Tuesday, December 16, 2008

"2008-Breaking Out the Bailouts"

Looking back on a historic year for financial markets and capitalism.

Bear Stearns

Date- March 14, 2008
Employees-13,500

Structure- Initially, Federal Reserve backed 28-day emergency loan to Bear Stearns. Subsequently, firm sold to JPM for $2 per share in conjunction with a $29billion non-recourse loan for illiquid mortgage assets. Offer later raised to $10 a share by JPM.

Logic- Since this was the first bailout the logic was that the fed needed to intervene to preserve the orderly functioning of financial markets. The initial loan was provided to stem the run on Bear as counterparties were pulling assets. It would then appear that the fed being concerned with a “moral hazard” argument pressured Bear management to find a buyer or face bankruptcy. Though when you consider the non-recourse loan JPM got, I have to believe the fed was not planning on letting bear go under and would have extended them more time had JPM not balked.

Message to Private Capital- Mixed. Initially, somewhat harsh as fed’s focused on moral hazard issue. But the raised JPM offer tempered this. As this was the first bailout, regulators believed that focusing on systemic risk was their top priority and thus very little attention was given to a potential banking sector panic.


GSE’s
Date- Sep 7, 2008
Employees-11,000

Structure- Placed into a conservatorship by FHFA. Treasury was then issued senior preferred stock and warrants that represented 79.9% stake in the equity of both entities. Treasury announced that they were willing to commit up to $100 billion in capital to each entity. Common and preferred dividends suspended. This bailout came on the heels of a failed backstop attempt by Treasury in early July.

Logic- After failing to restore confidence with a backstop guarantee, the government was forced to address the systemic risk posed to the housing market by a potential GSE failure. With outstanding obligations of almost $5 trillion the main concern was maintaining the orderly functioning of the agency debt market, and Fannie and Freddie’s ability to provide housing credit. The massive capital commitment was designed to instill confidence in anyone holding agency debt or GSE backed paper. As far as this is concerned, the government achieved their objective.

Message to Private Capital- Very harsh. Common equity was effectively wiped out by massive dilution, and the preferred stock was crushed by the subordination and suspension of dividends. Many critics have pointed (see GaveKal’s “Unintended Consequences of Mr. Paulson”) out that terms of the GSE bailout provided the catalyst for a mass-exodus of private capital from the financial sector. A move that would result in the bankruptcy of Lehman, the BAC/Merrill merger, several bank failures, and the conversion of all remaining investment banks into bank holding companies.


AIG
Date- September 16, 2008
Employees-116,000

Structure- Federal Reserve Credit Facility of $85 billion in exchange for warrants amounting to79.9% of total equity. Subsequently modified to include additional $37.8 billion facility from the NY FED, and then a $40 billion preferred investment via TARP. The TARP investment reduced the initial central bank facility to $60 billion. Term of credit facility was initially LIBOR +850 BPS. TARP modification reduced this to LIBOR+300 bps for borrowed funds.

Logic- AIG failure posed massive systemic risk to financial markets. Outstanding Credit default swaps sold by AIG on cdo’s meant there was tremendous counterparty risk in the event of an AIG default. Bankruptcy could cripple the financial system, and thus was not an option. Lack of liquidity triggered by loss of AAA rating meant AIG needed immediate cash infusion to post margin requirements. FED took initiative.

Message to Private Capital- Initially very punitive. Equity holders effectively diluted to almost zero by government warrants. Though subsequent modifications and TARP investment have somewhat blunted this move, message is still quite harsh. This bailout was about avoiding market disruptions and not about preserving confidence in financials. (That is if you believe the two can be effectively separated)


WAMU
Date-September 25, 2008
Employees-49,000

Structure- FDIC led secret auction. Bulk of banks assets including branch network, secured debt, and all deposits sold to JP Morgan for $1.9billion.

Logic-Unsecured senior creditors were subordinated to depositors to protect FDIC Insurance Fund from taking a potential crippling hit. Clearly, the focus here was on protecting depositors and stopping the 1907 style run on bank deposits.

Message to Private Capital- Punitive. Equity Stakeholders pretty much wiped out as surviving holding company filed for CH11. Also, WAMU board had no say in sale as regulators held auction without their approval.

Wachovia
Date- September 29, 2008
Employees-122,000

Structure- FDIC ordered sale to Citigroup. Wachovia was ordered to sell itself to Citigroup for $2.1 billion. Deal was backed by Treasury and the FED and in exchange for the purchase Citi losses over $42 billion on Wachovia’s loan book would have been absorbed by the FED. In exchange for this backing, the FED would receive $12 billion in preferred stock. Retail brokerage arm and asset management unit were not part of the deal and would remain independent.
Subsequently, sold to Wells Fargo for $15.1 billion on Oct 3 in a board approved deal. No federal assistance required.

Logic- It would appear regulators panicked once Wachovia’s deposits started to fall fast as the financial crisis spread and thus took the forced sale initiative as a step before receivership. What happened afterwards is still murky, but it would appear that the situation wasn’t as bad as initially thought and that the Wells Fargo deal for the whole company could not be ignored. Though it is perplexing how this deal even happened with Citi receiving govt approval for the initial purchase.

Message to Private Capital- Mixed. Shareholders would have been left with about 1$ but the brokerage business would have remained separate so the deal was not as nasty as WAMU. However, when you consider that the board was allowed to pursue an alternative solution, even after the govt forced bailout, that ultimately added shareholder value has to viewed as a positive, as wamu’s board was left completely in the dark and ultimately rendered useless.

TARP

Date- October 14, 2008

Structure- The Treasury Asset Relief Program was born out of the Emergency Economic Stabilization Act of 2008 which was initially passed by Congress(Oct 3) as a means for Treasury to provide economic relief via the direct purchase of distressed assets that were infecting the US banking sector. The program was modified before it was implemented into a direct equity purchase vehicle by which the Treasury has taken stakes in the US financial sector through the purchase of senior preferred shares. The shares pay 5% cumulative dividend for 5 years at which point they reset to 9%. The treasury receives warrants for common stock amounting to 15% of senior preferred stake at a 20day trailing strike price.

Logic- US Financial Stocks started imploding despite the Congressional approval of the TARP bailout. Treasury was basically forced into a corner as European governments took the lead by taking direct equity stakes in their banks. U.S. had no choice but to abandon their proposed toxic asset relief program. This moved was designed to stop a banking sector panic. It worked temporarily, however, within a few days financials resumed their painful slide and more federal intervention would end up being required.

Message to Private Capital- Supportive and encouraging. Govt is willing to step in and shoulder some of the de-levg pain. Treasuries stakes were at very low costs to the banks and current stakeholders and potentially high costs to the US taxpayer. These deals could have been much more punitive, but considering the state of affairs the government was trying to avoid an all out collapse of the financial sector. Thus, TARP was turned into a stock market support program as systemic risk had turned into systemic failure. Treasury probably hoped this move would put a floor on bank stocks and bank runs.


Citigroup

Date- November 24, 2008
Employees- 300,000

Structure- $306 Billion Asset Guarantee to be split between TARP, FDIC, and Federal Reserve Non-recourse loan in exchange for $7billion in preferred stock. Also, US Govt ups preferred stake via TARP to $45 billion by agreeing to purchase $20 billion more. Citigroup agrees to exec compensation restrictions and dividend restrictions and provides the US Govt with $2.7 billion in warrants with a $10.6 exercise price.

Logic- Citigroup shares were free-falling for five straight days despite the initial $25 billion TARP investment and thus the government was forced to act. Investor confidence was at critical levels, and thus something needed to be done to resolve the too big to fail question regarding Citi and their massive balance sheet.

Message to Private Capital- Extremely equity supportive. Treasury and Fed broke from past practice of punishing private capital at the expense of tax payer funds. The city deal was set up in such a way to make the actual equity recover as the government ownership stake was kept very small and also set at a much higher valuation then the prevailing market price. It would appear the goal here was to throw free money at anyone willing to get back into financial stocks with the hope that the sentiment impact would ultimately offset any taxpayer costs. Could be argued as an attempt to correct the Lehman blunder or the GSE/AIG precedent.

"Bush's Last Chance"

"We've already stepped forward and made enormous concessions," UAW President Ron Gettelfinger said Friday at a news conference. "But as we made it clear ... , we were prepared to make further sacrifices. But we could not accept the effort by the Senate GOP caucus to single out workers and retirees for different treatment and to make them shoulder the entire burden of any restructuring."

President Bush has one last chance to salvage what little shred of credibility his administration has left. He has presided over the worst collapse in U.S. history (politically and economically). A collapse that can be largely blamed on the government’s failure to effectively regulate private enterprise and mitigate economic risks. The UAW is playing a game of chicken with the rest of the country. They know that everyone now believes that an auto-industry bankruptcy is off the table. Thus, they are only willing to concede what little they feel they need to give up until a deal is done. Naturally, from a bargaining perspective this is not shocking, as they know the only outcome they fear will ultimately be avoided. So, why be the first to cave? In a worst-case scenario, the concessions that are being asked of them will be forced upon them by the government or a judge, and thus the current leadership will never have to take the blame for what will amount to life changing wages for hundreds of thousands of union workers. Best-case scenario, you get the money and only have to give up very little in the immediate term thus postponing the eventual reckoning for a later date.


It is for this reason that I think it is about time for the President to take charge and make a difficult decision. Will Bush stand firm, or will he usurp congress and allocate TARP(sect 102 limits the funds to financial institutions) funds to the auto industry? Reagan was willing to use drastic measures when the Air Traffic Controllers Union wouldn’t budge. This president should do the same. The solution is simple. Force the UAW and the Big Three to enter into a binding agreement under which the parties agree in principle to accept any future restructuring that is deemed necessary by and independently appointed “car czar” or committee. In exchange for this agreement, the government will extend temporary credit throughout this transition period that will allow the automakers to sustain their operations. The big three will agree to this agreement, if the UAW balks, dissolve the union under an executive order.


Btw- the trading in the common stock of gm is complete and utter nonsense. These shares represent an interest in a company that is no longer a going concern. How we get there is inconsequential. The new equity when and if it ever emerges from government control will represent a stake a very different company. That is the only way gm survives. The debt is worth cents on the dollar and the stock is worth zero. Any day is a good day to short this stock.

Thursday, December 11, 2008

"Guaranteed Grief"

Crack Down on Guarantees!

The one thing that stood out the most to me 6 months ago was the seeming limitless amount of firms offering guaranteed investment returns. To me this was a tell tale sign of a boom town market that was headed for trouble. Sadly, we have yet to see a crackdown on these “guarantees”. Today, I received an email from a friend regarding a “Buy Back Investment Consortium” being proposed by a real estate agency. According to the email(which I did btw confirm by calling the real estate agent), Smith and Ken “have taken away the uncertainty and are offering a guaranteed profit on your investment within 6months of 30%.” I do have to admit these marketing ploys are impressive. The words “Buy Back Investment Consortium” even caught my attention. Here is how it works. You put up what amounts to 10% down on a developers project. In return, Smith and Ken will give you post-dated checks repaying your investment and also entitling you to 35% return for the 6-months of your investment. Minimum amount you can put up is 100,000 aed. The current max is 18,000,000. Presumably this is because they have raised 22,000,000 of the 40,000,000 they are seeking(the project is valued at 400,000,000). Pretty straight forward. Smith and Ken raises 40,000,000 for the developer which can than market and launch their project. The developer than sells the units off-plan and at a decent markup and thus can buy-back the property or in effect the 10% down payment you provided them because it has swapped that down payment out with one from a purchaser. The developer in question in this transaction is M-Holding which the UAE property development arm of the Mundia Group. M-Holding has recently launched two executive tower projects in Ajman. Based on the success of these launches they acquired 15 plots of land from Dubai Investment Real Estate Company(DIRC) for 615 million aed(in July of 2008). Their goal is to develop a 3billion aed freehold community in Mirdiff. Seems pretty sensible. So, then why can’t the developer come up with the money needed to market this project? There are really only two answers to this question.

1) The developer has the funds but doesn’t want to take the risk and thus would prefer to pass it onto investors

2)The developer doesn’t have the funds.

My guess is their previously hot Ajman project is seeing more than its fair share of problems and this is now compounding the problem of what was probably a gross overpayment for land in Dubai this past summer. Thus, I do not see how this buy-back will ever be accomplished. The developer can claw back 8% of the funds from sales for their operations. That is supposedly how they intend to pay you back. If we take the 40 million and add the 35% promised return, we get 54million in cash outflows that will need to be made between the end of month four and the end of month 6. With the 8% claw back(not sure if they are right on this my impression was that RERA is allowing roughly 5% of the escrow funds to be used for marketing, broker fees, and disbursements) that means they need to come up with some serious sales to unlock the funds needed to pay you.

RERA’S Interpretation of Trust Law No 8. Of 2007

1. Payments will be managed on the following basis:

§ Installments will be made to the contractor of the project according to the agreement between the project consultant and the bank.
§ 5% of the sum will be given to the developers for marketing and other miscellaneous purposes.
§ Installments could be taken from the account if the sufficient funds were available for the completion of the construction of the project for the which the account has been opened.

Smith and Ken’s QA

2. Why does the Developer need to borrow cash?

With the trust account laws in Dubai, Developers have to have the funds in place in order to build their projects without using the purchaser's funds, and can no longer use the money from purchasers until the project is complete. They can, however, claim back a percentage of the money once the project has been launched which calculates to around 8% of the value of the project. In order to launch the project, the Developer needs money, and with their money tied up in escrow accounts(what money are they referring to here…this makes no sense) they can't launch. Hence the creation of the Buy Back facility providing the Developer with the cash to launch, releasing further funds, allowing/enabling the Developer to pay the Buy Back within either a 6 or 12 month timescale.

Doesn’t make much sense does it? The funds they need are for marketing and launch, which theoretically should produce sales, which then will lead to funds in escrow as trust law requires each project to have a separate escrow account. So, what additional funds are going to be released? Are S&K referring to other projects in which their money is tied up? To come up with 54million through the 5% release the escrow account needs to have 1billion aed in it. So, that is a pretty weak explanation. My guess is they are treating this as a free ride. They have bought the land and the only way to make any money of it is by launching a project. So, they cut a deal to come up with the funds for launch knowing that once they have a launched project that is generating some sales they can more easily fund their ops. If they are dead wrong, well then the land goes to Smith and Ken at a fraction of what M group paid for it. Seems sweet for S&K, but then again I am sure the details here are not as clear as we think. But in this market you never know.

Ironically, the notable headline of last week was angry investors looking for Imran Khan of Al Barakah Investments, who has failed to deliver the 50% returns he promised more than 100 investors who made down payments on Ajman and Dubai projects. Mr. Khan has presumably defaulted on his post dated checks and is now seeking time to repay these investors. In an emailed statement he says and I quote, “I am out of touch with the outside world and the real estate market in Dubai for more than a month now. Due to the above, I am not in a position to make a realistic forecast of the future.” I guess Mr. Khan is learning the hard lesson that actual returns can and often do vary greatly from expected or anticipated returns. Had he done just a little bit of reading before he formed his investment firm he would have known that promising or guaranteeing returns via post-dated checks to investors could end up very badly for him. He goes on to say that he “deeply regrets the we are in this unfortunate situation..I never expected the real estate market to come to such a standstill.”

But Mr. Khan isn’t the only person at fault here. Investors who were willing to put up money thinking there was such a thing as a guaranteed 30%-100% return in a six month time frame should have known better. Enter irrational exuberance and the madness of crowds. If people were willing to spend 20x their annual salary or the equivalent of 12 acres of land for one tulip bulb in the 1600’s, we should not be shocked by their willingness to put up money for a piece of property. This is why we need regulators to step in and create as many possible obstacles to stand in the way of self-destructive human behavior.

I am not calling for mass regulation, but rather just some level of oversight that prevents irresponsible behavior like the aforementioned “guaranteed” profit schemes. The people or entities propagating these schemes could be fairly characterized as reckless or even moderately deceptive. If you wanted to take it to the next level you could argue that some of them were being fraudulent as they knew that ultimately what they were selling was a ponzi scheme(which btw we’ve had a few of the plain vanilla variety in the UAE and Middle East in general over the past couple of years) that would leave some investors hanging dry. A good first step might be that RERA prohibits any marketing in which profits are guaranteed to investors or forces any marketing material to contain a disclaimer warning investors that actual returns may differ from anticipated returns.

It would be a step in the right direction for this market and would ultimately give other investors confidence that precautions were being taken to look out for their interests.

Wednesday, December 10, 2008

Regional Rental Inflation in a Global Deflationary World

On a side note, I’d like to throw in my two cents on the rental inflation argument made in the real estate report I referred to in my last post. According to the Khaleej Times (http://www.khaleejtimes.com/DisplayArticle08.asp?xfile=data/business/2008/December/business_December225.xml&section=business), the report stated that the “continued pick up in the rental market will prop up Dubai property prices with no signs of rental inflation slowing down with demand growing in outskirts like Jebal Ali and the Dubai-Abu Dhabi corridor”.

I do not buy this argument. To say the least the authors appear to be very static with respect to their assessment of the local market. I understand the tried and true argument of rents rising as end users switch from buying to renting in a typical real estate market. However, this argument does not strike me as very persuasive when it comes to Dubai properties. Why? Well, to put it simply this is not a true end user market, at least not yet. Most renters in Dubai were not choosing between owning a unit and renting one when the real estate market was booming. In fact, the actual demand/supply imbalance in Dubai and lack of available housing was largely being driven by hoarding of properties by investors parking money in local real estate with no intention of renting out the units. The incentive to rent a unit, floor, or recently completed building is not very high when you can sell it in a matter of months for a 30% premium or 150% realized gain if you were typically geared. Furthermore, rent controls in a booming real estate market provide a significant incentive for land lords looking to cash in on the boom to treat their properties like stocks and just hold them for capital appreciation, as an unrented unit is easier to sell in an economy with rampant inflation and negative real interest rates. So, if a 2000 sq ft 3br was renting for 350,000 aed a year in July when the prices in Downtown Burj Dubai were as high as 3500aed/sqft, I do not believe the rent on this unit is not going to come down significantly. Yes, the rental yield may rise, but the absolute rental price will fall as the selling price declines drastically from the July peak. There have been a few units in southridge listed for around 1600-1700 per square foot. Current rents being demanded for these units are between 180-210k per annum. This implies rental yields of over 7%. Personally, I believe yields will fall below 5% as rental supply starts to dwarf demand, but at even a 5% yield the asking price should be closer to 120-140k. Thus, the prospects for rental inflation in Dubai are in my view next to nil, particularly in the midst of a global deflationary shock.

"Deflation, Dubai, and GCC Growth Revisited"

There is a somewhat cautiously optimistic report out today saying that the temporary sting in the UAE property market is likely to be short lived. First, I would like to say that I hope this report is right, and I want to commend the authors for providing us with something potentially uplifting in the midst of all this gloom and doom. However, I do have to question exactly what it is they are basing this view on beyond mere wishful thinking.

The three major trends of the last 24 months have not only slowed and changed course but they have utterly imploded.

They are:
1) Dubai’s booming Real Estate Story
2) The GCC’s booming Oil Story
3) The overall boom in emerging financial markets


All three of these interconnected broad investment themes have slowed, reversed direction, and then proceeded to fall off a cliff in a matter of four months. The real estate story in Dubai was for the most part a function of themes two and three as the Emirate managed to leverage the surrounding wealth in the region and boom in emerging market real estate investing to fund its aggressive development. However, investors are not stupid, and foreign flows don’t find their way into a region whose major revenue source declines 73% in 5 months. The health of the real estate market in the UAE, if health is measured by a consistently upward sloping price graph (I would tend to disagree with the view of price as a determining factor but I’ll save that for another blog), is directly tied to the price of crude. This is a harsh reality that people in this region still have a hard time accepting. While I will concede the progress has been made with respect to diversifying the economies of the oil producing GCC nations, the reality is that they have for the most part barely scratched the surface. 2008’s record surpluses will turn into current account deficits at current crude prices. All things being equal, when you factor in the accumulated wealth during the oil boom this is not exactly a disaster, as the GCC should be better off than most other emerging economies. Problem is all things are not equal. The region has massive infrastructure plans that were predicated on a sustained oil driven liquidity boom. The marginal liquidity coming in was quickly being soaked up by future long-term investments. This means that liquidity at the margin needed to stay positive to sustain the increasingly ambitious plans of regional developers. Why? Well, simply put your ability to finance future growth plans through external capital inflows becomes seriously impaired when creditors and investors believe that your revenue growth has peaked. In most cases, you can dodge an economic shock if this scenario plays itself out gradually. However, if your major revenue source and liquidity provider collapses in a matter of months you will most likely find yourself in difficult situation. For Dubai, and several other GCC nations, the situation is exacerbated by the fact that they were operating a two pronged economic growth strategy. Not only were they borrowing against the future to fund massive and rapid current infrastructure projects, (I.E. building a long lived asset like a global city in a matter of five years with significant short-term funding) but they were also using accumulated wealth and borrowing against their future anticipated wealth to fund external acquisitions to complement their strategic vision and diversify their economies.(Think Sovereign stakes in pretty much every global financial company you can name, stakes in the likes of MGM, land mark real estate in N.Y. or London, football clubs in Europe, home builders in California, semi conductor makers, automobile companies, and ports) Thus, a global financial collapse coupled with a oil price implosion is going to pose a considerable challenge for the region, as both prongs of the economic development plan take a hit. Growth plans will need to be reined in, businesses re-sized and difficult decisions will have to be made with respect to foreign asset allocation.


I didn’t think oil would reach $147 and I also never thought it would hit $60 in a few months let alone the $40 it is at today. However, I am not going to plan my investment strategy under the assumption that the price of crude will rebound 100% in the next 4 months, and I assume the powers at be won’t be doing the same. Oil is an enigma and I have given up trying to come up with a fair price for it. All I know is that the world definitely relies on it, it has been at the heart of every major conflict over the last 100 years, and the West has always gone to great lengths to control it. Therefore, I won’t rule anything out with respect to the recent crazy price swings. But at the same time, I think one needs to be realistic about what impact a depressed oil price of even 6 months is likely to have on this region.


In my humble opinion, the real estate market will most likely follow the equity markets and oil market with respect to its correction. This is the most probable outcome. Many people will argue to the contrary, but I have hard time believing that this will be the case. If Emaar shares can fall 80% and crude can decline 70% then I see no reason to believe that very leveraged residential property won’t meet the same fate. History has proven that the belief that any one investment can be “unique” or “safe” is a complete and total fallacy that holds up only until conventional wisdom provides evidence to the contrary.

Keynes once stated that an

“investment becomes reasonably ‘safe’ for the individual investor over short periods, and hence over a succession of short periods however many, if he can fairly rely on there being no breakdown in the convention and on his therefore having an opportunity to revise his judgment and change his investment, before there has been time for much to happen. Investments which are "fixed" for the community are thus made "liquid" for the individual.”


When the convention is broken in a matter of months an investment is no longer perceived to be reasonably safe, as the investor has just witnessed a period in which he did not have sufficient time to revise his judgment and alter his investment. This is the problem with bubbles, and right now, we are getting a nasty dose of the illiquidity that comes with a breakdown in conventional wisdom.

My Top Five Ways to Ride Out the Global Economic Crisis

1) Cryogenically freeze yourself. Set the time lock for five years and hope that by the time you thaw aggregate demand has finally caught up with aggregate supply at an equilibrium point that can sustain your desired standard of living.
2) Hop on a plane and hope that you manage to find your way to the “Island”. There you can spend the majority of your time trying to figure out what the Dharma Initiative is while you dodge “the others”. If you are lucky, the time warp phenomenon will allow you to skip several years of economic malaise at the cost of no more than one year of your natural life.
3) Give up on capitalism and senseless
4) wealth accumulation and join the Peace Corps
5) Become a Buddhist monk and spend the next five years focusing on your spiritual self
6) Find and Ivory Tower that is willing to let you inside its walls.

Sunday, November 30, 2008

Dubai Real Estate- On The Ground Floor-Rental Edition

“Thus we have a housing bubble. It is a cascading tragedy of people using funds that are not theirs, to "purchase" real estate that they cannot afford, obligating themselves to make payments that will stretch their incomes and constrain their lives.”
-Byron King, Dailyreckoning.com, “free rent”

A recent conversation with a Dubai Property Agent

Me: Yes, good afternoon I am calling about the two bedroom listed in Barsha near the Mall of the Emirates.

Agent: Yes. 9,000 you want?

Me: Just to be clear you are talking about a two bedroom.

Agent: Yes. Yes. 2br 1300 square feet. Very close to Mall.

Me: Excellent. That’s a reasonable price. When can I come and see it; I live in Barsha.

Agent: Ok. Tomorrow at 2pm. Bring deposit.

Me: Ok, but I need to see it first.

Agent: Yes. Yes. No problem.

Me: Ok, tomorrow then.

Agent: Yes. But one thing.

Me: Yes?

Agent: Apartment has no electricity. You take chance. This your problem.

Me: Excuse me? No electricity. Are you kidding?

Agent: No. That is why only 9000 per month.

Me (in utter disbelief): Ok then. Good luck.

This conversation actually happened last week. Honestly, if I tried, I could not make up stuff like this. I have been spending an extensive amount of time over the past five weeks researching the residential rental market in Dubai as I am trying to move to a new apartment. As a result, I have learned quite a bit about how the participants in this market think and have gotten a very good peak at the underlying supply and demand situation.

It is at times completely mind boggling. For example, if you logged onto Dubizzle today you would see people asking for roughly the same amount for a 3br in Barsha, Dubai Marina, and Downtown Burj Dubai. There are 3br in Barsha going for 220-230. At the same time, I can get a 3br in southridge for 250 right now if I gave the landlord one check. Naturally, prime downtown space from a signature developer should be going for a lot more than some random residential tower in Barsha. Not in Dubai. All the landlords still think their properties are gold mines. Some are still actually kicking tenants out so that they can sell or raise rent. It is mind boggling as most of these landlords are ultimately going to be begging tenants to move in at some point in the not so distant future. And the price distortions don’t just exists between certain areas they also exist within the individual communities. I saw a 2br in the Burj Residences going for 195k. Two days later I saw an identical unit at 240k. The landlord would not budge as he is convinced that “rents are rising” and has in fact raised his rental demand twice over the past 4 weeks. I saw a 3br penthouse in Southridge 1 directly available under Emaar’s rent to own program. They are asking for 300k for a 3000 square foot unit. Two days later I called someone on Dubizzle that was also listing a 3br apartment penthouse in southrdige. Her asking price…400k. It turns out this unit is the one facing the unit I saw. So, rent directly from the developer at 300k(2checks) and get a free call option to purchase the property with your rent being converted into equity or rent from an agent representing a foreign investor asking for one check and the respective commission along with an asking price that is 33% higher than Emaar’s. Hmm, tough decision.

Sad thing is some of the agents don’t even get what is going on. Making money here was so easy that many of them can’t grasp the basic fundamentals of property rental marketing. I called one agent yesterday after walking by her advertised old town apartment facing the Dubai Mall. She is asking 285k for a 2br. Incomprehensible. I actually tried to explain to her that there are countless 2br being offered in the 180-220 range all over downtown burj Dubai. I even tried to explain the Emaar rent to own scheme to her. Her response was, “Fine go rent from them then if it’s a better deal, why call me.” I tried to explain that she would be giving me a better deal since she wasn’t the developer and wasn’t offering a free call option and was asking for 40% more than they were for comparable units. It was like talking to a wall. I almost felt bad for her. This can’t and won’t last. But the longer it does the worse it will be as buyers start hunkering down as they anticipate lower and lower prices once they notice that the unit they looked at 1 month ago is still available and has been joined by a few more units in the same building. The price discovery mechanism in the real estate market is completely broken right now.

Is there a solution?

It’s easy to comment on a situation and point out what’s wrong from the viewpoint of a bystander. It’s a lot harder to offer some sort of solution that might improve the situation. So here are some of my thoughts:

***Rent-to-Own- This marketing scheme launched by Emaar is brilliant. They are renting you properties in prime locations and offering you the option to buy this property 10months from now at a fixed price. Frankly, I think the scheme is ingenious, as it gives Dubai exactly what it needs which is swift kick in the behind on the way to an end user market in which buildings are lived in instead of traded. Furthermore, if the plan is aggressively executed it will accelerate the growth of the downtown area as warm bodies start to create the atmosphere of a community. Problem is while the deal being offered is brilliant from a marketing perspective, it lacks real teeth. If you sign up for a 2br in South Ridge with let’s say 1530 square feet of living space Emaar will quote you a sale price of 5.2million aed. That means they are still quoting you over 3400aed/ft for something that is being offered in the secondary market at less than 2000 aed and still not moving. So, there is a good reason you are getting a free call option, it’s because for all intensive purposes it’s not worth anything. The only way this option works out in your favor is if prices head north of 3400 aed/ft sometime in the next 10months. But wait, they will credit 100% of the rent, that’s got to be worth something. On this 2br they are asking for 200,000 aed in rent. That works out to a 3.8% yield. So, you basically get a 4% discount on a price that is already in some instances at a 50% discount in some highly distressed situations. Not exactly as good of a deal as you thought.

***If I was Emaar I would make it my mission to fill up downtown with renters as fast as possible. I would concede that I will not get optimal rents for the first year (heck my goal would just be to breakeven on the unsold units I own by covering my maintenance costs for the year), but the tradeoff will be that the market will become an end user market with people willing to contemplate permanently living there and the community becoming vibrant a lot faster than it would if they waited and waited to get the best price (which I believe is ultimately an exercise in futility). The idea is not about making money in the 1st year or two off of this renting but rather to add tremendous economic value that will make people want to buy once the correction has run its course. This means that developers and landlords(if I was emaar I’d offer to manage all owned and unoccupied properties in downtown for 2yrs at a very low mgmt fee cost..Again with the aim of jumpstarting the transition to lived in a community) need to come to terms with the fact that a sharp correction is unfolding and proactively respond with realistic proposals. Fully occupied buildings can go a long way to changing investor perception. Naturally, there will be losers, but you can’t recover until you bottom. Thus, I would recommend rejecting conventional wisdom which would say you need to toe a strong line about property prices and instead continue to focus on the vision of creating a vibrant metropolitan city in the middle of a desert in the Arab world.

There is of course an alternative course of action. We can continue to hope that the correction is not that severe and that property prices in Dubai will hold up while property prices everywhere on earth are under pressure. We could continue to believe that negative premiums(i.e reverting to 2006 prices or lower) are unimaginable in a world where most almost every asset class is trading at or has tested at least 2004 prices and in several cases are back to prices not seen since the 1990’s. A quick recovery is not impossible, it’s just highly unlikely. Oil prices could recover faster than expected. This would cushion the fall. Global markets could catch a whiff of dollar driven inflation. The fed is desperately trying to engineer this scenario. But odds are that a quick recovery in real estate prices when productive assets like corporate grade debt are so cheap will be hard argument to make. So, I think it couldn’t hurt to try something different for a change. Maybe…just maybe…it might work.

Sunday, July 27, 2008

George Bush and the 'Dark Knight'

So, I just finished reading an op-ed piece by an Andrew Klavan that was published in the Wall Street Journal. The piece is titled “What Bush and Batman Have in Common”.(http://online.wsj.com/article_email/SB121694247343482821-lMyQjAxMDI4MTI2NzkyNDcyWj.html)
It’s actually pretty entertaining stuff when you consider what great lengths neo- conservatives will go to when they want to make their argument for global domination sound like altruism or some sort of deep rooted desire to defend the greater good. At one point Andrew writes “ the Dark Knight..is at some level a paean of praise to the fortitude and moral courage that has been shown by George W. Bush in this time of terror and war”


Wow, where to begin. I could make a collateral attack and point out that Andrew spends a lot of time writing about his favorite bad guys … Hamas, Hezbollah, and Ahmadnijad and that his pieces titled “Why god chose the Jews” or his countless attempts to defend Israeli actions or rhetoric at all costs as evidence that he might just be a little bit biased when he tries to tie the Dark Knight, Bush, and Islamic Fascism together, but I won’t. That would be too EASY.
First, I would like to point out that Batman has a code. He could easily kill the Joker and anyone of these criminals who are ultimately going to do nothing but harm innocent people. However, he never does, despite being provided countless opportunities to kill them. Why? Well because even the dark knight has rules that separate him from the madmen like the Joker. The Bush Administration has consistently demonstrated that they have no rules. They will preemptively attack you, lie about your capabilities, torture you, lock you up and make you disappear, and just about anything else they can think of that they believe they can get away with. They don’t do it out of necessity. They do it because they want to maintain control. In the ‘Dark Knight’ ,Batman chooses to use the sonar tool to eavesdrop and ascertain the Joker’s whereabouts, but he also wires it to self destruct. The Bush administration would have fired Morgan freeman and put a whole team of people down there to spy on everyone in Gotham until some squealer wrote a book about what they were doing. At which point, they would focus all their energy on completely destroying the credibility of this person.


The Middle East is about influence. America and Israel have it and they are very reluctant to let that balance of power change. As an American, I can totally understand that…and I am willing to concede that a military super power is going to have a hard time learning to be charitable. But the Iraq war was a clear mistake on Bush’s part, and that’s what Andrew doesn’t get. A modern day Batman would have gone in and abducted Saddam and his local cohorts and dropped him off on the doorstep of The Hague. He would have broken international laws to facilitate something for what he believes is the greater good. I do not understand how you can compare Batman to a man who simply gave the order to bomb the smithereens out of a civilized country. Or consistently defend Israel when they have pretty much helped create the desperate situation that the Palestinians are living in.


At the end of the day I have seen guys like Andrew before, and like the Joker or Bush…there is no point reasoning with them. They are resolute or crazy…which one depends on your perspective…but either way they are no Batman…because at the end of the day they clearly have an agenda and simultaneously posses no code. The dark night on the other hand is tortured by what crime has done to him and Gotham, but yet principled enough not to be completely consumed by it.


Andrew needs to wake up and drop his obsession with Islam and terrorism because he just doesn’t understand the world he is living in. Movies like Syriana which are very COMPLEX actually perfectly capture the situation that exists in the Middle East today…and the global complexities that occur when guns, oil, religion, and politics all cross paths. Jewish terrorism if you can call it that (I think tying religion to the word terror is nonsense) was a very effective tool that was used in the 1940’s to pressure the Brits and just about everybody else in what was then known as the British Mandate of Palestine to get the hell out so they could run their own religious state. Whether that is what Hezbollah is trying to do in Lebanon or whether that is ultimately what Iran wants in Iraq doesn’t really matter to me as long as I can identify the fact that if we were not meddling in these countries by virtue of being a super power that armed Iraq when it was gassing Iranians (yes, that’s not a hard selling point if you are the Iranian govt) or gave Israel its cluster bombs that are now blowing the limbs off Lebanese children; we would have less enemies in the region. When you do these things people don’t have a hard time making you look like the bad guy. And when you fight a proxy war in Afghanistan in which you arm tons of very uneducated people and just teach them to kill every day and also give them the means to fight a dirty war against your enemy…you should not be surprised that things ended up getting much worse after you left that Country because you didn’t have the time to take an interest in how it would politically develop.

If Andrew had the chance, he would probably counter my argument by saying that I am biased and that my Lebanese heritage plays a part in shaping my opinions. I will save him the time by openly admitting he is right. We do not live in a vacuum, and my upbringing and background is bound to play a role. However, I will counter that as far as religion goes I am very open minded. I think religions are fine when they are kept at the personal/ family level. I have respect for all faiths, and frankly do not believe there is one right religion out there or such a thing as the “Chosen People”. The concept of a creator choosing one clan or tribe over all others completely turns me off. I will never believe that such a being would ever play favorites. I think the Arab world has a long way to go and that it can learn a lot from the west, but I would also counter that the west could learn a thing or two from the people out here. In the end, there is no right or wrong in global politics. Parties acting out of self-interest are always going to distort reality, and the bush administration is no different than any other self-interested government. It’s just that they have much more advanced and often confusing means of distortion at their disposal that they probably often don’t even understand. The Batman’s of the world are few and far between…the George Bush’s and Karl Rove are a dime a dozen.


Hence, I conclude that Andrew’s comparison of Batman to Bush is based on his misconception of reality or is politically motivated. In either case, given Bush’s global popularity as the most destructive President in the history of the United States, even a blind person will have a good laugh at this na├»ve and silly article!

Sunday, July 20, 2008

Dubai Real Estate- On The Ground Floor

There is only one industry in the world in which everyone is an investment expert; It’s called Real Estate!!

As the loser that I am, I decided to spend two hours last night going to every single real estate stand in the Mall of the Emirates. Why? Well, frankly I was curious to hear what these “sellers” where all about, and exactly what pitch they were all using to move their properties. Boy did I have some fun. The first stand I visited featured an attractive English lady selling a project tin Dubai waterfront. Her schpeel went a little something like this…”Dubai is the new Hong Kong, there is limited waterfront property, everybody wants this property, only a fool would not buy this project, the price can only go up.” Whoa…the price can only go up?

“Why” I asked.

Well, according to this investment expert,” Property prices always rise and they never fall because land only appreciates in value”.

Hmm, “Are you sure about that statement?” “Yes, of course I am!” she replied.

Honestly, where do they find these people? When I cited the falling property prices in the rest of the world as examples of instances in which property prices fall, she responded with “Dubai is different”. Ahh…these guys will never learn will they. Anyway, I could go on for hours about conversations with real estate agents who want to argue that land only goes up in value, but I am sure nobody cares. There is really nothing surprising about this.

What I do want to talk about is how aggressive these developers are getting, and how deceptive they can be with their practices. One developer told me yesterday that if I gave him 20 million dirhams he could guarantee me 30% return. In fact, he would hand over a post dated check for 26 million which I would be able to cash in 6 months. According to him, “It’s risk free”. It’s amazing how most of these guys behave more like con artists than anything else. How can you literally market yourself as someone who can guarantee 60% annualized return, and not expect some questions? Anyway, by the time I was done I realized that if I handed over 20 million to these people all I would have in return would be a collateral agreement between me and the developer that would give me title to the land if the defaulted on the check. How many other collateral agreements are out there? I don’t know. Was this guy pushing a ponzi scheme? Possibly. Anyway, let’s move on.

The Dubai real estate game is getting pretty crazy. All the off plan projects are 5% down and marketed as flippable. The agents spend all their time talking to you about the price appreciation and not about the actual building. For example, I looked at one project which had been launched in April. The building was sold out at launch. However, 95% of the units have been relisted by the buyers and are available for sale.(I did the math as I glanced over the listings) The markup: anywhere from 3%-15%. The stock market equivalent of this is day trading a momentum stocks. When it is working it seems like very easy money, as you gear up to maximize intraday returns on small moves. When it’s not, you get taken to the cleaners. But this is to be expected in a super hot market like Dubai. The stuff that really caught my attention yesterday was the developer financed luxury condo projects. In these deals, you pay 50% of the purchase price between now and completion, and the other 50% over a 7 year period commencing after delivery. They guarantee you 11% annual rental income on the property. When I asked how they can guarantee this, the Aussie agent responded because we will rent it out for you. I then asked, “what if you can’t rent it out?” His response: Why wouldn’t we be able to rent it out?

My response: Well, what if there are more apartments than people?

He quickly fired back, “Sir, 200 new families move to Dubai every week, there is no way there will ever be more units than people.” At this point I decided to not even bother, ignorance is bliss.

Anyway, back to the developer financing: 2 agents marketed it to me like this
“No salary certificate, no documents, no banks, no headaches.” Sound familiar? Looks like the elusive ninja marketers are alive and well….they just moved to Dubai. So, where am I heading with all this…To be frank…nowhere in particular. I am not calling a top, and not predicting a crash. All I am saying is the stuff that causes real estate disasters is alive and well in Dubai and gaining momentum. Right now there is a giant faucet of liquidity pouring money over this region and it makes everybody look likes geniuses. But liquidity can be tricky…just when you think you can count on it …it up and moves on to someplace else.

Oh…one more thing…there were a few projects that were in the pre launch phase yesterday. What is pre launch? Well, pre launch is when the developer sets aside a certain percentage of the building to sell before the official launch. They then bank on marking up the price at the launch 4-5 weeks later. When I asked who gets such a deal the agent responded “VIP’s”. I then asked how you become a VIP, she replied “well sir if you are interested in buying pre launch we can make an exception”. According to her, I would be able to sell the building at launch without restriction for at least a 10% profit.

Clearly, I am in the wrong business.

Saturday, July 19, 2008

"FREE" Markets- Only On the Way UP

From the SECURITIES EXCHANGE ACT OF 1934 RELEASE NO. 58166 / July 15, 2008

“False rumors can lead to a loss of confidence in our markets. Such loss of confidence can lead to panic selling, which may be further exacerbated by “naked” short selling. As a result, the prices of securities may artificially and unnecessarily decline well below the price level that would have resulted from the normal price discovery process. If significant financial institutions are involved, this chain of events can threaten disruption of our markets.”

Wow, now I am really starting to get concerned. The SEC has decided to educate financial markets about the normal price discovery process. I wonder if the person who wrote this paragraph has ever traded stocks let alone engaged in a short sale. I am asking this question because anyone who has a clue about financial markets would never write such garbage.


Rumor-“an unverified account or explanation of events circulating from person to person and pertaining to an object, event, or issue in public concern"




Chairman Cox and the rest of the gang at the SEC need to understand that there is a very good reason for all these “false rumors”. What is this reason? Well, to put it simply, investors have no way of verifying what exactly is the value of the assets sitting on the balance sheets of financial institutions. To make matters worse these opaque balance sheets carry assets that are 30-100x shareholder equity. As an equity holder, you are facing in many situations a potential 100% loss if your bank can’t adequately recapitalize. On the flip side, as a counterparty or debt holder you face default risk if the bank’s assets are not worth what they say they are worth. Solution: sell first ask questions later. For the SEC to actually call these rumors false they need to be able to confirm that every financial institution has adequate capital to weather a prolonged housing downturn. To be able to do this….they need to be able to verify that housing prices will not fall precipitously from present levels. Since no one is capable of doing this, the rumors are by definition not false. Every bank is carrying a certain level of housing related toxic waste on their balance sheets. Human nature tells us that the ones with the most toxic waste have a huge incentive to hide it as best as they can while they try to figure out ways to ride out the housing storm.(i.e raising more capital through dilutive offerings, selling assets, borrowing from the fed, or just praying that the bottom is around the corner) As the crisis has developed the only thing we have learned is that every bank is exposed.




It’s pretty sad to see the SEC focusing on shorts who are doing their jobs by exposing the weak links and bringing them to their knees before they sucker people into giving them capital that they clearly don’t deserve. If the regulators had done their jobs, the shorts would be failing and investors would be buying. My view is simple, stay out of the shorts way and let the market sort things out. If the system is healthy, buyers will emerge and bank stocks will stop falling. If it isn’t, the bad ones will fail quicker and we can get this whole mess behind us and start fresh.




We are now approaching the 1yr anniversary of the credit crunch, and it appears that we have made little to no progress with respect to shoring up our banking system. Why? Well, it’s because there is still too much dead weight out there dragging things down. Cut these banks loose, and let’s move on. Any institution that is over leveraged and incapable of surviving should be allowed to fail. If that means we are dealing with 90% of the system…than so be it…we can start over. Though my guess is it isn’t that bad.




…and the good news from wells fargo and jpm should be taken with a grain of salt. Wfc extended charge-off acknowledgement from 120 to 160 days. What does this mean? Well, for a bank this means you get to postpone taking loan loss reserves for another 40 days and actually hold onto precious capital. As for JPM, their loan loss reserves somehow actually came down from q1. At least the accountants are earning their salaries.

Oh, and one more thing…if there are no shorts in the market who is going to be left to buy these stocks? Maybe you should think about that. Shorts can at least make money by covering on the way down. If they didn’t exist, the market would only have sellers….and then Chairman Cox would get to see what real panic selling looks like.

Saturday, July 12, 2008

'Chuck, GSE's, Gold, and the Poor old shrinking dollar'

Does anyone like Sen. Schumer? Let’s set aside my personal distaste for the man as I have over the years become convinced that he just hates Arabs, and just focus on his utter incompetence as a public figure. This Harvard man(college and law school), Aipac member, DP World blocker, and all round publicity junky can now add bank destroyer to his long list of credentials. Last time we talked about Chuck he was trying to blackmail the Saudis into raising their oil production. His strategy worked and oil prices have done nothing but steam roll higher. If exacerbating an already tenuous oil situation wasn’t enough, he has decided to throw himself into the banking game. His much publicized letter to the FDIC Chairwomen in which he suggested they keep an eye on Indymac Banc probably caused the run that finally crippled mortgage lender and will leave some 19000 unlucky depositors wondering whether or not they will ever see their non-fdic insured funds. Honestly, I just don’t understand this guy. If he wrote this letter two years ago, I’d have some respect for the man. But writing it in the middle of a financial contagion? What is he thinking? Every regulator and his uncle is working overtime right now to make sure this crisis doesn’t get any worse…and along comes chuck shouting fire in a crowded theater. If this guy likes stampedes so much, maybe they should send him to the running of the bulls. Anyway, to pin the Indy failure entirely on chuck isn’t fair.(though I can’t see how his letter did anything other than publicly suggest the fdic do exactly what it was already quietly doing) When you build an entire lending business around no document loans your demise is your own doing, and the regulators are morons for not doing anything about this a long time ago. Honestly, what do we pay these guys for? Having formerly been an employee of Treasury I am starting to wonder whether or not the regulatory system will ever effectively regulate anything. Anyway, enough of chuck bashing for now…let’s move on to the Fannie/Freddie crisis.


Anyone watching these stocks on Friday must have been wondering what the hell is happening. Both where down over 40% at one point. Things have really gotten out of hand. Though I find some personally irony in this situation as I lost a good deal of money shorting these stocks a few years ago when Jim grant and company first started talking about their eventual demise… The thesis was so compelling, and yet nobody ever wanted to listen. Now, they are on the brink of disaster, and I find myself hoping that the powers at be find a solution to this mess. Why? Well, Fannie and Freddie are just too damn important. As the largest buyers of US mortgages, these firms are largely responsible for how the current US housing market functions. Any major disruption in their operations could be disastrous.


So what’s the problem? For those who have not being following this closely or for that matter don’t understand how these guys work ;I will provide a brief summary as I have spent a great deal of time studying these two companies over the years. Fannie and Freddie are Government Sponsored Entities(GSE’S). They were created with the express purpose of making housing more affordable. Fannie was one of FDR’s new deal initiatives to provide liquidity in the mortgage market, and for the past 70 years it has done precisely that. The company was turned into a private entity in the 1960’s, and it was joined by Freddie in the early 70’s. Their business model is simple. Fannie and Freddie buy or guarantee mortgages. They then sell bonds(agency debt) against securitized pools of these mortgages. They make money by charging a small premium for their agency guarantee. Which basically means that if the mortgagee behind a pool of mortgages defaults on principal or interest Fannie will guarantee that you are paid. These bonds are NOT backed by the US Government, despite the fact that most investors seem to treat them that way. The idea is that these guys buy high quality mortgages and as GSE’s can issue debt at a very low cost(a slight premium to treasuries). The business model worked for a very long time. But sometime in the late 90’s the mgmt of these firms got more aggressive as they sought to drive ROE. Whether they got too big or too careless(or both) depends on who you talk to… either way they started to come under fire. Both were hit with major accounting scandals, and both came under significant regulatory scrutiny. The temporary beating in their shares didn’t last very long though as the US housing boom provided enough of a tailwind to get them through the mess. Today, things are different. Both GSE’s are clearly going through some hard times as short term liquidity dries up while their giant pool of mortgages/and guaranteed mortgage obligations deteriorates. Many would argue that the companies are fundamentally insolvent. I tend to agree with this argument. When you consider the sheer size of their mortgage market exposure and the rising rates of delinquencies along with their equity capital, I find it hard to fathom that either of them can cover their near term obligations if they are adhering to US GAAP. So what should the US Government do?


1) Stay out of the way and see what happens. I.e. let them them fail. This option is off the table. The GSE’s cannot declare bankruptcy. It would be a financial fiasco. The agency debt market is huge and includes a long list of creditors that range from foreign governments to major pension funds and state and local governments. With all the different parties involved I doubt the creditors could ever agree on anything. Furthermore, the temporary disruption to the mortgage market would be disastrous. The GSE's account for nearly 40-60% of the market. Taking them offline even for a short while could send the US economy into a black hole. Mortgage rates would soar and housing prices would take another massive hit.

2) Put them in a conservatorship. This is an interesting option, and was discussed by the op-ed piece in the NYT on friday. The laws were amended in the early 1990’s to allow regulators to place either entity in a conservatorship if they were found to be ‘significantly undercapitalized.’ Since that appears to be the case, this seems like a very possible outcome. Under this scenario, the equity holders probably get wiped out while a team of regulators steps in to nurse them back to health. However, I don’t really understand how the funding issues would be solved. The dividend goes away and that saves some cash, but the rest will need to come from the FED. How much? I have no idea.

3) Nationalize them. Since Fannie and Freddie basically are sitting on close to $6 trillion in debt, this option is a tough sell. The Govt would have to issue treasuries to basically replace the agency debt. This would increase the public debt by over 60%. Not a very appealing thought for the already battered US dollar. They could of course just choose to expressly guarantee their debt instead and thus keep them as they are…but that would also basically have the same outcome for the dollar.

4) The government could take a controlling stake in both companies. This would provide much needed new capital and allow the Government to replace the board, change the mgmt, cut the dividend, and all the while maintain the private status of the entities. Kind of a Dubai move as you get an implicit Government backing to with a direct Government equity stake, and still maintain the image of a functioning capitalist system by maintaining the publicly held joint stock entity. Again not a very appealing move for the dollar or US treasuries, but a move that saves some face.

If Fridays market activity is a leading indicator, it would appear that agency debt holders are convinced that the Government will backstop any GSE’s debt, thus turning a deemed implicit backing into an explicit one. At the same time, it appears that equity holders, no matter what decision is finally made, will be left holding very little(if anything at all).


I would like to point out that when I did my piece on the fed’s balance sheet a few months ago, and all the garbage they are supporting; I said that the only thing I was sure of was that treasuries were a sell and gold was a buy. At the time the market was going in the other direction on both of those trades(not tooting my horn but I’ve been a gld holder for a very long time). I am now fully convinced that there is no stopping the gold bull run. It is the easiest trade around, and anyone ignoring it is making a big mistake. The US system has taken a credibility hit that it may never ever recover from or in the best case scenario will take several years to repair. I have concluded that the financial system is full of liars. Whether we are referring to rating agencies, commercial banks, mortgage finance companies, regulators, or investment bank; I no longer believe a word any of them have to say. Foreign holders of our debt will be spending the better part of the next few years diversifying away from the dollar. I expect gold will play a major role in this diversification as central banks and even sovereign funds start to turn from being net sellers to net buyers in the next few years. I know it makes no sense to the rational thinker, but until someone figures out how to print gold it will always appeal to individuals seeking safety and certainty.(and my bet is that group is growing awful fast)

Tuesday, July 1, 2008

"Green Cheese????"

“Someone started the rumor that Barclay’s Bank was going to underbid for Lehman and buy the company for $15 a share. This rumor ranks up there with the moon is made out of green cheese in terms of its validity.”
-Richard Bove, Ladenburg Thalmann Bank analyst

Some advice to Richard-

While I agree this rumor sounds ridiculous and at this stage in the game probably is ridiculous, I have to warn that over the past 12 months the rumors have been consistently right.

Let’s recap a few of my favorite rumors from the past 12months...To be honest i could list 200...but you have to draw the line somewhere

-E*TRADE had a huge drop on rumors that it was in serious subprime trouble…this was on august 16th…stock fell from $16 to $9.92. It then recovered as analysts came out with notes that put out the fire. Stock is 3$ today. Why? Because Etrade did have serious subprime trouble!!

-Mbia was constantly getting heat from shorts claiming the monocline insurer was in trouble. And with every analyst defense and rally came a new wave of lows. Then finally in jan the stock looked like it was going to die as it plunged 50% from $13 to $6. Again, some analyst came out and said the bankruptcy rumors were unfounded. Where is the stock today ..$4.39. Not bankrupt yet..but exiting one business entirely and defintently nowhere near being out treacherous water.

-There were rumors that the buyout of Harmon Kardon led by gs private equity fund was going to fall apart….again arguments where made this was rumor mongering and that the deal was fine…or that arguing for a MAC would be too hard. Well, the buyout was pulled and the stock dropped about 60%.

-Then there was the citi free fall and rumors that the dividend would be cut….a whole team of analysts came out saying that those rumors were unfounded. But a few months later citi cut its dividend.

-Oh, and Bear Stearns…rumors were circulating in august that the losses by two bear hedge funds could eventually force a run on the bank and that bear or a broker like bear could go under. Again, a whole team of analysts and pundits ridiculed that one. 5 months later….Bear Stearns doesn’t exist

-Oh and what about the Lehman rumors the day after Bear that were put out by Erin Callan. They were totally false right? Except 3 months later she has lost her job and lehman shares are lower than where they were when everybody thought a bankruptcy was around the corner.

So, when it comes to Lehman, I’d make sure I know the hand I am playing. The rumors may seem crazy…but if that’s the case I might just go to the Smithsonian and check the moon rock samples. Because as far as I am concerned I don’t believe these banks are coming clean. Look at the game being played with Merrill right now. Up until 3.5 weeks ago every sell sider had Merrill making money this quarter. Then…almost miraculously…they all started reversing course. One quiet downgrade 2 weeks ago, and then more and more downgrades over the past 10 days. Do you think these analysts went from predicting a profit to predicting a massive loss without any rumors…hints…direction…etc…in a matter of two weeks? Last I checked Merrill had not disclosed anything to the public. Either way these stocks keep falling…and while people bicker over why…I am content knowing that for now the words “investing” and “investment banks” should not go together. Nobody knows what’s going on, and very few people have been truthful.

I usually like bold notes out of analysts, but most of these notes have been pretty sad. Look at some of the price targets these guys have on brokerage names. They are like 50-100% above current levels. Anyone think this has something to do with all the underwriting that has been done with respect to raising equity for fellow brokers?

Sunday, June 29, 2008

Great Scott!!

Dear Past Me,
STC- September 28, 2007- 6:41pm

Don’t rip this letter up. It’s not a hoax. What I am about to tell you will come as a shock, but if you bear with me for a few moments, you will understand what’s going on. I am your future self. To be precise I am writing to you on July 1, 2008. Due to the oil boom in the Middle East, the Arabs have quickly moved up the technology food chain. It ‘s pretty impressive when you consider what a lot of oil money can accomplish. I am not going to get into the details as I don’t understand much about how the process works, but the jist of it is pretty simple…we can travel through time. Problem is so far the only thing we can send is letters to our past selves.



Impressive huh?



We don’t even have a mail system in UAE that will allow us to send letters from one Emirate to the next, but we can send letters through space-time. You can thank Sheik Mohamed and what you will later discover was an aptly named Dubai lifestyle magazine called Time Out Dubai that was a front for this super secret project. I think the goal was to figure out how to build buildings faster, and being the visionary that he is Sheik Mohamed decided to invest in a time travel project so that the Dubai government could retroactively correct any delays or design issues.
Anyway, enough about the science, I’m sure you have many questions. So…where to begin:
I know this may come as a shock to you…especially if you are reading this where I think you might be reading this….but you are now living in the desert. To be specific- Dubai. I can’t tell you what you do or who you are going to meet or what’s going to happen with your life (names like rocko, Achilles, and Kman may come into the fold-I’m being serious). Sorry, space-time is a monopoly and it’s not democratically run. (but it’s still pretty cool)




What I can tell you is that you were right about the markets. I know you know that already, but I just felt it might make you feel a little better as I know the September/October rally is killing you. (yes it runs into October) But as things stand today the credit crunch is still going on, and inflation is accelerating. Some advice for you- crox, lvs, sigma, bsc, mbia, and har will implode as you predicted…just not when….hope you can take this hint. As for rimm, stay out of its way it will do nothing but frustrate you. Don’t try and play both sides. Also, stick to your longs…oxy, btu, and gld are gems…..you can’t lose. Try and be a little more patient with your source of capital….you guys have the right idea…just not the best formula….work on it. Oh, btw, Cramer will be wrong on everything, and so will everybody on Fast Money. And the sell side is about to pull a 2000 repeat with respect to how off their price targets on stocks will be.




As for everything else, the family wedding will go off without a hitch. Yes, I know it seems like I am lying, but I am not. Sadly, you may miss a few of your best friends’ weddings, but as far as I can tell, they don’t hold it against you. A couple of your friends are about to have kids, so get ready to start feeling old. Btw your significant other will move to Paris in like 60 days. I know you don’t believe me, but its going to happen. Oh, your Law Professor will take at least another 2 months to submit your grade so keep on him or he will forget and you won't graduate.
It will be the year of Boston in professional sports, Obama will defeat Hillary, and Lebanon will plunge in and out of chaos. As for film, stay away from anything M Night makes from now and on, and also don’t watch the new Indy…just pretend like it all ended with the Last Crusade. Oh and I almost forgot….you won’t believe who dies on Lost…it’s *********(if you don’t see the name its because Abc has signed a deal with Dubai Holding and is probably in the process of protecting all its intellectual property throughout space/time)

Your friend in Time,
Dubaican(you'll get this eventually)

Wednesday, June 11, 2008

Shama Lama Ding Dong

Wow, I never thought M. Night Shamalamamama could sink any deeper into the depths of film purgatory. I mean his last flick was such a disaster that I thought there was no way his next work could be anything but an improvement. Boy was I wrong. When I see a film, I judge it by how often I find myself squirming in my chair and pondering what better ways I could have spent my time. If you register a zero on this scale, I can at least say I was entertained, and offer an opinion as to what I did or didn’t like about the film. However, if I find myself moving around too much, your film is doomed. At least in the abysmal Lady in the Water I survived an hour or so before I got restless. I can’t say the same for The Happening. The premise…humans gone inexplicably mad committing suicide in very graphic yet comical fashion…while potentially interesting….never really developed into a story. Moreover, the acting was horrific. Marky mark and john leqguizamo just looked so out of place in their roles….. so much so that they could have been replaced by extras and I wouldn’t even have cared.


The only upside- no cameo from the narcissistic writer, producer, and director. Maybe shamalama is making some progress with respect to his infatuation with himself. Honestly, after watching this film I started to think that maybe M Night’s body has been hijacked by aliens or something along those lines. Because there is no way this is the same guy who made Unbreakable and the Sixth Sense. Maybe he should just stick to making movies with Bruce Willis. Either way…my recommendation is avoid at all costs. Nothing Happening Here!!

LandMark Properties, Rich Foreigners, and American Know How

Rumors are circulating that Abu Dhabi Investment Council is looking to buy the Chrysler building, and they are not alone, as rumors have circulated the Macklowe purchase of the GM building included silent partners from Kuwait and Qatar wealth funds. I have but one piece of advice to ADIC….learn your history before you go shopping in America. Landmark American properties and foreign owners mix like oil and water. These investments have a record of bleeding foreigners dry before they end up back in American hands.


I can’t help but recall Mitsubishi estate’s disastrous purchase of the Rockefeller center in October of 1989. At the time it seemed like a great idea, but after 2 billion dollar in losses and a bankruptcy filling the property found its way back into American hands…all the while enriching the Rockefellers in the process. Moreover, let’s not forget another Japanese disaster…namely the 1990 acquisition of pebble beach by Minoro Isutani for $841 million. A decade later the property was sold to a group led by Peter Ueberroth and Clint Eastwood for slightly less than that amount.(Isutani was long gone as he filed for bankruptcy almost immediately after the purchase)


And for those keeping track the Japanese stock market peaked at 38,915.87 points on December 29, 1989. It still has not recovered. Now, I am not predicting the same fate for Arab markets, but I do firmly believe that those who don’t know their history are often destined to repeat it. If I had to wager, I’d guess that these acquisitions will end up doing more harm than good for these Arab countries.


See, capitalism is an American game. They have it down to a science. The rest of the world just doesn’t have what it takes to compete. I compare it to a retail investor trying to trade the US equity markets who naively thinks he’s going to outsmart the professionals. It’s just not going to happen. You may get lucky a few times, but in the long run the pros will clean you out. This may eventually change, but judging by what’s been transpiring of late….I doubt it. Whether you are buying internet stocks, real estate backed securities, us investment banks, American automakers, private equity funds, homebuilders, or landmark properties….the Americans seem to always end up on top. The Arabs, Chinese, Japanese, and to a lesser extent the Europeans all make the same mistakes. Don’t these people ever wonder why American investment arms are not snapping up their landmark properties?


At the end of the day, this is good news for America as the rest of the world looks like it has no intention of wising up anytime soon. In my opinion, these people need to get a good financial planner…and start thinking about more creative ways to spend their money. Trying to outsmart Steve Schwartzman or the Rockefeller Family is a sure fire way to go broke. My advice…stick to what you know…David Ricardo knew what he was talking about when he came up with the law of comparative advantage. And if you have concluded you don’t know much, keep your money under your mattress . There is no shame in that.

Monday, June 9, 2008

"The Exclusive R"

So, I was back in the states for a week. The occasion: my brother's wedding. However, most of my time was spent chaperoning my cousins and extended family around Baltimore’s malls. Not exactly how I intended to spend my week off, but as the grooms oldest brother I had no choice. Though I will have to say that this trip provided me with firsthand account of what's going on with the global economy. My relatives came to America to do one thing: Shop!! Seeing as most of them live in Europe or the Middle East, they were quite enthused about having the opportunity to throw their global purchasing power weight around. To quote one of my cousins, “I am going to tear it up."(KJ for those who know him well)

So, where to begin. My favorite story has to do with denim, and the ongoing designer jean craze. I went to a store with one of my cousins to look at Rock and Republic jeans. After about ten minutes of shopping my cousin had narrowed his selection down to three pairs. Two very expensive pairs of jeans, and one super expensive pair. And I will have to say the clerk in this store did his part to sell these jeans. As my cousin was struggling to make his up his mind, the clerk informed him that the super expensive pair was the way to go because they had an "exclusive R". Now, I had been quietly watching my cousin shop until I heard this. At which point I couldn't resist asking the clerk a few questions. "What's an exclusive R", I asked. "Well, sir I am referring to the design of the R on the back of rock and republic jeans", he replied. He then proceeded to explain to me that the R on Rock and Republic jeans is quite unique and that certain versions of the design of the R are rare and coveted by denim lovers. You learn something new every day. I guess jeans branding has reached new levels, because at this point even I wanted an exclusive R on my butt. Btw the store we were in was called Metropark. Which the clerk described to me as a boutique lifestyle chain with a fashion forward edge. More impressive branding. Basically, these guys bring Los Angeles living to non Californians. Anyway my cousin got a good deal on the jeans, that is if you can consider $330 jeans a deal.(Guess they are more expensive in Europe)

I also spent a lot of time in Abercrombie and Fitch, which to my surprise is developing a big international following.(It knew it as a store for north eastern preps when I was in high school) The shopping experience there is insane. You'd think you were in a lounge or club. The lights are barely on and the music is bumping. I guess ANF has been applying Vegas practices to shopping. Maybe they are pumping oxygen into their stores.

Oh and how can I forget the J-Crew red phone. It turns out if you can't find something in a J-crew store they have an emergency red phone with a direct line to a Jcrew operator who will find it for you. It’s considered a premium service, and as one of my cousins used it, I can say it works.

Can't beat shopping in America. And for you US consumer stock aficionados keeping track....the stores that my family and friends did the most damage at were ANF, Apple, and Nordstrom.

As for me, my venti vanilla cappuccino and croissant from sbux cost me 5.99. In Dubai, I pay 8.40. Not exactly the Big Mac index, but definitely worth noting. While this isn’t a perfect comparison, my purchasing power in Baltimore’s towson town center mall as measured by starbux is 40% better than it is in Burj Dubai.

Wednesday, June 4, 2008

Talking Tough

So, Big Ben finally decided to defend himself. The speech he delivered today arguably provided the world with the first candid discussion by the Fed Chairmen on the global credit crunch. He lays things out pretty clearly by breaking the speech down into three parts 1)what’s happened 2)outlook 3)how we’ve acted and why. In my opinion, the outlook and policy response sections reveal a lot about the challenges facing policy makers today.

Some interesting quotes from the chairman;


“However, until the housing market, and particularly house prices, shows clearer signs of stabilization, growth risks will remain to the downside. Recent increases in oil prices pose additional downside risks to growth.”

Loose translation- We are still very concerned about consumption and output risks in general. Monetary Policy should remain accommodative.


“Unfortunately, the prices of a number of commodities, most notably oil, have continued upward recently, even as expectations of future policy rates and the foreign exchange value of the dollar have remained generally stable in the past few months. The possibility that commodity prices will continue to rise is an important risk to the inflation forecast. Another significant upside risk to inflation is that high headline inflation, if sustained, might lead the public to expect higher long-term inflation rates, an expectation that could ultimately become self-confirming.”

Loose translation- We are concerned about inflation, and the risk that we may have permanently let the inflation monster out of the bag. Monetary policy may need to shift in a more restrictive direction


The market’s interpretation of this mixed message: Fed is done cutting. Dollar rallies, commodities fall, and equities catch a slight bounce because of the dollar. The problem with this interpretation is that nothing has really changed, and if the fed has really shifted into neutral; equity markets will run into some very strong headwinds in the future now that the prospects for further easings have diminished. There really is nothing for the fed to do but to keep talking tough while simultaneously being as accommodative as they can be without absolutely killing the dollar. In this situation, the dual mandate cannot be fulfilled. The fed made a decision a few months ago to save financial markets and asset prices from a sharp and painful correction. To accomplish this they sacrificed price stability. It’s really pretty simple. See, a decade of imported deflation from Asia and increased productivity provided them with some breathing room to bail out the markets. But markets are ruthless, and as a result the breathing room is now gone. Big Ben can keep talking, but he’s already showed his hand. The whole world knows he suffers from deflation phobia, and thus will do whatever it takes to prop up asset prices.


In my opinion, this fed can’t fight inflation without administering a lethal injection to asset prices. So, how will this all play out? Well, I think heightened inflation expectations are here to stay. Eventually higher prices will eat into corporate profitability and force equity multiples down. During this adjustment period economic growth will remain well below trend, and this will eventually lead to stability in commodity prices as demand will come under pressure. This economic scenario will play out over a few years and not at the hyper speed that wall street operates at. The fed has succeeded to the extent that the economy slows as gradually as current reported data indicates. But make no mistake…if we get some nasty employment number or gdp data….everyone will be calling for more rate cuts…and the fed will give them what they want.


As for the moral hazard debate, here is what Big Ben had to say


“The Federal Reserve's mandate is to foster maximum sustainable employment and price stability. To achieve these goals, we must also support the return of financial markets to more normal functioning.”

I have but one question for Big Ben- What is normal functioning in financial markets?

Rampant credit creation, irresponsible lending, inadequate risk controls, insane compensation, and activity that borders on the criminal. These things happen because financial markets can count on your support.

Friday, May 30, 2008

Indy Bust

So, I saw the new Indiana Jones last night, and I have to say I wish it had never been made. The story was weak, the jokes were not funny, and the supporting cast outside of John Hurt and Karen Allen were a total let down. In fact, the best parts of the entire movie were the memories of the old movies. A little glimpse of the ark of the covenant, the ridiculous pcitures of Denholm Elliot(brody) and Sean Connery, and the good old them music. As for the current story line- The Soviets were about 1/10th as interesting as the Nazis....they just didn't really come to life all that well. And the local natives also didn't come to life as well as they have in past movies.

Harrison ford was ok...but definitely not as good as before....but i don't think it was his fault. The blanchett character could have been developed a little more and had a lot more interaction with indy. Guess it's hard to outdue a masterpiece...and that's what spielberg, lucas, and ford were facing with the last crusade. John Rhys Davies, Denholm, Elliot, and Sean Connery were just too good...there are no better bad guys than the Nazi empire.....plus the grail story line was fantastic....gave the movie a real treasure hunt feel that this film really lacked.


At the end of the day i would have paid $8 to listen to John Williams for 2 hours so i can't complain. But i was hoping for a lot more.

Energy, the FED, and Inflation



"For years, Washington has failed to address the issue of rising energy costs and, as a result, the country now faces a true energy crisis, one that is causing serious harm to America's manufacturing sector and all consumers of energy. The government's failure to develop a comprehensive energy policy is causing U.S. industry to lose ground when it comes to global competitiveness, and our own domestic markets are now starting to see demand destruction throughout the U.S." – Dow Chemical CEO
I have to say this energy debate is really providing me with some great material. I also think this debate is revealing a lot about how out of touch with reality some of America’s politicians and business leaders have become. I have but one simple question: What is an Energy Policy in a Free Market? I don’t get it. Either you have it or you don’t. Alternative forms will act as substitutes at competitive prices or demand will eventually come off as the price increases. What policy is needed other than physically confiscating it from those nations that possess the resource in mass quantities? If the government forces people to drive less, carpool, relocate to urban areas, or any one of several things they can do to encourage conservation, there will be other economic consequences. Stores like Wal-Mart, Target, and Best Buy will suffer as human traffic declines. The broad services industry will take a big hit, and of course, the housing industry and financial services sector would go through some major adjustments (which is in fact what is already happening). So, while we save on oil, we lose in other areas as economic activity slows down. This is a natural rebalancing.

What people want is for economic activity to continue at the pace it was going over the last few years and for energy prices to fall. Hmm….if you know nothing about economics I can understand where you are coming from…but if you are senator Schumer…Donald trump…or the CEO of a major corporation…you do not have an excuse. Trade is about goods and services. It is pretty fricking simple. If what you have to offer in exchange for food and oil is financial paper…well then you had better make sure that paper is some high quality stuff. While the commodity boom is a great wealth transfer story, it is also a story about credibility.
Make no mistake one of the major drivers behind this commodity mania is that investors are storing value in them. So, while the financial prognosticators are focusing on how the U.S. markets are holding up, you should be focusing on the fact that many people are losing faith in certain financial assets. If you have figured out there is a lot of toxic waste out there and that regulators are utterly incompetent, well then… you simply are boycotting the system and moving your money into something more reliable. Why is this happening? Take a look at what’s going on with Fed’s balance sheet.

As you can see(the chart i built is based on aggregate assets of the FED as of May 23,2008) it’s changed quite a bit over the last 12 months. In fact, they had to literally change their subcategories, as the line item “loans to depository institutions” isn’t adequate to cover their lending operations anymore. They now use the classification “other loans” so they can account for their new Primary Dealer Credit Facility. Clearly the Fed has decided to bear the burden of risk within our financial system and bail out the banks and the mortgage backed security market. The upside to all of this is that their actions are providing a stopgap for the struggling real estate market and buying banks badly needed time to recapitalize. The downside is that it is at the expense of the dollar and long-term price stability. The fed does not have a magic wand. They cannot make the toxic waste in the system disappear. So, to the extent that they try to do this, and so far they have employed multiple strategies (TAF, TSLF, PDCF....more and more acronyms….but the same problems) they will ultimately fail. The Market Ticker Blog pointed out a great quote from Alan Greenspan that he made many years ago regarding FDIC insurance “We can guarantee you that you will receive your dollars, but not what they will be able to purchase.”
Honestly, this quote hits right to the heart of the problem. By trying to bail out banks and brokers and buy time for homeowners who made very bad decisions the Federal Reserve is creating another problem…inflation. Which problem is more serious? Well inflation directly affects every single person and corporation in the United States. It makes their lives and businesses more difficult to manage. The credit crunch on the other hand is bad for businesses and people that depend on debt and the use of levg to make money, and for the most part, if it had been left to work itself out would have done the majority of its damage outside of Main Street. The big losers would have been the stock market which would be lower…and the financial services industry….which would have had to shed jobs at a faster pace. These two things will eventually happen …albeit in a more orderly manner. Sadly, before the fed can celebrate saving Wall Street they will be stuck trying to figure out how to save everyone from inflation. Moreover, as we have seen great dissention at the Fed of late…it appears that a few members and plenty of ex members realize that this could be a difficult battle. What do we as Americans have to look forward to?
1) Higher long-term rates
2) Higher taxes
Two things I tend to associate more with long-term bear markets for equities than long-term bull markets.