One of the best lessons I've learned over my career as an investment analyst is the myth of excellent management or "great execution" is really just that – a myth.
When I see companies in troubled industries reporting quarter after quarter of great results, while all of their peers are getting killed, I know a fraud is going on. I remember in the early 2000s, WorldCom kept reporting profits when all of the other long-distance carriers were getting killed. I knew it couldn't last. And it didn't. WorldCom's accounting was revealed to be a fraud – the company was counting its network access costs as capital expenses. Once the real numbers came out, the company collapsed in what was the largest bankruptcy in American history at that point.
About three years ago, I saw Goldman Sachs reporting quarter after quarter of unbelievable results when all of the other investment banks were hurting. I spent a lot of time looking at its numbers – which didn't make any sense. It reminded me of Enron. It kept reporting bigger and bigger profits, but lost more money every year in cash. And its debt balances kept growing.
I wrote a lot about this in The Digest, but I never officially recommended shorting Goldman in my newsletter because I literally couldn't figure out how Goldman Sachs was doing it. I couldn't find the smoking gun... but I knew a giant fraud would be discovered there, eventually.
In October 2008, I figured out part of the big secret: Goldman had insured all of its subprime exposure via AIG. This allowed it to book huge profits on its subprime investments long before they were actually paid off because the bonds were insured. Of course, it was all a sham – AIG didn't have nearly enough money to pay off any of the insurance. (See the October issue of PSIA for more details.) A source close to the company even told me how big the exposure to AIG really was – $20 billion. That's roughly 100% of the profit Goldman claimed in 2006 and 2007, at the height of the credit bubble. Goldman completely denied my report and claimed it had zero exposure to AIG.
As was subsequently revealed in the spring of 2009, my report was right on the money. Goldman had roughly $20 billion in exposure to AIG and received roughly $14 billion of money the federal government used to bail out AIG.
But I completely missed one big part of the story... And once this fact becomes common knowledge, it will probably mean jail time for several leading Goldman executives and the end of the firm. What did I miss? The entire Goldman-AIG relationship was a complete sham. Let me explain...
Goldman eventually admitted it had insured roughly $20 billion worth of subprime CDOs with AIG and had major exposure to the firm. But the New York Federal Reserve and Goldman Sachs never revealed this critical fact: Goldman didn't merely buy insurance on a bunch of random subprime CDOs. It actually bought insurance on special CDOs it had put together and sold to its own clients. In other words, Goldman knew more about these CDOs than anyone else. Goldman bought insurance on these CDOs because it knew they'd collapse.
This is tantamount to building a house, planting a bomb in it, selling it to an unsuspecting buyer, and buying $20 billion worth of life insurance on the homeowner – who you know is going to die!
These facts all came to light because of research done by the office of Darrell Issa, the ranking Republican on the House Committee on Oversight and Government Reform. These new documents will certainly lead to a full investigation of the Goldman-AIG dealings and the subsequent $180 billion bailout led by the New York Federal Reserve. My bet? Heads will roll. If you own Goldman Sachs, you'd better sell.
In Jeff Clark's S&A Short Report today, he found another company that's numbers look too good to be true... Every earnings announcement is beating Wall Street's expectations. The media is showering praise on this company. The stock is up 200% in the past 15 months. In the last week alone, the stock has gained 50%. As Jeff said, this business "is firing on all cylinders. It's hard to imagine business getting any better - which can only mean one thing... It's bound to get worse." Jeff has developed a short trade around this Wall Street darling that he says will return 150% by next month. To sign up for Short Report, and ride Jeff's amazing hot streak, click here...
In the fourth quarter, the default rate for commercial properties more than doubled to 3.8% from 1.6% a year earlier. The default rate for apartment buildings hit 4.4% from 1.8%. U.S. banks with between $100 million and $1 billion in assets hold 25% of outstanding commercial property loans (a higher concentration than larger banks). And this increase in defaults (one real estate research firm expects defaults to hit 5.4% by the end of next year) is keeping these banks from lending. With no good loans to flush out the bad, these banks are just sitting, waiting to go bust. But as we pointed out yesterday, the FDIC can't afford to take these banks over. So they will sit longer, letting rising defaults eat into their deteriorating equity. Eventually they will explode.
Extreme Value editor Dan Ferris has researched the entire community banking industry and found one bank that's a particularly juicy short. This bank nearly doubled its commercial property loans during the real estate boom. And 35% of its loans are from Arizona, California, and Nevada (the three most troubled states). Dan expects this bank will write down some $4 billion in loans, although its market cap is less than $3 billion. The fundamentals of this bank are eroding (it looks like a blatant zero), but it rallied huge with the rest of the market in the past several months. The recent action spurred Dan to reinitiate this short position. When the market wakes up to the disaster in low-quality commercial real estate, this bank will crash... quickly. If you're looking for a great way to hedge your portfolio from the recent market gains, Dan's short position is the perfect thing. To access Extreme Value, click here...
For a record fifth quarter in a row, states saw a large drop in tax collections. Nationwide, tax revenue fell 4.1% in the fourth quarter from a year earlier. Seven states (Montana, Alaska, Wyoming, Arizona, Oklahoma, Texas, and Georgia) saw tax revenue fall more than 10% in the fourth quarter. You can bet governors of these states won't cut the size of government in response... which means you can bet we'll see soaring rates of state income taxes. Get ready to move to an income-tax-free state, like Florida (where I live now because of huge tax hikes in Maryland).
New highs: Tejon Ranch (TRC), IMS Health (RX), Jinshan (JIN.TO).
In the mailbag... a good question about Internet-based hecklers. What would you do about them, if you were us? Send us your ideas: feedback@stansberryresearch.com.
"Just where did you reference the govt. official, (senator?, congressman?) who wrote a paper on; 'And discussions are underway right now in D.C. about taking all 401(k) savings and "exchanging" them for new government securities to "insure" the retirements of the American people.'??? I've been hacking through months of past Digests, and either I need a course in speed reading, or it was covered somewhere else. I remember there was a link to a paper the chap published outlining this wonderful strategy, which I can't wait to embrace.
"Thing is, I've been yelling at my friends to read this, and I can't actually point them to what to read. Internet searches are not returning any hits, how can that be? This must, MUST, be about the most important storm cloud on the horizon for anyone who has saved more than ten bucks for retirement. Could you please refresh my memory on this, not least to help me stop sounding like a total plonker (ask Dyson), to my friends." – Paid-up subscriber Alan
Porter comment: The effort is being spearheaded by Mark Iwry, who wrote a book on the idea while at the Brookings Institute. His idea is to "push" people to purchase a government-backed annuity with all (or most) of their 401(k) balances. This, he argues, will insure a safer retirement than investing in stocks, bonds, or mutual funds. Why Iwry believes the government can do a better job with your retirement savings than you can isn't clear.
Nevertheless, Obama created a special new position for him at the Treasury Department – Senior Advisor for Retirement and Health Policy. According to Treasury's press release, he is also responsible for formulating the administration's policies on: "pensions, retirement savings, health care, and executive compensation." If you want to see the guy who thinks he knows what's best for your retirement savings... you can learn more about him here.
Oh... by the way... like almost everyone else in a senior position with the Obama administration, he went to an Ivy League school (Harvard) and has zero real-life business or investing experience. He's just the kind of person you'd want to keep as far away from your savings as possible.
"My cousin and I made our first farmland (wheat) purchase in Montana the end of 2008. We had our first harvest this past August and we just closed out our books for 2009. We learned a lot and I feel this farmland will be one of the best investments that we will own for years to come. I would be happy to share what we did right and what we did wrong and what we would do differently with any of your subscribers that may want to directly own farmland. Thanks for your daily updates and point No. 4 (owning a productive farm)/surviving a crisis prompted me to write in." – Paid-up subscriber Greg Gehlen
"How do you guys respond to people out there that think you guys are a bunch of con artists and scammers? I personally don't think you guys are... I think you are doing the best you can, but what say you?" – Paid-up subscriber Alan Church
Porter comment: That's a very good question, one I've wrestled with for a long time. I used to believe I should respond to every accusation... but it didn't seem to do any good at all. Most of the people who criticize our work (or our reputations) online are anonymous. And there's always another critic and more and more accusations, each one slightly crazier than the last.
After being in business for 10 years, I don't think I have anything left to prove in regard to my character, my reputation, or the value of our products. We've built the largest and most successful independent financial advisory in the world. We have more than a million readers around the world. And we have satisfied subscribers in more than 200 countries.
We built this loyal customer base by always being on the right side of the trade – the customers' side. We've never taken money to write about a stock. We don't even allow our analysts to buy the stocks they recommend to you because we don't want there to be any way possible for anyone to accuse us of having a conflict of interest. We only serve our subscribers – and we offer a money-back guarantee on nearly everything we publish. I don't know how we could do business in a fairer, more transparent way.
Our reputation for honesty and integrity is well known in the industry. Talented analysts now approach us looking for an opportunity because they want to work in a place where nothing comes before the quality of our products.
Of course, that will never stop anyone from criticizing us. So I've just come to accept it. I'm certainly not going to change the way we do business or the sharp edges of our editorial. We don't pull any punches. When I wrote GM would go bankrupt, I didn't expect GM shareholders to write me thank-you notes.
You must remember, we're not right about every stock we recommend. When we get it wrong, the people who have lost money following our advice get very angry. (They didn't follow our advice on position size or trailing stop losses... They didn't take our advice when we said it was time to get out... but it's still our fault they lost 50% of their life savings.) I'm sure you know people like this. They're going to say bad things about us. We can't do anything about it – except keep doing a great job, keep producing good overall track records, and keep publishing great insights.
We wouldn't have been so successful if we hadn't been right far more often than we've been wrong. I know for a fact that we've made lots of people enormous amounts of money over the years with our research – millions and millions of dollars. That's how we've built the trust of thousands and thousands of people.
So... what matters to me when it comes to my reputation? My track record and the relationships I've built. I have never been sued by a customer, an employee, or a partner. I've never even had a serious disagreement with any customer, any employee, or any of my partners. In fact, I've had the same business partners since the day I started in this industry nearly 15 years ago. And I've been best friends with my lead editor (Steve Sjuggerud) since I was 12 years old. These people know me, they know my character, and they know the value of our work.
It's my goal to make Stansberry Research the most trusted name in investment research, all around the world. We'll do that by serving our customers faithfully. And as long as we do that, it won't matter what a handful of nut-jobs on the Internet say about us.
"I have been a member for probably 4 yrs now. While I have known for all this time your dislike for our gov't or almost any gov't, your Monday's article regarding our demise was quite upsetting. We should stock up on ammo?? Should we rebuild the shelters built in the '60s during the Cold War? Buy a farm? Get another passport? Why? Our present one will not be accepted? You keep comparing us to the Argentinean Gov't. Is our society as unstable as that of Argentina? Is there ANYONE in the US gov't that can lead us out of your dire consequence? Why are you still living in Baltimore with your family if you believe we need to stockpile ammo? Do you want to bring up your children in that kind of society? While it is no doubt our financial well-being is in question, do you really think we need to stockpile gold in our safes along with medicine and ammo? If that be the case, we should pack our bags and head to where?" – Paid-up subscriber Stu Schwartz
Porter comment: Show me the example in history where a nation survives without a violent revolution after adopting paper money as its only standard, ringing up enormous foreign debts while fighting multiple wars, and relying on a tiny fraction of its population as its revenue base. Or... simply show me any democracy in history that survived after more than 50% of its population stopped paying taxes. Show me any economy that thrives after raising marginal income tax rates to more than 50% (which is what will happen in the U.S. if Obama's latest health care bill passes)...
There is no doubt our country is heading toward a crisis.
We have already begun to default on our foreign debts, which are enormous – roughly $2 trillion per year in foreign credit is currently required to meet our funding demands. If our creditors abandon our currency (and they have begun to do so), the resulting inflation will destroy what remains of the middle class in America.
The fact is, our government has promised a level of income and security it cannot possibly deliver. No country in the world can afford a government sector that's more than 30% of the economy for long. And we – the largest debtor nation the world has ever seen – certainly cannot.
Rather than facing any of these problems, we have elected the most liberal president in our country's history – someone who has promised to "spread the wealth" and expand the role of government across our entire economy.
Over the next 10 years (if not much sooner), the reality of our fiscal situation will become impossible to hide. And whom will the masses blame for the resulting chaos? What would happen for example, if inflation went to 20% annually and interest rates soared to 30%-40% annually? What would happen in that situation if someone killed the president... or blew up a bomb in the capital? I don't know if any of these things will happen, of course. I only know that when countries get this far into debt, their financial system is this fragile, and so few people contribute meaningfully to the finances of the government, very, very bad things always happen.
I don't believe America is immune from the laws of economics or human nature. And so, in Monday's Digest, I told you some simple things you can do right now to help protect your family in the crisis that's sure to come. Here's the best part... If I'm wrong and there is no crisis, doing these things won't hurt you. There's no downside to owning foreign real estate, saving gold, or having an emergency stockpile of food, ammunition, and medicine.
As for me, I'm not buying ammunition. I'm built for pleasure, not for fighting. So I've simply designed an "escape pod." I have a nice boat on the dock right behind my house in Miami. I can safely leave the country – at any time – with most of my wealth, within 24 hours. I'm building a house on the water in a safe foreign country that doesn't have any ties to America (Nicaragua). I've moved a significant amount of my savings out of the country – legally. I'm pursuing a diplomatic passport to ensure any attempt to restrict travel out of the country won't stop me.
Lots of folks might be critical of these steps. Believe me, I could not care less about what they think. It's not my job to save the U.S. from its own folly. It's my job to make sure that my family is safe. Only an ignorant fool would look at what's happening with our finances, our military, and our government and not realize we're moving in a dangerous direction that's not likely to have a happy ending.
Regards,
Porter Stansberry and Sean Goldsmith
Baltimore, Maryland
February 24, 2010