This blog is written weekly by Dock David Treece, a registered investment advisor with Treece Investment Advisory Corp. It is meant to share insight of investment professionals, including Dock David and his father, Dock, and brother, Ben, with the public at large. The hope is that the knowledge shared will help individuals to better navigate the investment world.

Friday, October 29, 2010

What’s Missing Here? Feedback Welcomed

In further considering the current circumstances facing US monetary supply, some new revelations have come to light that have further clouded the so-called “-flation debate.”

Is it possible that recent developments in the US economy might be leading to a result other than what is being widely anticipated by the market? Something which Fed Chairman Bernanke might not be considering, much less defending us against?

The Facts

1. Since the liquidity crisis in 2008, most corporations have wound down substantial amounts of leverage and built up large cash positions.

2. After recent developments in the mortgage market, the process of securitization – which has been helping to fuel money velocity increasingly since the 1970s – is effectively broken. Many big lenders are in more trouble than they could even hope to realize, as are investment banks that failed to their due diligence and have lost the faith of many investors.

3. Hence, the traffic jam in lending money means that many companies can’t borrow – at least not at reasonable interest rates – and don’t need to.

The Impact

With the lending system slowed so severely in this country, there is much less velocity of money. Even though so much money has been created in recent years, it simply isn’t flowing around the economy. This trend shows no sign of reversing in the near future.

Is it possible that despite everything Bernanke, Geithner (and Paulson before him) have done, the decrease in velocity of money might offset the recent increase in money supply? In other words, are we about to see a period of relative monetary stability, as opposed to inflation OR deflation?


As we assess developments in the US economy and monetary policy we continually fine tune our view of where the market is headed and why. As we ponder these new revelations, we can’t help but wonder whether we’ve missed something.

We are open to other perspectives on these factors, and would encourage any readers with well-formed opinions on these matters to weigh in either by commenting on this article or e-mailing its author at

Wednesday, October 27, 2010

Market to Dems: You’re Fired!

Lately the market has continued its strong performance, closing in on highs not seen since spring. Many investors and commentators have claimed that this has resulted from the market’s growing consensus on next week’s elections.

The truth is that the market has been doing well lately not in anticipation of recent earnings reports – which have been very positive – or next week’s elections. Not that these different factors haven’t benefited the market. In fact, these are the reasons why the market put in several relative bottoms 4-5 months ago before rallying back to previous highs.

Many investors with formal training in finance will recognize this concept, as the stock market is said to be a leading indicator of economic activity. That is to say that it anticipates developments as opposed to reacting to them. This is why we continually preach that investors can’t make money from what has already happened, only by anticipating how the future will unfold.

According to this well-documented theory, it is safe to assume that the market was fairly certain of the outcome of next week’s elections several months ago; and how right it was. It is for this reason that the market resumed its upward trend months ago, as it began to anticipate the gridlock that would result in Washington from the likely outcome of next week’s elections.

In a somewhat strange phenomenon, anticipation of gridlock has been limited to the market as a whole; few cases can be found in the actions of individual companies. For the most part corporations are waiting for gridlock to be assured. This is why they haven’t been hiring or beginning any substantial expansion projects. Corporations have, however, built up large cash positions, becoming poised to act should political conditions become more favorable.

The fact remains that even if gridlock results after next week’s elections, there is still uncertainty of exactly what gridlock will look like. For example, though the creation of new spending bills may cease, should Democrats lose the House, corporations still don’t know whether Healthcare Reform withstand judicial scrutiny, or if Republicans can find a way to kill the bill through lack of funding.

Now, several months after the stock market ended a short-term correction and turned back up, the economy appears to be resuming its recovery as corporate earnings surprise investors the world over. This isn’t to say that all is right with the economy. This is far from true. There remain, for example, numerous problems which banks need to work through, illustrated plainly by recent headlines pertaining to the mortgage crisis.

What makes this truly interesting is the confluence of factors dictating the market’s behavior. For example, recent earnings reports are interesting in and of themselves, but even more so when coming just shy of election season as certainty continues to grow that the Democrats will lose the House, if not the Senate as well.

The question now facing financial markets, one which is being constantly settled by consensus, is what course of action will be taken by the new Congress beginning in January.

Wednesday, October 20, 2010

Mortgage Makers’ Billion-dollar Boo-Boo

It’s seems the time may have finally come to say goodbye to a lot of the big banks, among the Bank of America and Wells Fargo.

A recent Bloomberg article revealed that bond giant Pimco, money manager BlackRock, as well as the New York Fed, are all attempting to force Bank of America to repurchase mortgages that have gone bad. The real problem is the numbers. These bad mortgages were among others that were packaged into roughly $47 billion worth of bonds by Countrywide Financial (owned by BoA) and sold to Pimco, BlackRock and other investors as mortgage-backed bonds.

One Wall Street Journal Article claims that roughly 40% of Bank of America’s mortgages sold have been paid off. That still leaves $450 billion in outstanding loans, hardly covered by the loan repurchase reserves held by the four largest US banks which totaled $8 billion at the end of June.

Wells Fargo, in which Warren Buffett’s Berkshire Hathaway is a large investor, is in nearly the same boat. As the institution begins to brace itself for large loan repurchase requests, it does so with very little in reserves. According to a recent report from Wells, the company has just $1.3 billion of reserves to support approximately $144 billion in loans it sold to the public.

In short, banks simply don’t have the reserves to pay for the likely wave of loan repurchase requests about to come in. Looking at the degree to which these institutions have leveraged their reserves, it seems we may be watching the unfolding of the next Long-Term Capital Management.

At its peak, LTCM was leveraged about 100:1. Thanks to the housing market bulging with excess leading up to 2006, many big banks have leveraged their repurchase reserves beyond that insane ratio.

Long Time Coming

For years many of the big banks reaped windfall profits by taking advantage of their clients every way they could. Their offenses included:

• Making predatory loans, knowing that many borrowers couldn’t possibly down their debt.

• Bundling bad mortgages together, slicing and dicing them into tranches, and sold them as “safe” debt. They used the capital they received from the sale of this debt to finance further lending.

• Cooperating with the formation and pervasion of derivatives markets, which helped supply additional income by helping investors to use exotic new “securities” to “hedge” their bets on mortgage-backed securities against default. Banks did this while purposefully downplaying counterparty risk faced by investors in this unregulated market.

• Now many banks have been fraudulently foreclosing on homes, because the housing market grew so quickly that many didn’t take the time to properly execute and store necessary legal documents.

Now it appears the bill has finally come due. Big banks, particularly big mortgage houses and lending units are going to hurt in a big way, as are their employees and their shareholders.

Many will point to the government intervention as a possible means of staving off crisis. However, given current political pressure on Washington as election season approaches, trust in a potential bailout seems misplaced, particularly given the illegality of many actions taken by these institutions.

A quick note of clarification: Depositors in these institutions need not be alarmed, as bank deposits are still insured by the government through FDIC. Investors holding positions in these banks, however, may want to rethink the outlook for their holdings.

Tuesday, October 19, 2010

When Business Talks Politics

Oh, how we long for the old days, when business and politics were two totally separate spheres of American society, never mixed even around the water-cooler. For the longest time, it was simply considered inappropriate for corporations to exert any influence in the political realms.

Those who did, including many of the industrial titans who built this country and prospered after the Industrial Revolution, received staunch criticism. Significant legislation aimed at RE-leveling the playing field, such as the Sherman Anti-trust Act, resulted.

And yet, lately the distinction between politics and business is again becoming blurred as businesses feel an increasing need to defend their own interests, a trend that will likely continue.

In modern history the line between business and politics was first crossed by mostly left-wingers, particularly environmentalists hoping to reshape American policy. More conservative businesses, however, remained mostly detached from the happenings of government. Meanwhile, men like George Soros and Warren Buffett began crossing the proverbial line in the sand in highly publicized ways.

Warren Buffett has been particularly vocal about his political views. The Berkshire Hathaway Chairman frequently attacks large companies and investors for aggressive structuring designed to diminish tax bills, but he also readily admits that he pays less in taxes than anyone in his office, despite his billionaire status.

Buffett is at least partially motivated in this new venture due to his previously-stated stance against inherited wealth. This sounds an awful lot like redistribution of wealth so highly held by communism as an ideal.

Unfortunately, the majority of more conservative businesses simply refused to enter the ring, or at least to take sides. And as history will show, when a pacifist meets a warrior on the battlefield, the pacifist tends to lose.

If there is any lesson to be learned from history, it’s that there must be a balance between the private and public sectors. Business simply can’t submit to government; the long-term results can be disastrous. Consider, as examples, Argentina, Venezuela, recent headlines regarding BYD in China, or the Mexican oil industry for a more historically perspective.

BYD, for example, is a Chinese auto manufacturer, in which Warren Buffett’s company Berkshire Hathaway is a major investor. BYD was recently fined by the Chinese government after apparently building several factories on land that was reserved for farmland. The factories were subsequently confiscated by the government, providing BYD little recourse for recouping their investment in building these facilities.

Conversely, business also can’t be permitted to exert excess influence on government. America’s robber-barons of the 1800s, largely resulting from the Industrial Revolution, showed just what can happen when industrialists are permitted to build vast business empires and accumulate the resources to defend their monopolies politically.

Over the past several decades, many businesses have been finding that they can no longer afford to remain on the sidelines. Originally they began to venture into the world of policymaking through the practice of lobbying.

However, thanks to the cloak-and-dagger practices associated with this dirty business, lobbying has become stigmatized, both for businesses and politicians, to such a degree that corporations today are much better off (from a PR standpoint) being involved directly rather than secretively.

Now, thanks to the recent US Supreme Court Decision of Citizens United versus Federal Election Commission (2010). Corporations no longer have to take a clandestine approach to political involvement.

As a result of the increased involvement from organizations like the Chamber of Commerce, the pendulum is swinging back to the right, further than many could have imagined. This has obviously led to substantial resistance from several more liberal sources, including David Axelrod’s recent challenge that the Chamber proves its innocence of funneling money to campaigns, as recently alleged.

Meanwhile, many Democrats have received campaign contributions just as dirty as those alleged by Axelrod.

After all, with the government now having involved itself in America’s private sector through bailouts, the expropriation of automakers, and financial reform bills government the operations and compensation of financial institutions, businesses are being forced to get aggressive and fight back.

As has been demonstrated repeatedly, especially in this election cycle, Congressman Tip O’Neill’s famous phrase that “all politics is local” is being proven increasingly false. The new phrase may very well be that “no politics is local.”

Thanks largely to the internet and e-commerce Americans have access to a greater amount of information – and the power to exert greater influence – than ever before. Look no further than Christine O’Donnell, whose campaign coffers exploded after she was praised on Rush Limbaugh’s show. Or consider the fundraising boost provided to American Crossroads, a Republican group backed by Karl Rove, after recently being slammed by Obama.

This growing trend among businesses to enter the political arena in a more visible and partisan way is one not likely to end anytime soon. Now more than ever companies have a responsibility to their employees and shareholders to defend their best interests by any morally defensible means necessary. Big business has been backed into a corner, and it isn’t likely to go down without a fight.

Wednesday, October 13, 2010

The Last Straw for Big Banking

Over the past several weeks, stories have emerged regarding potential fraud by big banks foreclosing on homes. The pressure of these charges was such that several banks went so far as to declare a freeze on foreclosures, despite President Obama’s apparently disapproval.

The question being raised now is whether these developments will prove to be the final nail in the proverbial coffin of big Wall Street banks.

After more than a decade of poor policy decisions ranging from lax lending practices to the creation of new, exotic but misunderstood securities, it seems the bill has finally come due for big banks. With the blow-up and a great deal of the ensuing fall-out having been crammed into just a few short, terrible years, many of the world’s most prominent financial institutions are seeing their empires of influence, as well as their financial resources, dwindle by the day.

[Note: The banks being referred to are not community banks or regional commercial banks, but prominent Wall Street investment banks and mortgage lenders.]

Those who have the painful events of the last several years seared into their memories will recall that the first domino to fall in this great collapse was in the derivatives markets (e.g. interest rates swaps, Credit-Default Swaps, etc.). Suddenly investors in this relatively new, unregulated market that had been growing exponentially for several years, found out the hard way that the ‘securities’ they were trading would not necessarily behave the way they had hoped or planned – or how they had been told.

Now, just as the derivatives mess seems to have been winding down, there is more trouble surfacing; and it seems to be related.

It now appears that big Wall Street banks have not only been hoaxing investors in recently created derivatives markets; they’ve also been defrauding clients in more traditional banking practices, from nearly every angle.

Back in the 1970s lenders who wanted to get loans off their books and gather more capital to lend began working through investment banks using a new process known as securitization to bundle up loans (a great deal of them being home mortgages) and sell them to investors, who would receive the monthly payments as they came in.

For a while this worked wonderfully, and helped to fuel economic growth as lenders finally found access to more capital. However, this also created a conflict of interest because these lenders suddenly found that they had no reason to make safe, reliable loans. They were just going to sell them to investors anyway, so they had no reason to care whether the loan would ever be paid back.

Unfortunately, not realizing this conflict of interest, hapless investors continued to expand the market for mortgage-backed securities. Many of the investors in these new securities were big pension funds, insurance companies, and other large institutions, which are usually very focused on safety.

Thanks to inadequate regulation in this new market, many debt-backed securities were marketed as extremely safe investments, nearly as safe as government debt. As we have learned since 2008, and are now being reminded, this was far from the truth.

The banks didn’t stop there. There’s a second side to the securitization equation that was just as open to deception.

Thanks to all the new capital available to banks since the advent of securitization, there were plenty of loans to go around, but few qualified lenders. As a result, the banks eased up their lending practices even further, in some cases even making what could be considered predatory loans (loans they could reasonably assume would never be repaid).

With many of these unqualified lenders having defaulted on their loans, many banks have had the messy job of foreclosing on homes. Here is where the most recent controversy has occurred.

It seems that many banks, in an effort to process loan and foreclosure documents speedily, may have acted outside the law by manufacturing documents, in some cases even falsifying client signatures or inventing liens on properties that were paid for in cash.

The result of this final development, once events finally play out, is that many people will likely stay away from big bankers; both for loans and for structured investments. Investors will likely clear out of the mortgage-backed debt market, and as a result of decreased demand securitization will likely slow to a snail’s pace. A much larger portion of loans made will be kept on banks’ books. This will mean tighter lending practices as banks have more motivation to make sure that the loans they make will be repaid.

In general, over the next several years we’re likely going to see a shift back toward community and regional banks as Wall Street banks fall from grace. Some larger banks – both lenders and investment banks that securitized loans – will probably be indicted; lenders for falsifying documents, investment banks for misrepresenting mortgage-backed securities.

Lately one idea that has been floated around to help solve this mess of bad debt is the use of an entity similar to Resolution Trust Corporation (RTC), which was used to help unwind the Savings and Loan Crisis in the 1980s and ‘90s.

Though this is certainly a possibility, it’s important to remember that circumstances today are vastly different from the S&L Crisis 20 years ago. Back then securitization wasn’t as popular, so a good deal of the bad debt was still held by the banks in crisis and was easy for the government to gather through RTC. Thanks to rampant securitization of loans since then, the debt now going bad has been spread around the globe.

The crisis facing banks today is one founded on bad debt but intensified by a lack of a confidence and trust. It will undoubtedly be unwound over time; the question is which banks will still be around to see its end.

Tuesday, October 12, 2010

Working in Socialist America

In the past two years the United States has become more of a socialist nation than ever before in its entire history. We rode here, not as at a snail's pace, but galloping on the backs of vague notions like "Hope" and "Change." Yet few people, whether at the top of the political food chain or the bottom, ever stopped to think about what employment might really be like in the United Socialist States of America.

By the middle of the Great Recession that began with the financial crisis of 2008, the United States had begun to get a better picture of just what socialism looks like. With real unemployment over 17% and an increasing tax burden as a portion of GDP, the federal government became the “Nation’s single largest employer” with a payroll about 2 million strong.

According to the Bureau of Labor Statistics, in 2009 more than 7.5% of all jobs in this country were government jobs at some level. Even more disturbing, a recent report released by the Heritage Foundation reveals that the average government employee is paid 30-40% more than their private sector counterpart.

Of course, this astounding figure doesn’t even include the automakers and banks that were bailed out by the government, acting in conjunction with the Federal Reserve, nor does it include the US postal service, all of whom effectively work for the government.

Even though the federal government has grown to a grotesque size as an employer, it still provides assistance (read: handouts) in other ways. Of the 307 million people living in the US, July saw a record 41.8 million collecting food stamps (aka “nutrition assistance”). Then there were the 4.4 million Americans continuing to file for unemployment, not to mention government welfare programs, Medicare, Medicaid; and the list goes on.

Late last month AFL-CIO President Richard Trumka called for the US to “re-establish popular control over the private corporations…” What’s truly odd is his choice of words: “re-establish?” It sounds like Mr. Trumka needs a quick refresher course on American History.

This notion certainly isn’t completely outlandish; certainly not in the United Socialist States of the Americas, where the nationalization of business would be a commonplace occurrence. In 1938 Progressive Mexican President Lazaro Cardenas nationalized the then-wildly successful oil industry in Mexico.

At the time the oil companies operating in that country were foreign-owned and thought to employ anti-labor practices. Thanks to President Cardenas’ forward thinking, these anti-labor practices declined significantly, as did Mexico’s oil production. By 1957 Mexico had become a net importer of oil.

Like Mexico, the recent shift in the US to the left has changed the relationship between Americans and their government. The government has essentially become one big corporation, stretching its tentacles into every aspect of American life. Those at the top understand this shift, mostly because they orchestrated it.

The US Government, Inc., like any corporation, has expenses to pay. However, unlike most good corporations, its concerns regarding revenue to support those expenses are rather skewed. Its sole concern is raising revenue to expand operations (in Socialist speak: “give back to the people”), regardless of whether revenue increases are burdensome for productive citizens.

Unlike those it governs, the vast bulk of government produces almost nothing. Admittedly there are a few small exceptions (e.g.: bailed-out automakers) which actually create, engage in commerce, and contribute to society. However, most branches and agencies of the US government, particularly at the federal level, are completely UN-productive, but serve only as outlets for the redistribution of wealth. Examples include the EPA, the Departments of Education, Interior, Agriculture, etc).

These agencies, as opposed to producing, act solely as a drag on the US economy. There is an old quote from long-time House Speaker Thomas O’Neill that “all politics is local.” The same is largely true of business. By and large, government that is closer to the people tends to be significantly more helpful. The more distant it gets, the less positive impact it has on citizens’ lives.

The real challenge facing the United States today is in disconnecting the dots, bringing government back home to put what little power the government ought to have back where it belongs: in the hands of the governed.

Wednesday, October 6, 2010

Bear Stearns: The Real Story

On Friday March 14, 2008, the US government, acting through the Federal Reserve, took steps to prop up the 85-year old investment bank Bear Stearns. Originally thought to be the end of the institutions woes, regulators gave Bear that weekend to find a buyer for the firm, as it had become insolvency and was on the verge of failing, which would have created a massive downdraft in the markets and potentially a wave of bank failures that could’ve ground the global financial system to a halt.

Executives from Bear Stearns and other banks, along with Fed and Treasury officials worked feverishly over the weekend to find a buyer for the firm. Ultimately bank titan JP Morgan Chase structured a deal to purchase Bear for less than the firm’s Manhattan headquarters was worth at the time.

The government’s decision to rescind offers of support left investors around the world, as well as Bear Stearns 13,000+ employees, in shock. When all was said and done, many questions remained about what went wrong, and why this once-great institution was allowed, even encouraged, to collapse, especially when other institutions like AIG were provided substantial, lasting financial support.

The real story of why Bear was allowed to fail can be traced back to a decade before its demise, and the downfall of a young, world-class hedge fund, Long-Term Capital Management (LTCM).

Founded in 1994, LTCM was headed by John Meriwether, who had just left his position at the head of bond trading for investment bank Salomon Brothers following a regulatory scandal involving one of his traders. With him at LTCM, Meriwether had 10 partners, including several of his brightest former colleagues at Salomon.

The management team at LTCM was thought to be the best ever assembled. It included two future Nobel Prize Winners, seven PhD’s (six of which were from MIT), four current or previous Harvard professors, one Vice Chairman of the Fed, and a combined 250 years of experience in finance and investments.

The other big thing that LTCM had a lot of, which proved to be its undoing, was leverage. When they founded the firm, partners were able to raise just over a billion dollars in capital. They then “leveraged up” (borrowed a TON of money) and began trading.

By 1998 LTCM had achieved several years of fantastic returns, building their equity capital up to roughly $4 billion, and had borrowed enough money to amass a portfolio worth over $100 billion – an incredible leverage ratio of 25:1.

In September of 1998 Russia defaulted on their debt, an event that LTCM’s partners, mostly academics, never could have imagined. Their portfolio fell apart almost overnight.

That same month the heads of nine of the biggest (at the time) Wall Street banks were called into the Fed to arrange a bailout of LTCM. As many people have lately been up in arms over the government’s 2008 bailout of banks, this was even more controversial. Regulators weren’t bailing out a bank, but a hedge fund engaged in speculation on behalf of very wealthy clients.

The fear, though, was that without some form assistance, Long-Term Capital Management would be forced into bankruptcy and the liquidation of its portfolio so quickly that it would destabilize the market. With a $100 billion portfolio to unwind, the fire-sale that would ensue would surely push stock prices down, which would hurt smaller investors and also cause several banks to fail, as LTCM owed many of them large sums of money.

In the bailout, which ultimately involved more than a dozen Wall Street banks, there was one lone institution that refused to participate or provide any kind of help to LTCM: Bear Stearns.

Less than a decade later, the tables had turned on this former powerhouse. Rather than being the puppet-master, deciding whether to help a struggle firm or simply let them perish, now Bear needed the help, and desperately.

Wall Street, though, is fond of team players. As cut-throat as the industry can sometimes be, banks have long memories of both favors and faults. Put simply, 2008 provided other banks with their opportunity to get payback with Bear Stearns for having to shoulder the LTCM bailout a decade earlier. Even then-Treasury Secretary Hank Paulson was an alumnus of Goldman Sachs, who was involved with the LTCM debacle.

There’s surely more to the story of Bear Stearns’ fall from grace and final days that is largely unknown, and many of the details may never be revealed. We can be certain, though, that there’s more than meets the eye in this cloak-and-dagger tale.

Monday, October 4, 2010

Business Hungers for Lame Duck

So far the trend has been subtle, but big business has begun to behave as though President Obama’s time for influencing American policy may be drawing to a close. Many companies that had been sitting on hefty cash reserves have begun deploying capital. Some, including Walmart, Microsoft, and AutoZone have been using cash to buy back stock. Others have been investing in plants and equipment for expanding operations.

Even better, it seems like the stock market likes what it sees from big business, and has begun to trend up again.

As students of the markets are surely aware, stocks historically tend to lead the economy by roughly six months. For example, after 2008 the stock market made a major bottom late in the first quarter of 2009. As we now know from the National Bureau of Economic Research, the recession officially ended in June of 2009, and the economy made significant advancements in the second and third quarters of that year – about six months after stocks turned up.

Now, after a mostly stagnant summer, the stock market seems poised to begin traveling north as it heads into winter. This hints at further economic recovery to begin in the first quarter of 2011. Interestingly enough, that would coincide with the beginning of 112th United States Congress.

We know from history that the market favors political gridlock, as that adds some degree of certainty to policy changes (or lack thereof) to be expected out of Washington. There is little that Wall Street likes more than certainty, even if it’s the result of gridlock. By turning up, the market seems to be anticipating that gridlock will result from the November elections.

So while Obama technically won’t be a lame duck until he loses his bid for reelection, the market is anticipating that he’ll only be a one-term president. Moreover, if he loses Congress (which seems likely) he won’t be able to do anything, especially spend. Essentially, the market is indicating that Obama will be harmless in six months.

In fact, even if Obama somehow avoids losing control of Congress, he won’t likely get anything passed. After all, Democrats in Congress still want to get reelected, not matter how unlikely. They seem to be realizing that helping to pursue Obama’s agenda makes their reelection much less likely.

Many policymakers, even administration officials, have been jumping ship as of late. Even Obama’s chief enforcer, Rahm Emanuel has been rumored to be thinking of a change of scenery.

And still Democrats reportedly have 20 bills are on docket for the Congressional lame duck period from November through December. The real question is what centrist Democrat would vote for such an unpopular hard-left agenda? Anyone who would do so is ensuring that they’ll never get reelected to Congress. Many might have trouble running for local school boards.