Friday, August 31, 2007

Jackass of the Day - August 31, 2007

"The program could play a very important role in saving from foreclosure American homeowners who have been taken advantage of by unscrupulous subprime lenders and brokers,"

Senate Banking Committee Chairman Christopher Dodd, D-Conn

And how will you tell them apart? Can you distinguish between greed and stupidity?

Quote of the Day - August 31, 2007

"It's not the government's job to bail out speculators or those who made the decision to buy a home they knew they could never afford,"

-President George W. Bush.

Thursday, August 30, 2007

The Market is "An Ass"

"If the law supposes that,' said Mr. Bumble, squeezing his hat emphatically in both hands, "the law is a ass--a idiot."

Charles Dickens, Oliver Twist

8/29/2007 4:34 PM EDT

Stocks in the U.S. were solidly higher Wednesday following a two-session selloff, as traders bid up equities amid hopes for a rate reduction.

The Dow Jones Industrial Average jumped 247.44 points, or 1.9%, to 13,289.29. The S&P 500 added 31.40 points, or 2.19%, to 1463.76, and the Nasdaq was better by 62.52 points, or 2.5%, at 2563.16

8/28/2007 4:30 PM EDT

Stocks in the U.S. fell hard Tuesday after the minutes from the last Federal Reserve meeting failed to give investors any firm indication that the central bank is considering lowering interest rates.

The Dow Jones Industrial Average plunged 280.28 points, or 2.1%, to 13,041.85. The S&P 500 lost 34.43 points, or 2.35%, to 1432.36, and the Nasdaq Composite was weaker by 60.61 points, or 2.37%, at 2500.64.

Monday, August 27, 2007

Festival of Stocks - #51

Check out the latest Festival of Stocks hosted this week by Dividends Matter

Average Joe has some good contributions and I urge you to take a look at:

Festival of Stocks #51

The home page of the festival is here at Festival of Stocks. If you write a related blog, and feel like hosting, then contact George and sign up.

The Housing Depression is not over yet - Part VI

The headline used by the mass media, burdened with an insatiable need to oversimplify everything they touch:

New-home sales rise 2.8% to 870,000 pace in July

Reason number 6 you should ignore the headline - price does not reflect concessions.

The Commerce Department reported a slight increase in the median price to $239,500.

Builders don't like to lower prices, they usually throw in free upgrades or give away consumer items to buyers. At this point in the cycle, they may have no choice since they have bills to pay, but the Commerce Department has no way to measure the concession and admits it in its survey documentation

"The sales price used in the survey is the price agreed upon between purchaser and seller at the time the first sales contract is signed or deposit made. It includes the price of the improved lot. The sales price does not reflect any subsequent price changes resulting from change orders or from any other factors affecting the price of the house. Furthermore, the sales price does not include the cost of any extras or options paid for in cash by the purchaser or otherwise not included in the original sales price reported."

The Housing Depression is not over yet - Part V

The headline used by the mass media, burdened with an insatiable need to oversimplify everything they touch:

New-home sales rise 2.8% to 870,000 pace in July

Reason number 5 you should ignore the headline - a very tricky formula or how statistics can lie.

Months' Supply

The months' supply is the ratio of houses for sale to houses sold. This statistic provides an indication of the size of the for sale inventory in relation to the number of houses currently being sold. The months' supply indicates how long the current for sale inventory would last given the current sales rate if no additional new houses were built.

Investors love this formula, but it can shift suddenly if there is a sudden move in either part of the formula.

The numerator is houses for sale, while the denominator is houses sold. The government reported that in July 2007, the months' supply was at 7.5 months based on a seasonably adjusted annual rate. This translates to 533,000 homes for sale and 71,000 homes sold.

The severe contraction in residential mortgage credit has been underway all summer, but reached its peak in earnest in August. Now when August sales are reported next month, the numbers will show the effect of that contraction. look for the numerator to rise sharply as unsold homes pile up, and the denominator to fall as many sales fell through due to unavailability of credit.

A 10% move up in the numerator, and a 10% decline in the denominator would cause the months' supply to rise to 9.17. A 20% move would result in a months' supply number of 11.25. the 9.17 number would be the highest since 9.4 in January 1991, while 11.25 would be the highest since September 1981. The highest ever recorded was 11.6 in April 1980.

There may be some shenanigans going on with this data as homes for sale, seasonally adjusted, has been remarkably stable the last year.

The Housing Depression is not over yet - Part IV

The headline used by the mass media, burdened with an insatiable need to oversimplify everything they touch:

New-home sales rise 2.8% to 870,000 pace in July

Reason number 4 you should ignore the headline - Revisions.

Once again from the Commerce Department Web site:

Historical Revisions

Historical revisions are quite extensive, ranging from -10.8% to -0.2%, with an average of -4.9%. Geographically, the West is the most volatile with a range of -20.1% to -2.0%. Now in case you forgot, the West was the only region to show growth in the report today. Here is the table:

Here is a real life example of the effect of these revisions. The Commerce Department also estimated today in its release that July 2007 new home sales were 10.2% below the July 2006 estimate of 969,000. The media ignored this number, and instead focused on the month-to-month “increase” of 2.8%.

The problem is that when the July 2006 estimate was released on August 24, 2006, the number was initially reported as 1,072,000, not 969,000. That is the effect of the "final" revision. in that case, 100,000 homes. Our conclusion then is that the so-called 2.8% month-to-month increase is nonsense since the June 2007 data will be revised substantially over the coming months.

Sunday, August 26, 2007

The Housing Depression is not over yet - Part III

The headline used by the mass media, burdened with an insatiable need to oversimplify everything they touch:

New-home sales rise 2.8% to 870,000 pace in July

Reason number 3 you should ignore the headline - Standard Deviation.

The range given for the data collected in the report is (+/-12.0%). In previous releases it has ranged as high as (+/-13.0%). The government itself admits that since the range encompasses zero then it is uncertain whether there was an increase or decrease during the month.

This raises the question that if the data is so unreliable and subject to revisions, why pay any attention to it except on an annual or even longer basis.

Saturday, August 25, 2007

The Housing Depression is not over yet - Part II

The headline used by the mass media, burdened with an insatiable need to oversimplify everything they touch:

New-home sales rise 2.8% to 870,000 pace in July

Reason number 2 you should ignore the headline - An easy compare.

The report stated that by region, sales rose 22.4% in the West to 213,000, rose 0.6% in the South to 492,000, fell 24.3% in the Northeast to 53,000, and fell 0.9% in the Midwest to 112,000. The entire increase, therefore, came from the Western region.

If you look deeper into the data you will find that the June 2007 number for the West was 174,000 home sold on a seasonably adjusted annual rate. This was an extremely weak month and was down from 209,000 and 203,000 in May and June 2007, respectively.

So basically, the entire rise in sales was due to this weak compare since every other region was flat or fell.

Friday, August 24, 2007

The Housing Depression is not over yet - Part I

The headline used by the mass media, burdened with an insatiable need to oversimplify everything they touch:

New-home sales rise 2.8% to 870,000 pace in July

Why should an investor should ignore this data?

Reason number one - new home sales are overstated during a down cycle.

How do I know this?

I read it on the Commerce Department web site and reprinted it below:


"The Census Bureau does not make adjustments to the new home sales figures to account for cancellations of sales contracts."

"The survey does not follow up in subsequent months to find out if it is still sold or if the sale was cancelled."

"Since we discontinue asking about the sale of the house after we collect a sale date, we never know if the sales contract is cancelled."

"If conditions are worsening in the marketplace and cancellations are high, sales would be temporarily overestimated."

Full Text

"The Census Bureau does not make adjustments to the new home sales figures to account for cancellations of sales contracts. The Survey of Construction (SOC) is the instrument used to collect all data on housing starts, completions, and sales. This survey usually begins by sampling a building permit authorization, which is then tracked to find out when the housing unit starts, completes, and sells. When the owner or builder of a housing unit authorized by a permit is interviewed, one of the questions asked is whether the house is being built for sale. If it is, we then ask if the house has been sold (contract signed or earnest money exchanged).

If the respondent reports that the unit has been sold, the survey does not follow up in subsequent months to find out if it is still sold or if the sale was cancelled.

The house is removed from the "for sale" inventory and counted as sold for that month. If the house it is not yet started or under construction, it will be followed up until completion and then it will be dropped from the survey. Since we discontinue asking about the sale of the house after we collect a sale date, we never know if the sales contract is cancelled or if the house is ever resold.

Therefore, the eventual purchase by a subsequent buyer is not counted in the survey; the same housing unit cannot be sold twice. As a result of our methodology, if conditions are worsening in the marketplace and cancellations are high, sales would be temporarily overestimated.

When conditions improve and these cancelled sales materialize as actual sales, our sales would then be underestimated since we did not allow the cases with canceled sales to re-enter the survey. In the long run, cancellations do not cause the survey to overestimate or underestimate sales."

Read the second reason you should ignore this data.

Read the third reason you should ignore this data.

Read the fourth reason you should ignore this data.

Read the fifth reason you should ignore this data.

Read the sixth reason you should ignore this data.

Monday, August 20, 2007

Sunday, August 19, 2007

Hedgehog Part Two?

There is a hedge fund manager named Timothy Sykes. He is the subject of a television show called Wall Street Warriors, which details the travails of several emerging figures in the financial markets.

Wall Street Warriors

He and I couldn't be more different in our investment philosophy. He is a short-term trader with an investment horizon of, at most, less than a day. I sometimes watch a stock for a year before I buy it. I read 10-K's carefully, almost obsessively, while I doubt that Timothy even knows what EDGAR is, much less where to find the web site. The one thing we have in common is that we both started up a Hedge Fund from scratch, using mostly our own funds.

Tim has written a very readable book outlining his start in the market, and how he got to where he is today. Starting with only $12,000, he tells of his beginning in High School and College, trading in his dorm room, through his current job at Cilantro Capital LLC, his own shop.

Tim sent me an advance copy and I would recommend getting it. Tim tells it like it is. He is direct and to the point. If the girls at Tufts University are ugly, then he's going to tell us.

He has a very adaptive evolutionary style of trading. He started with Penny Stocks, and when that stopped working, he moved on to the OTC Bulletin Board, and then to NASDAQ. When the bubble burst in 2000, he moved on to short selling.

I learned a lot from his tales of marketing his hedge fund to investors. I am about to go through a similar grind, and it is not something I am looking forward to, as I would rather be researching stocks, but it is part of what I have to do.

The book is self-published and I would imagine that it will be available on his web site here:

Timothy Sykes

Thursday, August 16, 2007

Predictions for the Crisis

In the spirit of Byron Wien, I give you my humble predictions for the current financial crisis:

1) One or more major publicly held homebuilders will go into Chapter 11 bankruptcy, despite all we heard about how they were better prepared for a downturn this cycle.

2) The Fed will make at least one inter meeting emergency rate cut of 25 basis points, more to restore investor confidence than in any hope of having the practical effect of jump starting the credit markets. The stock market will surge, and have one of the biggest percentage gains in history, as short sellers scramble to cover.

3) Berkshire Hathaway and Warren Buffett will finally use that powder he has been saving all these years and step in and make an investment in a major brokerage firm or bank and prevent it from following Drexel Burnham and the Bank of New England into oblivion.

4) Domestic GDP growth will slow down to recession or near recession levels for at least a quarter. Due to the lag effect of financial data being reported, this will not be revealed until after the crisis ends.

5) A major marquee hedge fund will experience a "run" by investors and do an emergency halt to all redemptions, invoking an obscure clause buried deep in the offering memorandum. Investors will rant and rave but the agreement is ironclad and proves why the best lawyers in the world are worth a $1000 an hour.

6) The wheels will fall off the Chinese stock market and the miracle of Chinese "growth" will grind to a halt when U.S consumer demand limps along without the tailwind of cash out home refinancing and the psychology of stock market wealth effects.

7) A shocking drop in either new home sales or housing starts triggers a new sell off in the S & P Homebuilders (XHB) SPDR just when everyone thought that the industry had bottomed.

8) The National Association of Homebuilders, the mouthpiece for the industry, finally admits that - yes - it is possible for home prices to decline on a national basis.

9) Commercial Real Estate will begin its own down cycle, as lenders get stingier, and everyone finally realizes that overly optimistic estimates of NOI growth are no substitute for common sense.

10) Oil and other commodities will gap down in price as demand falls off sharply, and the recent classic book "Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy," will start showing up in the bargain bin section of the book store right next to:

"The Great Reckoning: Protecting Yourself in the Coming Depression" (1992),

"Dow 36,000: The New Strategy for Profiting From the Coming Rise in the Stock Market" (1999)

"Deflation: Strategies for Building Wealth in the Coming Wave of Deflation" (1999)

and my last prediction -

10) The investment staff of the Retirement Systems of Alabama finally convinces their boss to sell 55 Water Street (this one is an inside joke, so sorry if you don't get it.)

Wednesday, August 15, 2007

Can an Index go to Zero?

ETF's have been all the rage the last few years, and there are something like 500 of them out there now, some broad based and others covering really obscure sectors and niche industries. I found one the other day called the iShares FTSE NAREIT Mortgage REIT Index Fund. The symbol is REM.


It is already down 48% from its peak in June, but taking a look at the holdings, it is conceivable that it could go much lower. Maybe not zero, but a lot lower than $26 per share.

Top Holdings


The Panic of 2007

Is it possible that we are on the verge of a full blown financial panic? I remember studying about the periodic financial panics that would hit the United States economy every generation or so. They seemed quaint and remote and not something that could happen in the age of deposit insurance, the Federal Reserve and the heavy hand of government intervention.

There have been so many financial panics in our history that they had to name them after the years they occurred. The panics of 1893, 1907, etc. Most of these panics involved banks, but the concept is the same. They are characterized by lack of confidence in our financial system, with a sudden shock to that system being the accelerant that sparks the conflagration or panic. And then a rush for the door, as everyone tries to get their money out first.

Let's look at what is occurring in our financial system:

1) Credit for purchasing residential real estate is drying up. It's no secret that sub prime and Alt A lending is essentially unavailable, but now it is spreading to prime lending and jumbo mortgages. If you think that jumbo mortgages is an issue only for rich people then you should take a look at the average home price in California, where you need a jumbo mortgage to buy a shack. This credit contraction will accelerate and prolong the housing downturn even further. This, of course, will have repercussions in the economy.

2) A money market fund just "broke the buck" or would have, if it let investors redeem their money. This is the first time that I can remember that this happened since Merrill Lynch, Pierce, Fenner and Smith pioneered these in the early 1980's.(Yes, I purposely used the former name to show how old I am.) Most non-professional investors assume that money market funds are "cash," and they are not.

3) We may be on the precipice of major redemptions in hedge funds, which will trigger another leg down in the equity financial markets. Think of all the money that has flowed into hedge funds the last decade, and then consider what would happen if that river reversed. Now if you think this is about a bunch of spoiled hedge fund managers whining because they have to sell their third vacation home, you are wrong. If I remember my numbers correctly, around 40% of Americans are invested in stocks.

4) We have a hyperactive media where every bit of information is available instantly, and then magnified tabloid style. Don't underestimate the effect that the media can have in creating panics. They are at the center of all of them if you look back at your high school history book.

The last recorded financial panic was in 1910, but of course we have had them since then but they stopped calling them "panics" and started using other terms for them. I hope that this doesn't happen in my lifetime, but I wonder sometime what really can be done to stop these events. After all, by definition, they are "panics," implying uncontrollable events.

Thursday, August 9, 2007

A Storm Coming?

Here's what people should be thinking about - the New York Federal Reserve did a study in May 2002 called Credit Effects in the Monetary Mechanism. This study examined the effect of changing loan standards or as they put it "do bank lending standards "matter" for the economy—that is, do standards affect loan growth and, more broadly, GDP?....also explore whether credit standards are independent of the monetary policy process or, alternatively, a channel through which policy affects spending and the real economy." They used the Senior loan officer opinion survey for data in this study.

Fed Study

So what does all this mean? Two things - when banks have tougher lending standards does it effect the economy, and second, does it matter what the Fed does to help? The conclusion:

"First, changes in credit standards have a significant effect on both loans and GDP. Second, credit standards appear to be largely independent of the monetary policy process, showing little sensitivity to changes in the Federal Reserve's key policy instrument, the federal funds rate."

They get a little more specific here:

"An unanticipated 10 percent net tightening of standards in the augmented model causes output to fall 0.5 percent at its trough and loans to contract more than 2 percent."

A 10 percent net tightening is not a significant tightening. Using the 2001 recession as an example, net tightening in commercial real estate loans moved 41.2 percent, while net tightening in commercial and industrial loans moved 54.3 percent.

Here's a chart from the study showing the net moves over time.

So when Helicopter Ben says that there is no evidence that the recent credit market turmoil is affecting the economy, he's right because it has only been three weeks since it started. Let's hope the Fed keeps its eye on this measure.

Don't Get All Worked Up

Blackstone raises record buyout fund say the headlines all over the financial press. Does this mean the music is not stopping? This fund has been in the works for two years, according to the Wall Street Journal and has already spent or committed two thirds of its capital. This news may not be as forward looking as everyone seems to think.

Tuesday, August 7, 2007

Another Leg Falls

How many legs do we have propping up the Stock Market? I've lost count. We all know that the Private Equity buyout "leg" is history. The latest one to collapse is the buyback stock craze, which has reduced the supply of stock the last few years. Once again a chart from The Wall Street Journal says it all:

Public companies have been levering up to buy back stock, most of them due to pressure from idiotic hedge fund managers who have apparently never lived through a business cycle. I have this picture in my head of the typical company in a meeting with its bankers to renegotiate its covenants during the next business cycle contraction. The CEO says something like this: "We don't know what happened, our largest shareholder told us this was the ideal capital structure." The bankers just stare back at them, their mouths open, unable to formulate a response to this stupidity.

This is now coming to an end as lenders tighten standards and credit rating agencies actually start doing their jobs. Now many legs does a table need to stay standing?

Pushing on a String?

There is an old expression that used to be heard a lot in connection with Federal Reserve monetary policy. It is the term "pushing on a string." So what does it mean? Well, take a string and thrown it down randomly on a table and then try pushing it. What happens? Nothing.

The market is convinced that the Federal Reserve will come to the rescue like Greenspan did in the old days and change the wording of its statement today, or in a best case scenario actually cut rates. But does it really matter what they do? They say a picture is worth a thousand words so look at this chart from The Wall Street Journal today.

The yield on the ten-year declines 40 basis points yet mortgage rates increase 40 basis points. Now granted, the Federal Reserve doesn't control long-term rates, only short-term rates, but the scenario here could still hold. If banks contract credit, then it doesn't matter what the Fed does. Also, keep in mind that this divergence in loan spreads is happening in the business loan market as well.

Keep your eye on the Federal Reserve Senior Loan Officer Opinion Survey. It is a quarterly survey of, you guessed it, Senior Loan Officers. The next one is due out very soon and can be found here:

Senior Loan Officer Opinion Survey

One of the questions they ask to the lenders is whether they have tightened lending standards. This should give us confirming evidence that the credit contraction is raging away in the market for commercial and industrial loans.

Friday, August 3, 2007

When Numbers Lie

"We will follow developments in the subprime market closely. However, fundamental factors--including solid growth in incomes and relatively low mortgage rates--should ultimately support the demand for housing, and at this point, the troubles in the subprime sector seem unlikely to seriously spill over to the broader economy or the financial system."

Chairman Ben S. Bernanke
June 5, 2007

American Home Mortgage Undertakes Substantial Reduction of Employee Base and Operations Aug. 2, 2007

American Home Mortgage Investment Corp. (NYSE:AHM) today reported that, in light of the liquidity issues resulting from extraordinary disruptions occurring in the secondary mortgage market, the Company has determined to significantly reduce its operating structure as it seeks the most appropriate course of resolution to preserve the value of its remaining assets.

From AHM 10-K for period ending 12/31/2006:

Mortgage-backed securities owned

$9.3 billion- Total Portfolio
$8.5 billion - AAA Rated
91.6% AAA

Loan Origination Summary

Prime Loans - 91.1% of all loans originated
Alt-A - 8.9%
Non-Prime - 0%

Cumulative 5 year GAAP Net Income

$682.1 million

Return on Equity

12/31/2006 - 22.74%
12/31/2005 - 28.05%

Book Value

$1.27 billion
$25.19 per Share

Thursday, August 2, 2007

White Mountains Earnings Release

I just saw this a few minutes ago but here are some quick observations:

1) Company grew book value 2% sequentially.

2) GAAP combined ratio for Esurance was up sequentially but at the analyst day in June, WTM said that this reflects requirement to amortize policy acquisition costs over 6 months rather than the economic life of 30 months.

3) Comments on Esurance business very different than comments given on analyst day. In June, management said

"Underwriting comes first in all businesses excepting Esurance – where premiums come first. This exception because it is a good business and can grow profitably."

"Combined ratio if WTM stops writing new business – 82% combined ratio. It is incredible that you can write new business at a combined ratio at that level. 2/3rds of Esurance is new business. It’s so good we are going to grow."

Compare this to the press release from this morning:

Gary Tolman, CEO of Esurance, stated, "In the second quarter, Esurance faced an increasingly challenging environment. Competition for new business increased as many of our competitors, along with Esurance, have reduced rates and continue to spend heavily on advertising. While our rate of growth remains strong, it will not be as strong as previous years. Additionally, we increased our reserves by $6 million during the quarter, primarily for bodily injury claims for prior accident years. Overall, we remain very excited about our position in the market and our performance. The current accident year loss results look good, and we have grown our policyholder base by more than 50% in the last 12 months."

4) I am still looking at the 10-Q filed this morning but WTM seemed to avoid stepping into the sub prime mess in its investment portfolio. I think if there were any impairments here it would have been mentioned in the press release.

5) I didn't see any update on the Symetra IPO.

6) Net written premiums were down in all businesses except Esurance, but this was expected due to the combination of declines in pricing and the WTM devotion to underwriting discipline.

Wednesday, August 1, 2007

Pink Sheets - Part III

Keweenaw Land Association Ltd. (KEWL.PK) is a timberland company in Michigan that owns 158,000 acres of land in the Midwest. It is another very open and transparent Pink Sheet stock with published financials and a web site. It has a very detailed and lengthy report on the value of its timberland assets as of 12/31/06.

I would urge people to read this if only so they can understand better the components of the value of timberland at other more mainstream publicly traded companies. This stock trades at $215 per share and has also been on a tear the last five years as seen below.

It's astounding to me how many quality companies there are that trade in the Pink sheet or bulletin board market. The web site is here:

Keweenaw Land Association

If you use the mid point of the asset value of its timberland, then KEWL is trading at 93% of its NAV. This analysis does not include any value for sub surface or mineral rights.