My Big Fat Greek Enron

My Big Fat Greek Enron... The Late Mr. Moody... The EU Ratings Agency... Indexes sell Greek debt en masse... Moody's thinks the BP spill is bad, too... Mother Nature is worse than BP... Is American Banker reading The Digest?... One of the aspects of the Enron debacle I'll never forget is that its credit rating wasn't lowered to junk until November 28, 2001... two days before its European subsidiary declared bankruptcy and four days before it declared bankruptcy in the U.S. In other words, when the sun rose on Enron two days before it became the (then) biggest bankruptcy in history, Moody's and the S&P still rated it investment grade.

The weird thing about Enron was, as a former Enron executive put it, the business model "didn't exist" without the investment-grade rating. This raises an interesting question: Should you ever assign an investment-grade credit rating to a business model that can't exist without an investment-grade credit rating? Isn't the model a confidence game from Day One?

Read the credit ratings definitions. The big enchilada, the pair of risks the definitions are built around, are "adverse effects of changes in circumstances and economic conditions." What company has control of "circumstances and economic conditions"?

Heaven knows Moody's can't be accused of timeliness. Enron had been under heavy scrutiny since February 2001, nine months before it went bankrupt. By the time Moody's downgraded it to junk, Enron was one of the biggest scandals of the decade.

Well, let's call Greece "My Big Fat Greek Enron," because Moody's just downgraded the ailing country's credit rating to junk – yesterday. Moody's nonchalantly declared, "Greece's creditworthiness is now consistent with a Ba1 rating, a rating which incorporates a greater, albeit, low risk of default."

Low risk of default?! If you're looking at a $135 billion bailout package from the EU and the IMF, you're pretty much in default, aren't you? I think so, but what's really amazing is Moody's total failure to take timely action. Anyone in the world who can read or watch TV knows Greece has been in a crisis for weeks. But it wasn't until yesterday Moody's said Greek debt was no longer suitable for pensioners, widows, and orphans.

Do we have any choice but to conclude Moody's is almost completely worthless to investors in sovereign-debt instruments? If it can't get Greece right, how in the world can we expect it to get any other country right? Hedge-fund manager David Einhorn reached the same conclusion some time ago. That's why he's short Moody's and McGraw-Hill, the parent company of Standard & Poor's, Moody's No. 1 co-conspirator in the (government-created) credit-ratings oligopoly.

To be fair to S&P, it cut Greece to junk on April 27 and warned bondholders might lose as much as 70% of their investments in a debt restructuring. Yesterday, Moody's said it sees "Greece implementing the policy changes it needs to stabilize its debt-to-GDP ratio at around 150 percent by 2013." I have to wonder, is a debt-to-GDP of 150% ever stable? Isn't a sovereign debt of that magnitude the definition of instability? Not to mention the fact that Greece's debt-to-GDP is now 125%... so 150% represents a big move in the wrong direction!

And who can blame the European Union's top economic commissioner, Olli Rehn, for calling Moody's decision surprising and unfortunate? He's right. It is surprising it showed up with a ratings change this early. And it is unfortunate Moody's isn't playing ball, keeping the rating up so Greece can borrow more money to keep paying off the trade unions that run its government.

You know what the EU is doing? It's setting up its own ratings agency, one which will be much more likely to play ball.

The $135 billion bailout means Greece might not have to borrow money for another year or two, but the ratings reduction will still discourage investment in the country's debt. Greek sovereign debt is being dropped pronto from Citigroup's World Government Bond Index, its EMU Government Bond Index, and its World Broad Investment-Grade Bond Index. Barclay's will drop the Greek debt hot potato from its Capital's Global Aggregate, Global Treasury, Euro Aggregate, and Euro Treasury indexes. All the funds based on these indexes will sell Greek debt. Look out below.

Moody's is nothing if not consistent. Like its sovereign-debt analysts, Moody's oil industry shills have also recently returned from a Martian vacation, where they, too, were deprived of all contact with our planet. Yesterday, in the nick of time, Moody's issued a statement saying the BP oil spill would have an adverse impact on "producers, rig operators, and service firms in the deepwater Gulf" region that could last two years or more.

I don't know if I'm ready to buy BP yet, but I did notice at least one report that said the oil washing up on the Gulf coast isn't all from the BP oil well leak. Some of the tarballs are fuel oil, probably from ships in the area. Some of that oil could have been dumped illegally, in an attempt to avoid having to clean fuel tanks properly.

More than 60% of the oil in North American waters was put there by Mother Nature, from the natural seepage of oil through bedrock. The biggest manmade source of oil in the water isn't oil wells, either. It's simply runoff from roads and spills during refueling and other events related to the use of oil, not its extraction or production. Less than 2% of the oil in North American waters got there from oil spills... though the BP spill, the largest in U.S. history, will give that number a boost.

Research into the source of oil could change BP's ultimate liability. When ExxonMobil was sued for $5.2 billion after the Valdez spill, analysis of the sources of oil that washed ashore in the Prince William sound and nearby helped to greatly reduce the fine.

Finally today, I had to smile at the following headline on the front page of this morning's American Banker: "Comp Shortage Creates Vicious Lending Cycle."

In other words, a lack of housing transactions has led to fewer housing transactions being approved by banks.

I told you the same story from a boots-on-the-ground perspective, as I intermittently chronicled the sale of my old home and purchase of my new (magnificent, dirt-cheap McMansion) home in The Digest. The appraisal for the home I'm sitting in today took two weeks, including a review. Appraisals normally take a day or two. Reviews are normally 24 hours.

The sole reason for the two-week appraisal/review process was a lack of comparable transactions within the area in the last three months. The appraisal report wound up using short sales and REOs. As American Banker points out, "the REO and short sales are the market."

Banks are approving fewer home loans, and the foreclosure pipeline is at record highs. Housing sales are seasonally strong right now, due to the warm weather. Later this year, as fall and winter descend on us, the housing sales numbers could really fall off a cliff. Shorting homebuilders still looks like a reasonably good bet, especially those trading at premiums to book value.

New highs: Keyera Facilities (KEY-UN.TO), HMS Holdings (HMSY), SM Energy (SM).

In the mailbag... more on the etiquette of booing. Send your messages to feedback@stansberryresearch.com.

"Yes it is rude to boo. But does one have to be polite when you catch someone picking your pocket? Should you be polite to the criminals that are holding your children for ransom? However Steve Rattner was correct in one respect, the income inequality should be addressed. The inequality of civil servant pay and benefits as compared to the private sector is not sustainable. From municipal governments to the federal level, civil servants demand pay raises, full insurance coverage and guaranteed retirement and they want me to pay for it. As a small business owner I paid for my employees benefits including health care and pension. Now in retirement who is guaranteeing my family's health care? Who is guaranteeing my pension?

"Civil servants where possible load their last year before retirement with overtime pay so that they can further raid the system. The practice of allowing teachers to collect and add up sick days so they can play hooky and get paid for it or submit it as over-time is despicable. Accumulating sick days for prolonged vacations while leaving their students with substitute teachers to hold down the fort and then claim how dedicated they are has a distinct mal-odor. How about 'teacher work days' easy to know when they occur by the number of teachers at the mall in mid-afternoon.

"The UAW now wants me to guarantee their pay, health care and retirement. Yes retirement must be nice when the taxpayer is guaranteeing your benefits and pension. For me I must now get back to work managing my retirement account lest it evaporate or my savings be wiped out by the government printing press.

"Hooray for free speech and the right for peaceful protest. I note the very proper British, in Parliament, frequently boo and it is encouraged. Now allow me to quote Abraham Lincoln: 'To remain silent when one should protest makes cowards of men.'

"I personally appreciate your outburst which I suspect was more the result of personal disgust than bravery. I detect that perhaps you feel some remorse at not being a perfect gentleman. Would it be better to be a perfect Assh***le?" – Paid-up subscriber E. Albin

"Greetings, I am an Alliance member and looking for a way to invest in agricultural land through an investment vehicle, rather than direct purchase. Any ideas of where to look for REITs, ETFs, etc? Thank you for all your great publications." – Paid-up subscriber Kathleen Cregan

Ferris comment: The best farmland investment vehicle I've come across is a natural resources stock I've recommended in Extreme Value. It's also got investments in oil and gas, precious metals, and other minerals. But I think the farming investment alone has the potential to double or triple the stock in the next few years. It owns one of the largest farms in North America. I visited some of its property in May and met with executives and investors involved in the company. It's a huge and growing operation and has a competitive advantage that would be the envy of any company in the world. I can't reveal the name of the company, because Extreme Value readers pay me $1,000 a year to keep that information under wraps. Since you're an Alliance member, you can read the latest issue of Extreme Value for the details. To those who don't subscribe, click here to find out more.

"Ok, so I want to run ten years of projections of a DRIP with McDonalds versus ten years of owning Berkshire-Hathaway stock. Is there an easy way to do a compute and compare? Thanks, Tom.

"Of course I am not asking which one I should do – that would be asking advice, but I just want to understand how to get some ballpark comparisons as part of my decision-making process." – Paid-up subscriber Don Barrett

Ferris comment: You're asking about comparing a dividend-paying stock with one that will never pay a dividend. To make it an apples-to-apples comparison, you could make total return projections for each stock and compare them. Don't forget to think about tax implications. You won't pay any tax on your Berkshire stock until you sell. You'll pay taxes on your McDonald's dividends. I'm not saying Berkshire is better than McDonald's on that basis. It's just something to think about.

Regards,

Dan Ferris and Sean Goldsmith
Medford, Oregon and Baltimore, Maryland
June 15, 2010