Monday, September 29, 2008

Blame the Feds, Not Wall Street

Given the unprecedented financial crisis and the government's proposed $700 billion so-called bailout, I have to say I am a little sick of hearing how greedy Wall Street bankers are to blame for getting us into this mess. I agree some of them do bear some responsibility. I also agree that many CEOs are grossly overpaid. (So are many professional athletes for that matter.) Yet the fact is that the government bears at least some of the blame for the current crisis.

Many years ago (circa 1993), I listened to a lecture delivered by a then prominent Federal Reserve governor. He argued that banks had to be pressured to lend money to those who were otherwise not creditworthy. The government in its wisdom had decided that home ownership was a good thing and wanted to see more of it. It is often argued that neighborhoods are safer, cleaner, and better kept when a large number of people own (rather than rent) the homes in which they live. The government wanted to promote home ownership so it pressured lenders to make mortgages available to those who did not qualify under traditional standards.

The New York Times (not known for espousing a conservative point of view) published a prescient article in 1999 (that's before George W. took office) exposing all this. Steven Holmes wrote, "Fannie Mae...has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people..." The article then went on to predict the current crisis. It warned, "In moving, even tentatively, into this new area of lending, Fannie Mas is taking on significantly more risk, wihch may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980s."

I thank Cesar Chekijian for bringing this article to my attention. Click below to read the article's full content.

Fannie Mae Eases Credit To Aid Mortgage Lending

Monday, September 15, 2008

The Perils of Long-Term Investing

The following commentary is extracted from a special report sent to subscribers of the Forbes Special Situation Survey.

Lehman Brothers was selling for more than $85 per share in early 2007. American International Group (AIG) was around $70. Both companies were thought to be among the bluest of the blue chips. So much so, that Dow Jones even added AIG to its prestigious Industrial Average in April 2004. Yet over the course of just a few short months, both Lehman and AIG have been decimated. Lehman is now a penny stock seeking bankruptcy protection. AIG is scrambling to stay alive.

Yet Lehman and AIG are not the only “great” long-term investments that have since collapsed. For years, General Motors, Ford, Fannie Mae, and Freddie Mac were included in almost all long-term oriented portfolios. Fannie Mae, for example, generated a 25% annualized return for the 20 years ending in 2000—and that does not include dividends. Unfortunately, those who bought the stock back then and are still holding it, are now sitting on a loss. As impossible as it is to believe, Fannie Mae is worth less today than it was even 30 years ago!

Warren Buffett is clearly one of the greatest investors of all time. He is famous for avoiding risk and for having a long-term buy-and-hold orientation. Like Buffett, many investment professionals are also convinced that buy-and-hold is the best way to go. Yet recent events should make all investors question this advice. Buying, after all, is just half the story. Successful investing also requires selling. And despite his reputation, even Buffett engages in short-term trades from time to time. PetroChina and Pier 1 Imports provide just two recent examples.

There is no doubt that a buy-and-hold approach can be profitable. After all, those who buy and rarely sell minimize trading costs. They also minimize taxes because, if they do not sell, they do not realize their gains. However, I have seen too many investors get burned by holding onto a stock too long simply because they wanted to avoid paying taxes. Recent events should convince even the most diehard buy-and-holders that sometimes there is fate worse than taxes. (But, of course, not worse than death.)

It is extremely important to keep an eye on intrinsic value. If a stock is no longer undervalued, it makes little sense to keep holding it. In hindsight, I have gotten out of many positions much too soon. However, I would rather move on to a stock I believe is undervalued than take the risk of holding on to one that is becoming overvalued.

Tuesday, September 09, 2008

Whether Or Not the Facts Change

While preparing for an MSNBC interview recently about the presidential candidates' energy plans, I was struck by how similar they are. They are both in favor of reducing carbon emissions, they both want more wind and solar power, they both favor clean coal technologies, they both like cap-and-trade systems to reduce greenhouse gases, and they both want to see more nuclear power. Of course, they differ on degree and implementation on some of these issues. John McCain would rely on market forces and incentives. Barack Obama prefers more government mandates.

Until very recently, one critical difference was where they stood on offshore drilling. Obama was opposed to it. McCain is in favor. Obama stressed that oil companies already hold leases to 68 million acres of land and 40 million acres offshore. He said he would force them to drill in these areas or lose their rights to do so. However, McCain thinks it is better to let oil companies drill where the oil actually is. He has called for lifting federal restrictions on drilling in the Outer Continental Shelf.

But now Obama has changed his tune. Last weekend, he indicated a willingness to compromise on offshore drilling. Some have criticized him for changing his mind. I applaud him. Obama is moving from idealism to reality on this and other key issues. Even the Wall Street Journal applauded Obama this morning for backpedaling on his threatened tax increases. Apparently his advisors have told him that tax increases (even if they are intended to hit only the rich) can indeed slow the economy. That's not a particularly good idea when unemployment is rising and recession is a real possibility.

John Maynard Keynes once said, "When the facts change, I change my mind." Facts haven't changed, but it is encouraging to see that Senator Obama shows a willingness to change his mind as he becomes more familiar with the facts.

Wednesday, September 03, 2008

McCain or Obama: Who is Better for Taxes?

The following commentary is from the Sept. issue of the Forbes Growth Investor:

The stock market was open for trading last month, but as a former track & field athlete, I have to admit that the Olympics monopolized my attention. Usain Bolt was magnificent, as was the entire contingent of Jamaican sprinters. With a population of just 2.8 million, this small island country managed to win 11 medals on the track—six of them gold.

During the commercials, however, I did notice that stocks were rallying. In fact, the S&P 500 gained 1.22% in August. This is better than it did every month so far this year except for April. At least some of August’s rally was due to the 3.3% preliminary GDP figure for the second quarter, which was announced on August 28. This number was much better than expected and significantly better than the 1.9% advance figure reported a month earlier. Because the preliminary figure is based on more complete data, investors can have more confidence in it. Although overall growth was certainly robust, it came primarily from importing fewer goods and services and exporting more. It turns out the weak dollar is having a much bigger impact on international trade than almost anyone expected. I hope Barack Obama is listening.

Personal consumption expenditures were also very strong in the second quarter. Unfortunately, this is not likely to be repeated during the third quarter because the tax rebate checks have been fully disbursed. Some economists are already calling for another stimulus package. You can put me in that camp. However, tax rebates won’t do the trick. Their impact is just temporary. Tax cuts are the way to go if you really want to boost the economy in a long-lasting manner.

Speaking of taxes, here is something to ponder. Is it possible that taxes could actually go higher in a McCain administration than in an Obama one? That certainly does not sound logical. After all, Obama has been threatening to raise taxes while McCain has been calling for tax cuts. Yet a Congress controlled by Democrats is not likely to help a president McCain reduce taxes. Instead, under McCain, Congress could very well let the Bush tax cuts expire, in effect, giving us a significant tax increase. However, with Obama in the White House, Congress will almost certainly deliver a package of tax hikes. Yet this option could be less onerous than an outright expiration of the Bush tax cuts. “You’re next stop: The Twilight Zone!”

Stocks also may have responded to the latest S&P/Case-Shiller figures on housing prices. As I discussed in last month’s issue, a bottoming out process is underway. Housing prices are still falling at an accelerating rate, but the rate of acceleration is beginning to stabilize. Because the Case-Shiller figures are delayed by almost two months, we could actually learn in October that August was not so bad. Furthermore, we have already seen an uptick in mortgage applications. Yet despite marginally better news in the housing market, Fannie Mae and Freddie Mac continue to get crushed. There is even talk that these mortgage giants will be restructured and equity investors will be wiped out completely. However, if these government sponsored entities survive, those who have the guts to buy now could eventually find themselves sitting on huge gains. While this is a distinct possibility, it is a much better bet that an American relay team will drop the baton in the next major track meet.