At last: OBAMA! forced out GM CEO Rick Wagoner over the weekend, doubting he could come up with a viable plan to save the company – something that's no surprise to any longtime reader of The Digest. Ironically, the company's Chief Operating Officer, Fritz Henderson, who was Wagoner's right-hand man, will replace Wagoner as CEO. Fritz is at least as culpable as Wagoner for the company's dismal performance over the last decade. New boss, same as the old boss.
In terms of corporate incompetence, Wagoner now owns the all-time record. Since he became CEO of GM, the stock has fallen from more than $70 to around $2. And the company lost close to $90 billion. He was CEO for roughly 3,000 days. So... he lost about $30 million per day as the CEO of General Motors. That is, without a doubt, the longest and largest corporate losing streak of all time. GM had about 300,000 employees during the period. Instead of making cars, Wagoner could have simply paid each employee $300,000 back in 2000 and closed the doors. GM would have lost the same amount of money, but at least the employees could have done something profitable with the last 10 years of their lives. There's no bigger burden on an economy than an unprofitable business. It wastes resources... and time.
For new readers, you might get a kick out of our first "Letter from the Chairman," a satire we wrote predicting the demise of GM, from the perspective of Rick Wagoner. (First published on the March 14, 2007, S&A Digest.) You can read it here...
What will break next? That's what we find ourselves wondering as we watch the government pour money into one disaster after another. But... perhaps we've become too pessimistic. At least some of the people we respect in finance are becoming more bullish...
Value investor Whitney Tilson, of T2 Partners, was one of the most outspoken voices describing how the mortgage crisis would play out last year. He shorted Lehman, MBIA, American Express, Moody's, and nearly every other financial company out there. Now he's seeing value in some of the destroyed financial stocks... particularly American Express (AXP) and Wells Fargo (WFC). "I think there's a 70% chance Wells Fargo makes it without any kind of catastrophic outcome in which case it's a $40-$60 stock. And at current levels [less than $15] that's a pretty attractive risk/reward," Tilson told CNBC.
Tilson believes most people make one major mistake when evaluating financials... "People often look at what the losses will ultimately be and then compare it to today's balance sheet and make a decision." In reality, the losses come over many years. So if the company's profits keep pace with losses, it will survive. In regards to Wells, he believes the bank will "have losses of $8 billion a quarter for many quarters to come but they're making $8 billion-$10 billion of profit per quarter."
In another step to make the U.S. a little more similar to Mother Russia, New York is trying to raise taxes on the state's highest earners. The temporary hike would be the "largest state income tax increase in recent history." The new "millionaires tax" will hit those whose incomes start at $300,000, who would be taxed at 7.85%. The highest bracket, those who earn $500,000 or more, will get taxed at 8.97%. We know all of these new taxes on the "rich" will prove to be popular with Dufus americanus. Meanwhile, of course, his standard of living will continue to decline as more and more of the productive assets of the country are confiscated or controlled by the government. Old Dufus americanus is going to get what he deserves, not what he expects.
Oh, no. There's a new scheme for what to do with Fannie and Freddie. Grab your wallet... For years, Fannie Mae and Freddie Mac existed to guarantee mortgages. They were, in effect, government-backed insurance schemes. Unlike insuring banks that are inherently insolvent (like the FDIC does), insuring mortgages was actually a pretty good business, provided you charged reasonable fees, you insisted on good underwriting, and kept plenty of capital on hand in the event of a crisis.
Freddie and Fannie operated this way... for a while. But later, after they became publicly owned, Fannie Mae and Freddie Mac primarily existed to enrich their government overseers and their government-appointed executives. Well-connected politicians would "stop by" the company for a year or two and walk away with several hundred thousand dollars in compensation. And as you already know, Fannie and Freddie operated the largest and most lucrative lobbying machine on Earth. Everyone got paid.
This "paying" couldn't be financed solely by insuring safe mortgages. So Fannie and Freddie borrowed huge sums of money and bought up mortgages of all types – including roughly $500 billion of subprime mortgages. They made enormous amounts of money, but only because they were taking enormous risks. (They used all sorts of fraudulent accounting to hide these risks, too.) By keeping less than 2% of their balance sheet in equity, even the slightest losses on their mortgage books would wipe them out.
And as you know, that's what happened in 2008. There's probably never been a financial debacle more widely expected than the collapse of Fannie and Freddie. In fact, that was the only possible outcome since at least 2000 – as many Washington observers warned, year after year.
And now the saga takes a most interesting twist. Fannie and Freddie are now (again) owned by the government. That puts the two firms at the mercy of politics. Nonbank mortgage finance companies are being squeezed out of the business because the big banks that operated the so-called warehouse lines of credit have stopped supplying these competitors with credit. The big banks have finally wised up: Why fund your competition? Since 2006, credit available on warehouse lines has decreased by 90%. Bank of America and Wells Fargo are now making a lot more money than they used to make on mortgages because they face much less competition. That's probably good – especially considering our government is now a large shareholder in both banks.
But politics doesn't care much about profits (or the taxpayer). So now, Fannie and Freddie are being asked to create a new market for warehouse lending, all in an effort to save the nonbank mortgage companies – the very firms that were largely responsible for the decline in mortgage underwriting. There's never been a bad idea a politician couldn't
find a way to use to his advantage. But the worst of these bad ideas is to combine politics with banking. It inevitably will destroy both the economy and the currency. And once it gets started, it's almost impossible to kill.
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New highs: none.
In the mailbag... questions about insurance and how to escape from the U.S., plus praise for Friday's Digest (drunks). Send your comments here: feedback@stansberryresearch.com.
"Could you give us a little run-down on dangerously weak mutual insurance companies? I know the publicly traded firms, like Aetna and Phoenix, may be in dire straits, but what about the mutuals, like Mass Mutual and National Life of Vermont? Any research/insight into these that are not publically traded entities?" – Paid-up subscriber Ronald Baker
Porter comment: Dan Ferris dedicated his last issue of Extreme Value to the problems plaguing the insurance industry. You can access his research by subscribing to Extreme Value, here...
"Please expand on how you plan on achieving your goal of being able to leave the country with fortune intact, within 24 hours. I have this same goal, for the same reasons, but lack a clear vision. How can one actually GET a large sum of money out of the country? Physically carry it out? Wire it? I think that both of these options are or may soon be, impossible. And if the poop really DOES hit the oscillating device, would I really WANT to walk away from my multitude of almost-paid-off rental properties and my other cash-generating business as well? And risk regretting it at a later date if, for instance, America recovers. If your new, international wealth club, The 400 Club, could shed some light on any of this, please sign me up!" – Paid-up subscriber Rich Levine
Porter comment: I honestly don't know yet, in terms of specifics. But I have a pretty good idea of what needs to be done. First, you've probably got to have a second citizenship. Foreign banks generally will not do business with Americans because of U.S. laws and diplomatic pressure from D.C. You can get around these restrictions by becoming a citizen of another country. Such citizenships can usually be purchased, if you know the right people in the right places. Next, you'd want to move as many of your assets as possible into trusts and foreign corporations beyond the reach of the U.S. government.
If your asset base is a bunch of real estate in the U.S., this might not be possible. But if your asset base is a company like mine with lots of international customers and mostly intangible assets, it can work very well. It would be hard to seize my business, if my core assets were located on a computer server in Costa Rica, if my bank accounts were in half a dozen different countries, and if I was a citizen of Switzerland. That's just hypothetical, of course, but you can see the gist of it.
(If you missed the earlier discussion about why anyone would bother doing all of this, we think there's a good possibility – bordering on certainty – that eventually the U.S. government will impose currency controls in order to rein in inflation. If you haven't gotten at least some of your assets out of the country before that happens, you might not be able to escape the economic destruction that's sure to follow.)
In regards to The 400 Club, we've heard from a number of our subscribers who are now living (at least part time) in places like Panama, Uruguay, and Costa Rica. They've offered to tell us how they made their escape... We're also looking for a very experienced and well-known financial leader to become the head of the club. We're in discussions with a few such people currently. I can't say when we'll be ready to begin in earnest... It usually takes us a year or two at least to get the personnel and the resources in place.
We do know, however, that most people will not be interested in the club because it will be expensive to join. We're planning on charging $20,000 for the charter memberships and the price will go up substantially after we reach 200 members. Obviously, if we hope to succeed in this effort, we will need to provide significant benefits to our members. But the biggest reason to join the club will simply be the opportunity to meet and do business with a well-connected and wealthy group of fellow club members. Again, if you're interested in the idea of an international wealth club – either as a member or as a service provider, please get in touch.
"It was refreshing to see some mega-content in The Digest. I have to admit that the constant banter and criticism began to make me want to hit the delete button when issues arrived. Friday's edition was a masterpiece – right or wrong.I found the analysis/discussion on natural gas crystal-balling energizing (we own Peyto for income) and so are really only concerned if natural gas stays at the $4 level or even drops well into 2010. However, supply is one thing, demand another. Betting on commodities, as you note, is a crapshoot unless one is taking a secular approach... Your CAL analysis is, of course, based on certain assumptions.
"That's what makes markets. I won't short, but why the heck would I buy airline notes, any airlines notes? I can buy the senior debt of many companies for near to double digit returns, with far less volatility and insecurity than I can CAL's notes. And I can buy [the Alliance Bernstein Global High Income fund (AWF)] and get instant diversification along with about a 13% annualized yield. I can buy Annaly's preferreds and get a 9.2% return at the current price of about $20.10. Why burn my brains with a company like CAL? For me, this is the real issue – what is the best relative deal available?" – Paid-up subscriber Jim Pursley
Porter comment: I have n
o doubt that Continental will go bankrupt. But bear market rallies like the one we've just had will knock almost any short seller out of the market. And that was the steepest rally in the stock market since 1938, so it's no surprise we got bumped from the trade. Just remember: The downside from here is always 100%. So whether we hop back on the trade at $7 or $6 or $5 or $4 or $3, it doesn't matter: We'll still have the same amount of potential.
It's not uncommon for us to have one or two small losses in our short positions until we finally get the timing right. See our Capital One trades from last year, for example. To be successful shorting, you have to get the fundamental analysis right. Then you have to have a strategy to mitigate losses. And then you just have to be patient. Sooner or later, the trade will line up. Most folks can't do these things. But if you will read my letter, PSIA, and follow my advice, I promise you can learn how to be a great short seller.
"The 3/27/09 narrative was the best in a long time. No politics, no bull, just what I am sure is good advice. Thanks." – Paid-up subscriber Charles A. McDonald
Porter comment: The grubby world of money is our beat. When it comes to politics, we're sure we know less than nothing. But politics seems poised to be the dominant force in our economy for several years to come...
Regards,
Porter Stansberry
Baltimore, Maryland
March 30, 2009