is that dire.

Without some major overstepping of legislative boundaries or attempts to run a muck on the printing presses (0% interest rates), Dimon is certainly on the right track with regards to his exclamation that 'too big to fail' is a fallacy in this economic environment and the reality in the days of Long Term Capital Management no longer applies.

Unfortunately there are proponents on capital hill such as Barney frank that want to increase the federal reserves' powers and socialize capitalism, deadly formulas. The best way to avoid past mistakes is to learn from them. A slap on the wrists (massive reform and bail out) will only lead to an even bigger problem in the future. There is no easy solution here but to let the market self correct itself, otherwise the US will continue limping down the same debt laden road with misguided investment under short run assumptions.