McCain Campaign in Disarray

Today’s news that the McCain campaign was unable to settle on any economic plan is the latest evidence that the campaign is in utter disarray. To catch Sen. Obama at this point would surpass the Bad News Bears or even the Boston Red Sox. If misery loves company, they might want to spend some time with the Chicago Cubs in their respective off seasons…

Presented with 30 options for new economic measures, Sen. John McCain (R-Ariz.) has – at least for now – chosen none of them.

His campaign had been planning to roll out new proposals this week that would be aimed at restoring confidence in financial markets and encouraging investors to return…

But when the meeting ended, so did plans for a new economy push. The campaign now says no new policy announcements are planned. Participants in the meeting refused to say what happened.

“We’re locked down,” said one official.

His advisors surely understand that one of the biggest drags on our economy is the corporate tax code (and to a lesser extent, policies that distort the relative values of residential housing, medical benefits, astronomical executive compensation, etc.). Our biggest concern is that a sophomoric understanding of economics and finance is at work here, and that Sen. McCain is unwilling to talk up corporate tax cuts lest they be associated with executive compensation–when in reality, they are two very different things, with very different effects on domestic investment and employment.

URLs:

http://www.politico.com/news/stories/1008/14508.html 

NY Post: “An Obama Panic?”

The NY Post carried an op-ed by CNBC commentator Charlie Gasparino entitled "An Obama Panic?". It’s a partisan piece in a partisan paper, but raises some important concerns that we’ve been attentive to since 2007. It also echoes concerns of many CEOs that we alluded to in a recent post:

…if [Obama] governs like a liberal ideologue – with a belief that the government that works best is the one that’s biggest and raises taxes the most – he won’t even have to work hard to get his way. House Speaker Nancy Pelosi and Senate Majority Leader Harry Reid won’t stop him…

And the markets know this – even if pundits (even many of the financial ones) refuse to face it.

No one can blame the faltering stock market solely on Obama’s tax plans or McCain’s own inanity on economic issues. But stock prices reflect current market conditions plus best guesses of what’s coming down the road. And I keep hearing nervous traders and investors talk about "a lack of leadership from Washington."

On the Sen. McCain alternative:

…McCain hardly instills confidence among the Wall Streeters I speak to. Why has his campaign spent the last week focusing on Obama’s friendship with former terrorist William Ayers – when it should be hitting Obama’s blind loyalty to policies that bring together the worst elements of Herbert Hoover and Jimmy Carter?

That assessment of Sen. Obama’s policies is a bit harsh, and as Gasparino admits, we don’t yet know how he will govern (and if Congress were controlled by the Republicans, we would view an Obama presidency favorably). However, his aspersions are an accurate description of the 110th Congress, in our view. We maintain a laundry list of federal policy directions, and since 2007, the directions have become rather worrisome. Here’s a sampling: expiration of the 2003 tax cuts (i.e., a large net tax increase); Rep. Rangel’s corporate tax ‘reform’ that would both broaden the tax base AND raise the effective tax rate; threats to rescind corporate LIFO accounting at a time when global inflation was making itself apparent for the first time since the 1970s (LIFO accounting was introduced to help corporations deal with the negative tax effects of inflation); windfall profits taxes against oil companies; punitive threats against corporate inversions (locating corporate headquarters in lower tax jurisdictions) and transfer pricing (taking accounting advantage of business activities in lower tax jurisdictions); impotent fiscal "stimulus" plans and higher budget deficits; draconian (rather than well designed) energy mandates; ostracism of any point of view calling the climate change (ex-’global warming’) hypothesis and most appropriate policy measures into question; anti-business labor and health care policies; and more recently, threats to undermine defined contribution plans (interestingly, ERISA was also born out of the economic turmoil of the 1970s) as well as calls to re-regulate everything because deregulated free market enterprise has proven to be such a dismal and obvious failure (that, despite the fact that it’s working wondrously in many parts of the world, and despite the fact that every point of this crisis can be tied in some way to poorly designed public policies in the U.S.).

Gasparino’s assessment of the McCain campaign’s tactics is absolutely spot on however. Sen. Obama and the current Congress should be extremely vulnerable on these counts, but neither Sen. McCain nor Gov. Palin are well suited to the task. Had their campaign realized the importance of these issues earlier on, they could have been better suited to address them now. And as with Sen. Obama, no one really knows how effectively Sen. McCain would govern on economic issues. For example, Sen. Lindsey Graham claimed this weekend that McCain was going to argue for lower capital gains and dividend taxes. These are fine in isolation, but they are utterly foolish when looking at the financial (and coming economic) crises in total. In the coming days or weeks, we will try to issue a piece that explains why. For now, we’ll just point out that genuine corporate tax reform is the right place to focus, and also distortions inherent in our tax code. Neither candidate understands these areas. For example, McCain proposes that the government become the country’s mortgage bank, while Obama proposes a steeper tax break on mortgage related interest. Both of these would worsen the distortionary bias towards debt-financed residential real estate that helped get us into the current mess!

The bottom line? The best that markets and the economy can hope for is a political arrangement at the federal level that does the least damage. In other words, there is absolutely nothing to be optimistic about. The best that can be hoped for is to be pleasantly surprised once in awhile. No wonder markets have been showing a strong streak of pessimism since 2007.

URLs:

http://www.nypost.com/seven/10132008/postopinion/opedcolumnists/an_obama_panic__133374.htm?page=0 

http://www.symmetrycapital.net/newsandviews/newsandviews/2008101035.html 

CEOs: Obama = “Disaster”

Interesting results from a survey of 751 chief executives–neither presidential candidate is viewed very favorably on economic issues, which we would agree with. But 74% of them agreed with the statement that Senator Obama would be a "disaster" for the economy! Wow…

John McCain is the hands-down preference for president among chief corporate executives, according to a recent survey by Chief Executive magazine. Democratic hopeful Barack Obama fared miserably in the survey which showed a 4 to 1 preference for the Arizona senator.

In fact, 74 percent of the 751 CEOs surveyed believed Obama would be a disaster for the country.

McCain didn’t get overall high marks, however. According to the survey, McCain rates only a B minus grade. He got high marks for foreign policy and defense, but only a C plus on energy, education and environment.

We planned to post an observation here regarding the three week market meltdown and whether it can be attributed to any degree to Sen. Obama’s rise to near electoral certainty (based on the electoral college outlook). Obviously, that’s not the only factor, nor is it the primary one. But policy expectations matter to asset prices, and Sen. Obama’s campaign promises and rhetoric do not promise to be kind to public equity capital (to be fair, we think he would be a very effective President if Congress were not under full Democrat control).

To this point, the stock market has seemed to believe that Sen. Obama would be the second coming of President Carter, which is not a bad comparison policy-wise. However, yesterday’s closing decline seemed to put us into FDR/Herbert Hoover territory. And if we string together five or more of these 5-7% down days, we’ll eventually be discounting the arrival of Joseph Stalin in the White House. Reasonable minds should be able to agree that this is a preposterous notion, however negatively you might view a President Obama’s economic policies.

URLs:

http://blogs.bnet.com/ceo/?p=1418&tag=nl.e713 

A Small Dose of Good Medicine

There’s nothing funny about the credit bubble, the financial crisis, the economic contraction, or the market meltdown. But humor is one of the best antidotes for stress, and here’s a small dose–"Strategery Capital Management, LLC":

Strategery is a unique hedge fund.

It is the largest in the world, with expected initial capital of $700 billion. It has a free and unlimited credit line should it need more. It has no fixed mandate, though it is expected to initially focus on mortgage-backed securities. And it is the only fund backed by the full faith and credit of the U.S. Government.

Strategery is a way for you to be more patriotic. Supporting this fund is an American duty. Criticizing this fund or any of its associated legislation or regulations may be subject to civil and criminal penalties.

We hope no one mixes up our two firms…

(Link via Poor and Stupid) 

IMPORTANT DISCLOSURE: Strategery Capital Management, LLC is not even a real entity, never mind a hedge fund!!! Symmetry Capital Management, LLC (our firm) does not currently offer private placement services for hedge funds or any other entity. This blog post is not an offer to engage in a private placement, nor is it an offer to buy or sell any security public or private. It is an attempt to make you laugh, and nothing more!!!!

URLs:

http://psychcentral.com/lib/2006/the-healing-power-of-humor/ 

http://strategerycapital.com/our-team 

CFO: U.S. Financial Superiority at an End?

Here’s a refrain that echoes observations expressed in some of our recent posts:

…America’s biggest global banks, desperate to rebuild capital ratios, are surviving on life-supporting cash infusions from sovereign wealth funds. Huge chunks of the once-vibrant securities markets in the United States, such as collateralized loan obligations and asset-backed mortgages, are moribund. And prominent international bankers, like HSBC group chairman Stephen Green, are declaring the end of Wall Street’s "center of the universe" status.

The numbers speak volumes. The combined domestic market capitalization of Nasdaq, the New York Stock Exchange, and the American Stock Exchange ($18.2 trillion as of last June) accounted for just 35 percent of the total on exchanges worldwide. That’s down from 52 percent in 2001, according to the Committee on Capital Markets Regulation (CCMR), an advocacy group. While the market capitalization of exchanges outside the United States has grown 22 percent since 2002, U.S. exchanges have seen their collective market cap rise only 9 percent. And today, when foreign companies go public outside their home countries, they choose the United States much less frequently.

These are inevitable trends, but their speed since 2001 is disconcerting. It’s also not surprising. Policymakers need to rethink current approaches to supporting U.S. competitiveness. We’ve leared that unbridled or poorly designed deregulation won’t cut it, but that in no way means that unbridled and poorly designed "re-regulation" will. Unfortunately, that’s where the pendulum is currently swinging, and the Presidential debate last night was dishearteningly devoid of constructive ideas for repairing American competitiveness. In fact, we don’t expect to see that occur for another 4 to 8 years.

URL:

http://www.cfo.com/printable/article.cfm/12294789/c_12323697?f=options

CFO.com: Fair Value Fight

Interesting story on IASB reactions to the storm that’s been brewing around fair value accounting and FAS 157: "The Global Fair Value Fight"

URL:

http://www.cfo.com/article.cfm/12371585?f=alerts

Karabell: America and the New Financial World

River Twice president Zachary Karabell penned a compelling op-ed for the WSJ today. Some important passages follow (emphases added), and those who follow our writings should hear some familiar themes. 

First, Karabell observes that the U.S. now risks following a path similar to Great Britain’s in the 20th century, something we termed ‘Superpower Past Tense’ in 2006, and an outcome that seems more likely to us now than it did then:

In 1945…the United Kingdom emerged militarily victorious only to see itself economically exhausted…unable to find capital and on the verge of collapse. It had nowhere to turn but the U.S….The U.S. is not yet in the position of Great Britain, and our creditors in China are not yet as we were then. But absent a more humble and realistic attitude toward capital in Washington, that is the path we’re headed down… 

Second, he observes that the 1970s were a period of relative decline, especially in manufacturing, due to anti-competitive practices and a suboptimal policy mix (which in our view, along with other factors, accelerated the social breakdown of some regions and communities of the U.S.):

What is happening to finance today is similar to what happened to manufacturing beginning in the 1970s…Germany and Japan began to exert themselves as manufacturing titans. So did Taiwan, Singapore, Korea and others…

Karabell doesn’t refer to this explicitly, but we believe it’s critical to understand the role that the domestic policy mix played in accelerating the loss of manufacturing in the 1970s–uncompetitive taxes, tariffs and regulations combined with easier monetary policy were the wrong way to deal with the crisis then, and are the wrong way to deal with the financial crisis now–though we clearly appear to be headed in that direction.

Third, he observes that the financial world is becoming increasingly less U.S.-centric:

Few major deals were brokered without involvement from a U.S. bank or access to Wall Street financing. That is now at an end…for two reasons. One is structural. There are now vibrant economies that don’t depend on the U.S., are not heavily levered, and have a burgeoning…middle class. But is is also at an end because those newly affluent regions of the world do not find the U.S. a welcoming home for capital…

Fourth, Karabell articulates why he believes this is happening:

Uncertain growth for the United States is one reason. But the nature of the American regulatory regime is also to blame. Sarbanes-Oxley and the Patriot Act…combined with a tax code that places a heavy burden on corporations doing business in the U.S. has meant that…there is less and less inclination…to place…capital in the U.S.

In addition, the regulatory requirements of listing a company in the U.S. have led many companies to look to other markets and other exchanges for financing, hence the boom of financial centers such as Hong Kong, Dubai, and even London…

And finally, he observes what this means for policymakers, where we appear to be headed, and what we must do to change course: 

…The U.S. government can no longer dictate to global capital. Once, when the U.S. was the engine of global growth, when the world needed Wall Street for funding, capital could be taxed and controlled by the fiat of the U.S. government…

The current debate in Washington gives no indication that this reality is understood. Both sides of the aisle are susceptible to a false sense of American economic sovereignty…[when] in reality there is increasingly less inclination and less need for the world to go either to Wall Street or to Main Street…the crisis hitting Wall Street is leading the rest of the world to form bonds that bypass the U.S.

…we must understand…that attempts to unilaterally force capital to stay here will only lead to its continued flight…A more secure domestic capital base depends on the U.S. being seen as a desirable place for investment… 

Good stuff. 

URLs:

http://online.wsj.com/article/SB122325757745406687.html 

http://www.symmetrycapital.net/idlespeculation/2006121502.pdf 

http://www.symmetrycapital.net/idlespeculation/20080925_policy_mix.pdf 

Fed Cuts Rates by 200 Basis Points!

OK, not officially. Instead, the Federal Reserve has begun paying interest on excess reserves that banks have on deposit with it. But that has a real impact on the cost (and existing supply) of money, and based on recent money market and inflation data, the cost of money is as low as it has been since the 1970s. Here’s how we arrive at that conclusion:

The Fed announced that it will now begin paying interest on banks’ reserves at a rate of 75 basis points below its fed funds rate target. Today, that equates to interest of 1.25% (2% – 0.75%= 1.25%), and can thus be viewed as a 125-basis point cut in its nominal rate target (banks can borrow from the Fed at 2%, and lend to the Fed at 1.25%, for a net funds rate of 0.75%).

However, it’s important to look at the effective fed funds rate, which is the actual market price of money, based on the Fed’s attempts (or lack thereof) to keep the interbank rate close to its nominal target. The effective fed funds rate as of October 3rd was 1.10%; on October 2nd it was as low as 0.67%. The fact that the effective funds rate is well below the Fed’s target of 2% indicates that (a) banks have excess liquidity but are keeping it on deposit with the Fed rather than creating new credit or lending to other banks, and (b) the Fed is unwilling to extinguish excess monetary reserves under current financial and economic conditions. Using the lower effective rates of last week, an interest payment of 125-basis points against an effective fed funds rate of 0.67% or 1.10% would equate to an effective funds rate between -0.58% and -0.15% (0.67% – 1.25% = -0.58%, and 1.10% – 1.25% = -0.15%).

Furthermore, those are only effective nominal rates, unadjusted for inflation. Although recent market indicators show that the level of inflation is expected to fall, perhaps to a range as low as 1.0-1.5%***, the effective funds rate is still below zero. Conservatively, the real effective cost of money could be -0.25% (2% fed funds, minus 1.25% interest, minus 1% inflation = -0.25%). More aggressively, it could be as low as -1.15% (1.10% effective funds rate, minus 1.25% interest, minus 1% inflation = -1.15%). And if our prediction of long term inflation in the neighborhood of 3% or more is accurate, then the real effective cost of funds could be as low as -2.25% to -3.15%. And as we’ve pointed out previously, a negative cost of money is territory that the Fed has only visited twice in the last thirty years: during the 1970s, and in the prior Fed easing cycle. Granted, if inflation rates fall to zero or less, then the Fed’s current stance could turn out to be appropriate–but only if it stands ready to reel in a good deal of liquidity, once the velocity of money picks back up.

*** For example, subtract the current yield on 10-year Treasury Inflation Indexed Securities from the current yield on 10-year Treasury notes (Bloomberg and other websites update this information daily).

URLs:

http://www.federalreserve.gov/newsevents/press/monetary/20081006a.htm 

http://www.federalreserve.gov/releases/h15/update/ 

Roubini: A Disgrace and a Rip-Off

Congressional Democrats (and others, to be fair) have frequently referred to Fed Chair Bernanke’s expertise on the Great Depression as an argument for the proposed bailout plan from Treasury and Congress. Bernanke is a smart guy and an accomplished academic, but in the crisis at hand (which we recently argued is not a repeat of the Great Depression), we place more credence in economist Nouriel Roubini, who has been calling the credit crisis for some time. According to Roubini, the rescue plan as currently conceived is a "disgrace" and a "rip-off":

…the claim by the Fed and Treasury that spending $700 billion of public money is the best way to recapitalize banks has absolutely no factual basis or justification. This way of recapitalizing financial institutions is a total rip-off that will mostly benefit – at a huge expense for the US taxpayer – the common and preferred shareholders and even unsecured creditors of the banks. Even the late addition of some warrants that the government will get in exchange of this massive injection of public money is only a cosmetic fig leaf of dubious value as the form and size of such warrants is totally vague and fuzzy.

So this rescue plan is a huge and massive bailout of the shareholders and the unsecured creditors of the financial firms (not just banks but also other non bank financial institutions); with $700 billion of taxpayer money the pockets of reckless bankers and investors have been made fatter under the fake argument that bailing out Wall Street was necessary to rescue Main Street from a severe recession. Instead, the restoration of the financial health of distressed financial firms could have been achieved with a cheaper and better use of public money.

This makes us more confident in our assessment that the electorate (and the House members who listened to them) are "smarter" than the group of people who drafted the plan. Something needs to be done, but doing it poorly could be worse than doing nothing, as painful as that might be. Michael Lewitt apparently agrees with that argument. He echoes the advice we offered in a client note this morning, which is to breathe deeply and relax–the best thing to do in a panic. He also garners our admiration by quoting Thomas Kuhn.

On a side note, we also agree with him that the income gap (more properly the compensation gap) is a legitimate social concern. But we disagree with the rather simple prescription of higher marginal tax rates as the best way to rein it in. Consider that the gap accelerated in the 1990s following legislation that capped the deductibility of executive salaries at $1,000,000. That led to the expanded use of derivative compensation, which made the leverage gimmicks that Lewitt describes almost inevitable. He sounds to me like a Bill Gates or Warren Buffet, someone who seems to believe that, because they are willing to endure a much higher marginal tax rate, everyone else in their income bracket would be too. When the total tax burden on income is accounted for, it becomes exceedingly unlikely. That said, we think the income tax is the least of our tax code concerns. Complete overhaul would be nice, but short of that, we need to focus on the anti-competitive and distorting nature of corporate taxes.

URLs: 

http://tinyurl.com/RGE08093001

http://www.investorsinsight.com/blogs/john_mauldins_outside_the_box/archive/2008/09/29/haste-makes-waste.aspx

A Few More Dominos Fall

Two more financial institutions across the Atlantic–U.K. mortgage lender Bradford & Bingley, and continental bank Fortis–tumbled over the weekend. And today, Wachovia is apparently the next casualty in the U.S., and is reportedly in talks with Citigroup, federal regulators, and the FDIC. On top of last week’s demise of mortgage-laden Washington Mutual, this is quite a string of dominos. However, the fact that a major money center back has now tumbled makes us think that we’re finally starting to see the beginning of the end.

The global economy still faces a long, drawn-out delevering, and it’s very likely that growth in the U.S. and Europe will be low or negative, and that unemployment will rise.

URLs:

http://biz.yahoo.com/ap/080929/eu_britain_bradford_bingley.html 

http://biz.yahoo.com/ap/080929/eu_netherlands_fortis.html 

IMPORTANT DISCLOSURES:  The foregoing blog post is informational and entertainment purposes only. It does not constitute in any way a recommendation or an offer to buy or sell any security, or to engage in any particular investment strategy. Clients and/or principals of Symmetry Capital Management, LLC may hold long or short interests in any of the securities mentioned.

Symmetry Capital Management, LLC participates in the Amazon Associates program. If you follow a link from our site to a product carried on Amazon.com, and you make a purchase, we earn a 4% referral commission.