Educate Yourself

Week in Review
For the week 11/5/2007 - 11/9/2007
Brian Trumbore
President/Editor, StocksandNews.com

North Carolina Democratic Congressman Brad Miller on Treasury Secretary Hank Paulson.

"I can't help but notice that when middle-class homeowners were losing their homes to foreclosure, he was pretty nonchalant about it. But when Wall Street CEOs start seeing trouble in their absurdly complicated financial instruments built on the mortgages of middle-class homeowners, he feels their pain." [Bloomberg News]

Rep. Miller echoes a sentiment being felt increasingly across the land. What he doesn't say, though, but what is implied, is the fact Wall Street and many of its banking brethren, both regulated and unregulated, have been playing games with the rest of us, reaping riches beyond their wildest dreams, until the music stopped. But now it's not just some investors and homeowners who may have suffered, many of whom admittedly took risks where they shouldn't have, but also the reputation of the United States is being damaged with untold consequences.

I myself nailed this crisis going back years with my first observation 'these guys don't know what they own,' on through the whole real estate bubble that fed the need for the crack of the day, mortgage securities and their derivatives kin. So I loved a piece by Landon Thomas Jr. of the New York Times on the $3.7 billion charge that Morgan Stanley took this week as a result of both its collateralized debt obligations and trading acumen.

"Mr. Kelleher said the large trading loss [that made up a majority of the mega-writedown] was a result of a bet taken by several traders that the subprime market would worsen.

"The traders were right in predicting that the market for subprime securities would deteriorate, but they did not foresee the severity of the decline in September and October. Because of the complexity of the trade, what had been a money-making short position turned quickly into a money-losing long trade, in which the firm suddenly found itself holding billions of dollars of illiquid C.D.O.'s that were plummeting in value."

That's comical, and typical of the loss suffered by the Nobel Prize-winning geniuses at Long-Term Capital in 1998. They were so right, they ended up being wrong.

Speaking of geniuses, I caught most of Federal Reserve Chairman Ben Bernanke's performance before a joint committee of Congress on Thursday, as he updated us all on the state of the economy, and it was truly embarrassing. Now I know Mr. Bernanke's grade average was double that of mine in college, but he still doesn't have a clue how bad the real estate debacle is, saying at one point that it just had another six months to run.

Which leads me to remind everyone that when the bottom is hit, whether it is 2008 or 2009, we don't just head straight back up. Housing will sit there, dead, for a lengthy spell thereafter. Anyone doubting this thesis need only look at the huge inventories around the country, ever growing inventories, that need to be worked off first before there is any kind of sustainable rally.

And let me interject, again, a fact few recognize when talking about the terrific global economy. Much of it has been built on a thriving real estate market at its core, as history will prove, and with each passing week there are further signs the global bubble is topping out.

In Japan, housing starts plummeted 44% in September, year over year, though part of this is due to new construction regulations following the building scandals there. Regardless, the Japanese economy is back in recession, for all practical purposes.

And it's official, housing has peaked in the U.K. with word from all the major players there that prices have fallen two consecutive months due to the Bank of England hiking interest rates five times (though holding the line this past week) amidst record household debt as I described last time. Incredibly, some in Britain say home prices will soon resume their climb. See above.

On the other hand, real estate is still topping out in Australia, where home prices keep rising, but housing starts are down, also, as it turns out, because of rising interest rates. An economist told the Sydney Morning Herald, "The acceleration in home price appreciation suggests that housing affordability will continue to deteriorate further from already record lows."

Of course you should have noticed a pattern in these last two examples; "rising interest rates." As in the world is raising rates to combat inflation, speculation, or both, but back here in the good old U.S. of A., Wall Street is clamoring for further cuts in rates that in turn would only exacerbate what is now a full-blown dollar crisis, by most estimations.

As I set off for Europe again this afternoon, knowing I'll be paying $20 a beer, or more, it's yet another reminder of what a joke our currency has become. I know, a falling dollar has been good for U.S. manufacturers and our exports, but this is beginning to boomerang back on us, as it already is in terms of foreign investors and governments abandoning the greenback for other havens of perceived safety and investment.

This week a top China official said his government was looking to put an increasing amount of its $1.43 trillion in foreign exchange reserves into currencies other than the dollar, while the oil-producing nations, reaping the rewards of record prices for crude, want their largesse in anything but a bunch of Benjamins.

And with our European allies, in particular, seeing many of their manufacturers being slaughtered due to higher prices for their exports, it's increasingly tension city on the trade front.

Back to our beleaguered Fed chairman, at least he now recognizes the economy "will slow noticeably in the fourth quarter," and it will "remain sluggish during the first part of next year." But as I noted months ago he's really irrelevant at this point. The bears have decided hibernation can wait a few more months and they are devouring financial stocks in particular, slashing earnings as bankers and accountants, fearful for their lives, are beginning to come clean.

"Don't kill me, Mr. Grizzly! I'll, I'll show you where the crap is buried. I have a wife and kids to care for."

It hasn't been pretty. Wachovia revealed it has another $1.1 billion of mortgage-related losses, the aforementioned Morgan Stanley's hit, IndyMac, the second-largest independent mortgage lender, reported sizable losses and a cut in the dividend, Bank of America late Friday said it didn't have a clue what the heck was going on; even General Motors' world class charge of $39 billion was partly due to mortgage losses emanating from its finance unit.

Plus you still had the ongoing rumors of far more pain to come, including from those such as Merrill Lynch that have already seen their book values bludgeoned.

So this is going to play out for months and months, with two key dates coming up fast; Nov. 15 and year end.

The former involves the Financial Accounting Standards Board's rule 157 which says that on this date the banks must put a value on their opaque garbage that is lying on balance sheets around the world, waiting to be uncovered.

These involve what are called Level 3 assets, the hardest to value, or as we discussed back in August during the first mortgage crisis, "mark to make believe." [Level 1 is mark-to- market and Level 2 is mark-to-model.]

Then at year end, or a month later depending on when various Wall Street firms and banks close their books, they will have to come clean concerning all assets for their SEC-mandated annual reports. You can play some games quarter-to-quarter, but year end is a different matter.

Lastly, it's hard not to notice that retailers are already gearing up for Christmas, but if October's punk same store sales are any indication, there won't be a lot of mirth and merriment at the malls. You really only need to know one thing; housing is no longer the piggy-bank it once was. But if you require further evidence it could be a rough stretch, look at gasoline prices, which spiked on cue per my recent missives. From the "Today Show" to the lead story in USA Today, forecasts of not $3, but $4 gasoline were being echoed across the land, and at the worst possible time. Plus it suddenly got a bit brisk across much of the country this week, particularly in the Northeast and Midwest, and that means the first heating oil bills reflecting this change will be arriving just in time for you to have that sit down with Little Bobby and Peggy Sue.

"Kids, Santa is having problems fueling his sleigh and there's a chance he might not make it to our home this year."

"Kids, Santa had all his assets in dollars from last year's trip, but when he exchanged them for euros, the now accepted currency on the North Pole, he was left with little money to buy supplies for his workshop and kids all across the country are going to see a cutback in the number of toys they receive. It's called sharing the pain."

At least that would leave your kids scratching their heads and it might buy you a few hours of peace until they figure out that, as in the case of Hank Paulson and Wall Street, the fix is in.

--It was a brutal week, with the Dow Jones dropping 550 points or 4.1% to 13042, while the S&P 500 lost 3.7% to 1453 and Nasdaq plummeted 6.5% to 2627. For Nasdaq it was its worst week since April 2002. One of the culprits for the tech swoon was Cisco Systems, which had been performing like a champ until CEO John Chambers, in reporting earnings basically in line with expectations, said capital spending in the U.S. was slumping. That's all traders needed to hear, plus the likes of Google and Apple finally suffered major corrections after skyrocketing all year.

Overall, earnings for the 4th quarter are being ratcheted down faster than Marion Jones on steroids, with the expectation now being just 6% growth vs. an estimate of 12% last month.

But after this week's drubbing is it time to step up and buy? Are you kidding me? If you want to take a chance that some of the financials have seen the worst, be my guest. For starters, that means you know more than anyone else in the world. No doubt, though, some will make a killing in some shares or sectors when looking back two years from now. I'm content to sit back with my 80% cash position and let the others sort it out first.

Bonds rallied in a flight to safety, even though Chairman Bernanke warned inflation was still an issue.

--Josh P. passed along a comment from Goldman Sachs concerning California, as in "California seems to be sliding into recession. Together with the regional recessions already visible in Florida and Nevada, a California recession would mean that the housing bust has pushed an area responsible for 20% of U.S. GDP into an outright downturn." Goldman avers this is yet another reason for the Fed to ease, but then you've got that nasty dollar issue, sports fans.

--The International Energy Agency said energy consumption in both China and India would double by 2030, which since their use of coal is also expected to double over the same period spells huge problems on the greenhouse emissions front. Of course this means demand for crude oil will increase commensurately, while for the first time the IEA is admitting "geology" is becoming a problem on the production front (i.e., peak oil). Ergo, today's high prices aren't solely due to the 'terror premium' and speculation.

--The U.S. Energy Information Administration has raised its forecast for 2008 oil prices to $80 from $73.50, citing demand that will continue to grow faster than supply.

--General Motors posted one of the largest losses in the history of the planet, $39 billion, as the automaker took a charge involving unused tax credits. GM Chairman and CEO Rick Wagoner said the accounting issue is not easy to explain, but don't worry, be happy. Of course the growing subprime mess is clearly going to do a further number on car sales well into 2008.

--From a survey by the Pew Research Center, the question was asked, "Is America divided into haves and have-nots?" Back in 1988, 26% responded 'yes' and 71% said 'no.' Today it's split 48-48.

--A Washington Post/ABC News survey revealed 2/3s continue to give the U.S. economy negative marks.

--Merck has decided to pack it in on the Vioxx front, agreeing to pay almost $5 billion to settle 27,000 lawsuits where family members claim injury (or death) after taking the pain medication. The average plaintiff is expected to receive just $50,000 to $70,000, though, after legal expenses. Wall Street once estimated the pain to Merck would be in excess of $10 billion. Shares in Merck rose on the news as investors saw the positives in putting the issue behind it.

--Homebuilders continued to take it on the chin, as if I needed to tell you this. Toll Brothers saw its revenues in the recent quarter tumble 36%, with cancellations at 39%, while writing off another $450 million in land costs. Beazer Homes said new sales were off 53% and it was laying off a full quarter of its work force, while for its part Beaver Brothers said the rising cost of kindling was impacting its ability to ramp up construction ahead of winter and frozen ponds.

--Fannie Mae announced it took a huge $2.2 billion hit in a derivatives position. Now that's a weapon of mass destruction, as Warren Buffett first said of the instruments. Separately, CEO Daniel Mudd said the housing market will worsen in '08.

--This is a typical real estate story across the land these days. The Star-Ledger in New Jersey reported that the developer of a 45-unit condo complex in the northwest corner of the state had sold just "two or three" units, initially priced at $350,000 to $400,000, and defaulted on a $9.5 million construction loan. I've been writing of a similar project going up a few blocks from where I live and no more than one or two of these have been sold. This involves a loan well in excess of $10 million.

--So, do you think Saudi Prince Alwaleed, Citigroup's largest individual investor for years, is pleased? Talk about an example of where 'buy and hold' wasn't the appropriate strategy, the least he wants to do, I imagine, is send a flock of falcons to Citi's next board meeting and let them have some fun?the falcons, that is.

As for Citigroup's deposed leader, Charles Prince, unlike Merrill Lynch's Stanley O'Neal, Prince leaves with only $30 million in cash and prizes, but he will receive a pro-rated bonus for 2007, whereas O'Neal didn't. Of course O'Neal had accumulated $161 million in benefits.

But I get a kick out of Prince's package because aside from the obligatory office and administrative assistant, he gets a car and driver for at least five years (or until he finds a new employer). I imagine a few Citi shareholders would like the car to be a Yugo.

--Since it received so much publicity, and because this column is a running history of the decade, I do have to note for the archives that supermodel Gisele Bundchen is insisting she be paid in a currency other than the U.S. dollar, in yet another sign America is turning into a laughingstock.

--I follow the situation in Beirut closely and I feel for the tourism business there. For the first 8 months of 2007, the hotel occupancy rate is down to 38% after the war of 2006.

--Wal-Mart has begun mass layoffs at its mainland China purchasing centers; a sign the retail giant is looking for lower- cost countries. For China the worm has turned as they begin to export inflation.

--Google, Google, Google?.it's all about Google. Last Sunday's New York Times, for example, had two separate articles, titled:

"I, Robot: The Man Behind the Google Phone," and "Why Google Turned Into a Social Butterfly."

--Yahoo shares tanked after a congressional committee blasted CEO Jerry Yang for misleading Congress about its role in the jailing of a Chinese dissident. Journalist Shi Tao is serving a 10- year prison sentence after Yahoo's now-defunct China arm turned over information about his online activities to Chinese authorities. He was then imprisoned for revealing "state secrets." Yahoo's general counsel Michael Callahan had initially told Congress in February 2006 that the company didn't know the facts of the case, but it turns out it did.

--An art auction by Sotheby's fell 25% short of its goal and shares in the company plunged about a third. One Van Gogh painting failed to come close to its estimate and was pulled, thereby confirming my long-held belief Van Gogh was overrated, though Kirk Douglas did a nice job portraying him.

--My portfolio: The China biodiesel holding delivered a solid earnings report and announced the plant expansion is proceeding, though financing hasn't been wrapped up as yet. The company seems to have a handle on its raw materials costs, but I'm a little leery in this regard as I see one article after another about soaring costs for items such as palm oil. Nonetheless, those of you involved in this stock (and I'm finding out there are more than I thought) should be pretty pleased thus far.

--Be careful investing in mutual funds this time of year, even those of the bond variety. More than a few are projecting large capital gains; not an awful thing for existing shareholders, but a real bummer for new ones in a taxable account. Check with the fund company first.

--A new train line is opening up between London and Paris that cuts the time between the two to 2 hours 15 minutes. Very cool.

"Last week I wrote how President Musharraf, waffling anew, did not want former prime minister Benazir Bhuto to return from exile. Well she did, and on her first day over 130 were killed in a suicide attack on her convoy?.

"The parliamentary elections, slated for January, are still on as the government is saying all the right things, 'terrorism will be stopped, we will not surrender to it, etc.' but at the same time, I see this attack, and others that will follow, only further consolidating Musharraf's power yet again as he declares a state of emergency."

And so late last Saturday Musharraf did just that. Addressing the nation, he said Pakistan is standing at a crossroads and it was time to take hard decisions.

"If we don't take these decisions then there is a grave danger to the solidarity and security of the country?.My guiding principal has always been Pakistan first?.These extremists were roaming around freely in the country while the law enforcing agencies have become demoralized creating concern among the general public."

At one point, speaking to his American allies, Musharraf compared himself to Abraham Lincoln, saying "Lincoln usurped rights to preserve the union."

Opposition leader Bhutto replied, "He says that he is acting for the good of Pakistan but he is acting for the good of General Musharraf."

"Pakistani President Pervez Musharraf claims that he suspended the constitution and imposed de facto martial law Saturday to save his country from Islamic extremists. But his crackdown has been directed almost entirely at Pakistan's moderate, secular and pro-democracy opposition - the very people who could offer a political alternative to the Taliban and al-Qaeda. At least 500 lawyers, judges, political party leaders, human rights activists and journalists have been arrested. Independent television stations have been shut. Lawyers who tried to demonstrate against the repression in front of the Supreme Court yesterday were attacked by security forces.

"Mr. Musharraf is waging war not against extremism but against democracy. He acted because he feared the Supreme Court was preparing to rule that his orchestrated reelection as president last month was unconstitutional. He was seeking to escape from commitments made to Pakistan's secular political leaders and to the Bush administration that he would step down as army commander by Nov. 15 and hold free and fair parliamentary elections early next year."

"Secretary of State Condoleezza Rice was quick to criticize Mr. Musharraf's move and said yesterday that the U.S. would review its financial aid to Pakistan, which has amounted to more than $10 billion over the past five years (most of it for the military). Senator Joseph Biden, chairman of the Foreign Relations Committee, issued a statement urging the Administration to 'move from a Musharraf policy to a Pakistan policy.' That oversimplifies both current U.S. policy and the options going forward, but it should indicate to General Musharraf how his 'second coup,' as some are calling it, will be received in Washington?.

"But the violence is not the product of democratic opponents of Mr. Musharraf's rule. It is the work of the same Islamist extremists who have also tried to kill the General more than once."

As I go to post, Musharraf, after a tough call from President Bush, agreed to hold elections before Feb. 15 and would give up his military uniform at that time before taking the oath of office for a new term as president. But on Friday, he blocked an attempt by Bhutto to stage a rally against emergency rule.

What seems clear is that the odds of this crisis ending very badly are rising, with Musharraf, Bhutto, or both becoming victims. And while it would appear the nukes are secure, and there are responsible officials in Pakistan's military (as well as some scary elements), the terrorists are watching this whole situation play out with glee. You would be, too, if you knew at least for the time being you weren't being targeted.

Iran: Israeli intelligence and defense officials are now saying Iran is just two years away from having the bomb, meaning were Israel certain of this fact there would be a pre-emptive strike on suspected facilities within 12 months. With diplomatic efforts seemingly stalled out, despite some past success on the sanctions front, time is rapidly running out.

This week, French President Nicolas Sarkozy reiterated "It is unacceptable for Iran at any point to have a nuclear weapon," joining his new soul mate President Bush.

An editorial in the Nov. 5 edition of Defense News, though, expresses my long-held feelings.

"The problem is Washington is divided. The State and Defense Departments oppose a near-term attack. Better, they say, to negotiate and build international consensus to diffuse the situation [Ed. as opposed to the view of hardliners in the White House.]

"They're right. The United States won't even talk to Iran, which plays into the hands of factions in Tehran who seek confrontation with America and want to reinforce the perception that America is a unilateralist bully. But Iran's rulers are as divided as Washington over confrontation. More broadly, it's unclear whether the Iranian people and body politic share Ahmadinejad's zest for brinksmanship.

"Diplomacy and statesmanship are prerequisites to curbing Iran's influence and ambitions, nuclear and otherwise. If wide-ranging and highly visible diplomatic efforts fail, that process will add the needed legitimacy for future military action.

"Moreover, such diplomacy would help reassure allies left rattled by the Iraq war that has eroded America's credibility worldwide, particularly in the Middle East. Precipitating another Middle East war isn't the way to do that."

Israel: The Washington Post's Jackson Diehl had a good description of a troubling event this week concerning the rise of Israel's far right.

"In a bold speech broadcast on national television Sunday night, Prime Minister Ehud Olmert explicitly overturned the judgments that have guided Israeli governments for the past seven years. Israel, he said, does have a worthy negotiating partner in the Palestinian Authority. It cannot afford to postpone negotiations or drag its feet in endless talks. 'Real accomplishments' are possible before President Bush leaves office. 'We will not avoid fulfilling our own obligations' - such as dismantling West Bank settlements - 'to the letter,' Olmert said, '?no matter how difficult it is.'

"For the next several days, Israel's talk radio and op-ed pages converged on a single subject - but it was not Olmert's groundbreaking speech. Instead, the buzz was all about something that took place at a soccer game in Haifa while Olmert was speaking. Before the game began, an announcer asked for a moment of silence in honor of former prime minister Yitzhak Rabin, who led Israel toward peace in the early 1990s before being assassinated on Nov. 4, 1995. Hundreds in the crowd, most of them supporters of the visiting Jerusalem team, responded with boos; some began lustily singing songs in honor of Yigal Amir, the man who murdered him."

As Jackson Diehl concluded, "The message drawn?was grim. The return Olmert signaled to an aggressive pursuit of a final peace with Palestinians also will mean the comeback of the ugly and potentially violent resistance from Israel's far right."

Posters showing President Shimon Peres wearing an Arab headdress have also recently appeared on walls around Jerusalem.

Iraq: Turkish President Erdogan met with President Bush over the issue of the Kurdish terrorists, the PKK, and as I wrote last week he received some worthless assurances from Bush that the U.S. would do all it could against "their common enemy." Erdogan then flew back to Turkey and vowed he would launch some kind of strike regardless of any agreement he had with the White House.

And for the record, despite the success of the 'surge' in reducing the level of casualties, particularly as it pertains to the U.S. military, 2007 nonetheless became the deadliest one for American forces.

Afghanistan: In a highly disturbing development, at least 75 (the exact total is unknown) were killed in the worst suicide attack since the war began in the normally peaceful north, including over 50 children and six members of the Afghan parliament. While on Saturday, six U.S. soldiers were killed in an ambush in the worst such attack of the year.

North Korea: U.S. officials say they are satisfied with Pyongyang's initial steps to disable its nuclear weapons capability at the Yongbyon facility. The North is to disable the plants there in question by year end, but, just as importantly, provide a full accounting of its existing weapons as well as all fissile material in order to receive 1 million tons of heavy fuel oil and other aid.

This is disablement, however, not 'dismantling.' It's reversible, though there would be a lengthy delay should the North Koreans once again boot out inspectors and reset the program.

Separately, the Washington Post reports Saturday that the North is "providing evidence to the United States aimed at proving that it never intended to produce highly enriched uranium for nuclear weapons, undermining a key U.S. intelligence finding, South Korean and U.S. officials said this week."

The North's existing nuclear arsenal has come via the plutonium route, solely, according to the report. This is yet another potential huge embarrassment for the Bush administration.

China: U.S. Defense Secretary Robert Gates met with his Chinese counterparts in Beijing in an attempt to get them to toughen sanctions against Iran as well as address White House concerns over China's burgeoning military and its test of an antisatellite weapon. It was largely a waste of time.

Russia: Former prime minister Mikhail Kasyanov, who was sacked by President Vladimir Putin in 2004 and is now an opposition figure, said "Russia is heading into a dark, totalitarian state, and its citizens should understand that." The campaign for the Dec. 2 parliamentary vote kicked off last Sunday.

Georgia: In a blow to the United States, President Mikhail Saakashvili, a long-time supporter of the administration, felt compelled to declare a state of emergency and shut down independent media after six days of anti-government protests. Over 500 were injured in violent demonstrations that culminated in the edict. Saakashvili's handling of the crisis is an embarrassment to Washington, though the Georgian president blamed "high-ranking officials in Russian special services" for fomenting unrest. Opposition leaders say the people are tired of Saakashvili constantly blaming Russia for its own problems, and it's important to note the opposition is not anti-West, from what I know. They claim their issues have more to do with corruption and Saakashvili's increasingly iron fist.

On Friday, parliament approved a 15-day state of emergency, ignoring calls from the United States to suspend it, while Saakashvili has called for a snap election to be held in early January. The state of emergency is being presented to the people as buying time to investigate the claims of interference by Russia's intelligence apparatus. Meanwhile, Putin is loving this. More next week from Moscow, including how Putin can call a state of emergency of his own, related to Georgia, to stay in power.

France: President Nicolas Sarkozy received a rousing ovation from a joint session of Congress with lines like these.

"Let me tell you solemnly today, France will remain engaged in Afghanistan as long as it takes, because what's at stake in that country is the future of our values and that of the Atlantic alliance."

[In praising American values, spirit and culture?.] "America liberated us. This is an eternal debt. I want to tell you that whenever an American soldier falls somewhere in the world, I think of what the American army did for France. I think of them, and I am sad, as one is sad to lose a member of one's family."

"In times of difficulty, in times of hardship, America and France have always stood side by side, supported one another, helped one another, fought for each other's freedom."

Yes, quite a change in tone from that of the last 50-60 years, I think you'd agree. I didn't go along with all the French bashing of the past few years in particular because I kept saying one day there will be a change in leadership, just as there was in Germany in terms of a leader more to our liking.

Italy / Romania: Tensions between these two continue to rise, despite the efforts by both prime ministers to defuse them, over the issue of illegal immigrants flocking to Italy and some high- profile criminal cases, which in turn led to Italy's new rules allowing swift deportation for those deemed to be a threat to public safety.

Belgium: It is now 150 days and counting that Belgium has been without a government because the parties can't agree on a coalition arrangement, with the country remaining deeply divided between the Dutch-speaking Flemings and French- speaking Walloons. There was a time when this would have been cause for war.

The Vatican: Pope Benedict XVI met with Saudi King Abdullah in the first official meeting between the Pope and so prominent a Muslim leader from the Middle East, the king being the guardian of the two holy cities of Mecca and Medina. The 30-minute exchange was described as "cordial."

Dow Jones -4.1% [13042]
S&P 500 -3.7% [1453]
S&P MidCap -2.8%
Russell 2000 -3.2%
Nasdaq -6.5% [2627]

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