Rogers was right

Rogers was right... Neither a lender nor a borrower be... AIG to disappear... Charley's Dominican pad... Where to look for investment bargains... How to avoid "value traps"... No more bad news...

After reading yesterday's Digest by Dan Ferris, I had to spend a little time on the beach this morning... by myself... away from sharp objects. Unwittingly, we've become the doom-and-destruction report. We report the facts. And sometimes they're not pretty. Sorry about that.

The sun is always shining somewhere, though. For example, I wonder what Jim Rogers' brokerage account looks like now. He's been shorting investment banks all year. When a CNBC reporter asked which banks he'd recommend selling short, Rogers answered, "All of them." He wasn't kidding.

Fannie and Freddie blew up. Lehman went bankrupt. Morgan Stanley has gone from $44 to $16. Goldman Sachs has gone from $170 to $100. I thought we'd done pretty well by recommending Fannie, Freddie, and Lehman as shorts and warning you about Goldman's accounting. Maybe we should have just taken the Rogers approach: Sell them all. It's probably not too late to follow that advice. It's hard to imagine how Goldman will survive.

What's the problem with the investment banks? They all have borrowed money on a short-term basis and bought assets for the long term, assets that can't be liquidated easily. As asset prices are falling, their creditors want to see more collateral. Some are unwilling to extend their loans – which is what happened to AIG this week. Without access to credit, all of the investment banks will be wiped out, just like Jim Rogers predicted.

Last night, the government essentially took over AIG with an $85 billion loan. The Feds will take 79.9% of the common stock and all of the company's assets as collateral. The loan will also cost the company dearly – about 11.5% per year. In effect, AIG will now operate in "run-off" mode, where the business exists to service current accounts and then disappears.

When the Wall Street jobs leave, so do the attorneys and consultants. Upper East Side bankers are now sitting on retirement portfolios worth at least 50% less than they were last year. And banks, which lease a ton of office space, will need far less square footage. Lehman Brothers was responsible for 2% of Boston Property's (one of the largest REITs) rent revenue. Shares of SL Green, the REIT with the most exposure to New York, dropped more than 24% in less than two weeks.

Here's what I'd love to ask all of these financial managers: Why in the world would you operate your business in a fashion that ensures you can't survive a credit crunch? If you know anything about financial history, you ought to know a severe credit crunch happens about once every 20 years. Credit crunches seem like something you ought to plan for and be ready to take advantage of, instead of something that surprises everyone.

How should you take advantage of the situation? As I've written all year, by buying up shares of super high-quality businesses, with ironclad balance sheets. For Friday's Digest, I'll ask each of our editors to supply you with his top, safest pick. For now, I can tell you buying shares of Verizon (VZ) at these prices (four times EBITDA) is almost a one-way bet.

And if you want extra protection, you can sell a January 32.50 call against your position and earn an extra $2.35 per share in income. Assuming you're able to roll over these calls in January (which you could do if the stock remains at $32), you should make close to $6.50 in income ($1.84 in dividend, $4.70 in options). That's more than 20% in income, owning what's probably the safest cheap stock in the United States. A similar trade is available in ExxonMobil – perhaps the safest stock in the world.

I'm sure you've seen the news about Charley Rangel, the chairman of the House Ways and Means Committee. Classic. After years of complaining the "rich" aren't paying their "fair share," it turns out Rangel, supposedly a public servant, hasn't been paying taxes on the rental income from a Dominican Republic condo. Don't all public servants own luxury condos in far-away resort communities?

Here's my suggestion: Make it against the law to pay Congress a penny unless it balances the budget. And never allow Congress to raise its pay. Make it earn higher real wages by keeping the dollar strong.

New highs: none.

In the mailbag, a crucial test for long-term investors – how to avoid "value trap" stocks. Plus, a subscriber warns we're starting to sound like The Daily Reckoning – a fate worse than death. Send us your comments, good and bad: feedback@stansberryresearch.com.

"This isn't a complaint about your analysts, just a rant. Why is it that so many 'value investors' seem to be unable to tell the difference between value and crap? A year ago, my wife put a chunk of her 401(k) into the Dodge & Cox Stock Fund. We figured with the turmoil in the markets they'd find some good values. So what did they go and invest in? Fannie Mae, GM, AIG, Wachovia, Capital One. Unbelievable. Aren't value investors supposed to know how to read a balance sheet? And don't get me started on Bill Nygren and WaMu. At least Ferris had the good sense to cut his losses in Oakmark Select. Then there's Richard Pzena, Bill Miller, Mason Hawkins, et al. jumping head first into the value trap. Any fund manager wanting to call himself a value investor should take a class in Leverage 101 first." – Paid-up subscriber Brad

Porter comment: That's a great question. And I can't answer for these other investors. But for myself, I've avoided a lot of these situations by looking carefully at two accounting items...

First, I measure the value of a business by looking at its market cap plus all of its net debt. After all, that's the price you'd actually pay if you were to buy the entire company. That keeps me away from any company with lots of debt. Second, I pay a lot of attention to a company's return on assets. Lots of crappy businesses (like securities dealing) dress themselves up with debt, which allows them to make good profits despite having a lousy core business. Consider Goldman Sachs. This most respected Wall Street firm earns less than 1% annually on its assets. Less than 1%. That's not a business, that's a pipe dream.

"I'm a pretty patient guy, but I'm getting REALLY tired of your rants concerning our monetary system, the Fed, Amerika, your comments concerning 'elitist morons', etc., etc., etc. If I'm looking for daily tirades on how the world will end any day now, I'll read the daily emails from The Daily Reckoning (which is now in my spam file so that I don't even see it every morning...) Your daily email is coming very close to the same fate, and that doesn't help you nor I (as I do, from time-to-time, get something useful out of it). Again, if I want this type of commentary, there are numerous sources out there from which I can choose from... If this doesn't quiet down, my next step is the spam filter, and then finally, canceling my subscription. Porter, I do think you're a smart guy, but constantly raising my blood pressure (I'm not kidding – I take medication for it) with some very questionable vitriol just doesn't help me when it comes to making investment decisions..." – Paid-up subscriber Gene Szaj

Porter comment: Gene, I completely agree with your criticism. Nobody needs anyone to point out the problems with our financial system anymore. They are now readily apparent. Our focus will be the assets, corporations, and people who will lead our economy out of this crisis.

"Doctors do not have unions. We are not allowed to by law. Nor are we allowed to join with other physician groups (that are under a different medicare billing number) to negotiate prices with insurers or government. My income dropped 20% last year due to the continued cuts in our reimbursements, while overhead and administrative costs continue to rise. The doctor-patient relation has been virtually destroyed by the combined actions and power of the government and insurance companies. It is becoming increasingly hard to find primary care physicians will see my medicare patients, because they lose money on every case. I generally agree with your philosophy, but you are wrong about physician salaries (they are dropping like a rock) and unions (non-existent)." – Paid-up subscriber PG

Porter comment: I have to wonder if your answer is genuine... It's hard to believe any doctor is this naïve. But I'll play along. The American Medical Association (AMA) is your union. It's one of the most powerful unions in the world. And it has completely co-opted the government to enforce its will. Its purpose, from its founding, is to limit the number of people who could practice medicine and thereby increase the wages of doctors – all in the name of better health, of course. I invite you to learn more about its history on this website.

"Mid 90s, had a handful of positions in the gold mining sector recommended by Doug Casey. Golden Star resources went from around 2 bucks to over $17 a share. At the time, I thought that was normal fare for small stocks. Soon after, I got burned in the Diamond Fields Resources (?) scandal of Mr. Guzmon's making. No I didn't have a stop loss. Yes, in hindsight I wished I would have. I know from personal experience that what you are advising your readers about investing rules is excellent advice." – Paid-up subscriber M.C.

Porter comment: The name of Michael de Guzman's fraud wasn't Diamond Fields. It was Bre-X. And by the way, I happen to know that Doug made a pile of money on that deal. I also know he advised selling it once its market cap grew to an absurd level. So... trailing stops are a surefire way to avoid a big round-trip investment (when a stock goes up and then comes all the way back down). But the other way is simply to know what something should be worth and to sell it when its price becomes silly.

Regards,

Porter Stansberry

Hatteras, North Carolina

September 17, 2008

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