Friday, August 14, 2009

The horror...the horror

"Are you an assassin?"

I'm not sure which scene from Francis Ford Copolla's Apocalypse Now is most analogous to the wealth destruction I've watched in real time over the past two years. On the macro/CNBC level, the broader market meltdown resembles the opening, slow motion, napalm air strike with the Doors' "The End" as the soundtrack. That's what the public got to see as the pretty T.V. people put on their serious face as they came out of commercial. If you go upriver, after passing over the bridge where the whacked out G.I's had no idea who the commanding officer was (which was how I felt the weekend Lehman failed), to the real heart of darkness, it's more like the ritualistic machete hacking Martin Sheen's character deals Marlon Brando's Colonel Kurtz. The battle between two crazed egos, the hunter and the hunted, is choreographed and inter cut with the tribal butchering or sacrifice of the water buffalo. It's almost as if they were killing the fatted calf in some respects.

"I'm a soldier"

A lot of people lost a lot of money. I have clients that lost money. Now, in defense of my and my partner's management style, I feel that we did manage the downside appropriately in our balanced accounts in that only 60% of the downside of the benchmark was (i.e. if the market is down 41%, we would be down 25% percent) "captured". Nevertheless, a loss is a loss. It still sucks. You still get pissed of when the number on your statements is in brackets. As far as my personal investments fared, 2008 and 2009 were the best since I started investing money for myself at the age of 14. OK, I'll brag 59% and 52% respectively, before taxes net of fees. How did I do it? For compliance reasons, I can't go into great detail. I can say that I didn't use options or shorting or commodities. I did follow Baron Rothschild's dictum of "…buy when you hear the cannons…sell when you hear the violins." Again, in defense, when clients asked me what I was doing with my money, I shared my strategy with them. Their reaction was either "Are you insane?" or "Whoa! That's way too risky for me." That's what frustrates me about my job, sometimes. When was the last time you second guessed your doctor before a triple bypass?

"You're an errand boy…sent by a grocery clerk to collect a bill"

-25% here, -18% there, -41% everywhere. Those numbers are merely annoyances when compared to some of the carnage lying around financial ground zero: bank stocks. Because of their perceived conservative image, bank stocks have always been a haven for the widows and orphans style investor. Low price to earnings ratios, low price to book value ratios, generous dividends have always been their repp tied, buttoned down allure. My grandmother was a public school teacher. Her husband (the grandfather I never got to meet) died in 1960. He left behind a relatively small investment portfolio that included a municipal bond, a few shares of an electric utility and 90 shares of a local bank. Ironically, an old broker I worked with at the beginning of my career had handled my grandfather's account when he was alive and bought those shares for him. My grandmother never reinvested dividends and enjoyed the check she got every quarter. Through mergers and splits over the course of 40 years, she wound up with 11,000 or so shares of a large regional bank that was valued at around $500,000. Not a mint but not bad for a widowed math teacher who saved wrapping paper and didn't cook. Honestly, I saw her cook maybe twice. Both times it was terrible. No wonder my father puts ketchup on everything. Those dividends helped pay for school tuition, bar mitzvahs, a couple of trips to Israel and Europe, a comfortable little apartment in a retirement community and nursing home care in the last few years of her life. That was then. This is now. Today $500,000 would be worth about $50,000. Luckily, she died at the top of the market and the inheritance was passed along and spent or diversified. Again, $500,000 turned into $50,000.

I'll throw out some bigger numbers. One of the largest individual shareholders of a large regional bank owns around 4 million shares. At the top he was worth around $151 million. Today, he clocks in at a beggarly $22.5 million. While $22 million is nothing to sneeze at, your lifestyle will change even at that level. Honey, we're going to have to sell the Gulfstream and the house in Maui. Chin up.

"…a snail crawling on the edge of a razor"

Now, let's say you were a lifer at the same regional bank. You worked your way up from an assistant branch manager in the worst neighborhood in town to upper mid-level or lower upper level management. You're pushing 60 and are on the cusp of retirement. It's highly probable you've collected $1million worth of the bank's stock in your various retirement and stock purchase plans. That $1million is now worth around $150,000. Golf four days a week? Probably not. A paper route? Highly possible. This story is hypothetical, but the battlefield is littered with real bodies with the same story.

I have a client who , like my grandmother, had accumulated regional bank stocks. In a recent conversation, he mentioned that he was back to his cost basis. He'd been collecting it for the last 25 years. As I write this, a large bank in Alabama has entered FDIC receivership which means, that for all intents and purposes, the institution has failed. One of the largest individual shareholders position was worth over $30 million at one point. Before they halted trading this morning it was worth $1.7 million. Again, like the detective story says, the city is filled with a thousand stories.

"Charlie don't surf!"

And if Charlie owns bank stocks he doesn't sell either, especially if he worked there. Where was he during the whole Enron clusterfiretruck? That was almost a decade ago. Why did these people hang on like a battered spouse? Emotional attachment maybe. "Well Daddy and Grandaddy did business with ' bound to come back." I'd love to be an optimist. However, the market, love it or hate it, is a pricing mechanism. Usually, its pretty irrational. Hell, I'd say its bipolar. We're either going to the moon drinking champagne with Vegas hookers in a hot tub full of money in a stretch Hummer limo or the world is going out of business, there'll be no electricity or cable, we'll be riding bicycles and we'll be growing radishes in our front lawn. This time, as far as the bank stocks are concerned, I think the market is batting close to a thousand. I'll veer from Apocalypse Now and quote one of the last lines from Planet of The Apes: "YOU MANIACS!!! YOU BLEW IT UP!!!" They're trading based on fundamentals here and the fundamentals are terrible. The bank stocks deserve these prices. They earned them.

Trillions of dollars evaporated. Butchered like the water buffalo on the patio of Colonel Kurtz's Mekong chateau. One regional bank, historically had paid an annual dividend of 83 cents per share. That dividend is now 4 cents. The journey upstream back to 83 cents will be long and dangerous. Put on your flak jacket. Buckle your chin strap. Lock and load.

-Jake Stein

Tuesday, July 28, 2009

Well..How Did We Get Here?

David Byrne of the Talking Heads isn't just a genius. He very well may be a prophet. We all should have paid closer attention to the lyrics of "Once In A Lifetime" and "Burnin' Down The House" before 2007. It would have been better than having a crystal ball.

And you may find yourself behind the wheel of a large automobile…

It's easy to blog-n-rail on the culprits of our current, painful, economic mess. The usual suspects are marched through the lineup: Wall Street, corrupt politicians, the Federal Reserve, deregulation, the Rich, speculation, the media, conspicuous consumption, and the list could go on for days, weeks, or years.
If you were to take all of the guilty out to the courtyard to face a Spanish Civil War style firing squad, you will definitely need plenty of bullets, blindfolds, and cigarettes. In the final analysis, though, easy access to credit on both the commercial and consumer level gets to wear the hair shirt. Post 9/11, the auto industry opened up the hydrant with zero percent financing. I'll admit, I drank some of that Kool Aid. I later escaped from that scenario by the skin of my teeth thanks to four dollar a gallon gasoline and some fuzzy math on the back of a Steak-n-Shake menu. Our family bought a blinged out, Sport Utility Behemoth around 2004. "Hey, zero percent, that's a deal!" I thought. The reality was that this was the largest monthly car payment (in excess of $500) our household had ever shouldered. Our mortgage payment has always been around $900 (we're different; we've lived in the same house for 16 years. More on houses in a bit). This meant that the car payment was more than half of the mortgage payment. We were paying an ass load of money for an "asset" that lost $5000 in value the minute we bought it versus what I considered a modest payment on an asset that seemed to be appreciating in value. Or at least, so we thought.

And you may find yourself in a beautiful house…

As a consumer, I never really understood the housing bubble. As a professional, I understood it perfectly. My wife and I came very close to building a house pre- 9/11. We had purchased a lot down the street from the house we still live in. The lot was financed by, drum roll please, home equity, which, naturally would be paid off when we sold that house. We never even got past the house plans selecting stage of the process. I seem to remember every conversation ending with me saying "Well, I'm sure you and your next husband will love that house." Some couples can build a house together. Some can't.

While we were arguing over French doors, two planes smashed into the World Trade Center and changed the world as we knew it forever. I was concerned about the financial future, so, we agreed to sell it. A handsome couple with matching bleached teeth and tasteful cosmetic surgery, who lived around the corner, bought it for what we paid for it and built a McMansion. Good for them. That's the extent of my participation in the housing bubble. My wife would always comment about how cookie cutter all of the newer neighborhoods looked. If you were paying that much for a house, wouldn't you want something unique? Again, we moved in to our house in 1993. We're still there. Our oldest son just turned 10. I plan to stay there as long as I can walk up the stairs.

Hold tight, wait 'til the party's over/Hold tight, we're in for nasty weather...

Okay, I'm jumping around a bit. David Byrne was equally and frighteningly prophetic in "Burnin' Down The House", which I always thought was one of the Talking Heads' weaker offerings. It was a smash hit. Shows you what I know. And that's why I play Rock Band with my sons instead of playing Budokan.

My professional understanding of the Housing Bubble was crystal clear: greed and stupidity which is usually the gas that inflates most financial bubbles. I was fortunate in that I got to watch the financial fall out from the bursting of the Tech Bubble in real time from the trenches. Greed and stupidity were smoking crystal meth and taking steroids. One of my favorite quotes from a client while I tried to discourage him from taking a position in some stock that had a "dot com" in the name and was trading at $110 a share (and the company would NEVER earn any money) was "Yeah…I know. But technology's gonna stay." Really? I thought it was going to hang out for a bit, leave with someone else's date and we'd be left holding the bag, in the dark, and communicating via smoke signals. I had a pretty good idea before but that conversation confirmed my belief that things were going to end badly.

So, when things did end badly (2000-2002), where did a well informed thanks to CNBC, Money magazine and the rest of the financial pornography, put their money? Ah yes…land. They weren't making it any more and property values always seemed to be heading northward. Best of all, you didn't have to worry about the wild swings of the stock market and you could even get rental income. If I had a dollar for every client that pulled money out of financial investments to go into real estate, I'd have about a hundred bucks. Don't laugh. I can stretch a hundred dollars like it was a piece of Super Bubble.

I would ask clients if they were afraid of the iliquidity real estate presented. It was really more of a suggestion and, no surprise, one that fell on deaf ears. Now, let me make a clarification. These were non-professional real estate investors: doctors, dentists, small business owners, trust fund babies. Throughout my career, I've been fortunate enough to work with a hand full of smart, successful, and prudent commercial real estate developers. They understand risk completely and manage it accordingly. They build distribution hubs for shipping companies, class A office buildings, or real shopping centers anchored by big box clients. The aforementioned amateurs wanted to flip houses, buy rent houses, do condo pre-sales, or waterfront property. If they did venture into "commercial" real estate, it was developing a slapped up strip mall anchored by a Subway and a nail salon. 98% of the time, they paid too much for the dirt as well. "But, its just gonna keep going up". One: take loaded gun. Two: insert in mouth. Three: pull trigger.

Then came the "Everybody's A Homebuilder So I Can Have A Contractors Account At Home Depot" boom. Everybody was a building a "spec" house. That would be a house you built, usually with borrowed money, before you had a buyer with a goal of selling it before completion for a gain. When I say "EVERYBODY" I mean, almost literally, everybody. People from all walks of life: retirees, firemen, the guy who runs the cafeteria at you kids school, mother in laws, brother in laws, mother in laws AND brother in laws. Now, I would be the last person to scoff or discourage anyone from dreaming the American dream, but sometimes it pays to stick to one's knitting. A lot of the behavior I witnessed during the "Everybody's A Homebuilder So I Can Have A Contractors Account At Home Depot" boom, at times, matched the frenzy of the Dot Com Bubble. This guy was making money hand over fist or this person knocked the cover off of the ball and has a huge boat and house at the beach now.

Everybody associated with the boom made an assload of money: realtors, the photography studios that had to take those glam shots of the realtors, the guy who made the magnetic signs to stick on the doors of realtors Lexus, the Lexus dealership, etc. etc. It’s a safe bet that the beneficiaries of the beneficent fallout were building spec houses, too. The difference was that people were rolling the bones on a tangible, yet, highly illiquid asset. A ticking financial time bomb with granite counter tops, if you will. Eventually, bombs explode and destroy shit.

Into the blue again. after the money's gone...

Ah, back to "Once In A Lifetime". The money partied like Pacific fleet sailors in Thailand on payday. Watching from my professional perch, I could spot signs that things were at or near full tilt boogie. A prospective client was referred to me and my partner. He was a 28 year old salesman who worked for a large commercial lumber distributor. He had made $329,000 that year. Selling wood. Not curing cancer. Selling wood. Apparently, I picked up the wrong brochure on career day. Again, I had a sneaking suspicion things were going to end badly.

My God! What have I done!?

It ended very badly. We filled our shiny new houses and driveways with shiny new stuff. And here we are. Overextended, overbought, overpriced, over stimulated, bowing to the neon (or plasma) god Simon and Garfunkel described in the "Sounds of Silence". Where do we go from here? Maybe the Talking Heads got their prophecy fulfillment on in the tune "(Nothing) But Flowers"

This was a Pizza Hut
Now it's all covered with daisies
you got it, you got it

I miss the honky tonks,
Dairy Queens, and 7-Elevens
you got it, you got it

And as things fell apart
Nobody paid much attention
you got it, you got it

Same as it ever was. Same as it ever was.

Thursday, July 9, 2009

Welcome To The Brand New Normal

Well, here we are. Twenty years ago, if anyone had told me the world and its financial systems would look like this, I would've immediately asked them if they had any more of what they were smoking. I'm not completely surprised, though. Twenty years ago (plus one or two) I was an amateur musician, a semi-pro beer drinker, and a professional history student. Twenty years later, I am still using the history book smart skills effectively, I think. Especially now.

To give credit where credit is due, the title for this soon to be bi-weekly piece was inspired by Pimco CEO Mohammed El-Arian's May 2009 secular outlook published on the firm's website. Pimco, if you're not familiar, is an investment management colossus whose fingers, eyes, ears, and anything else sensory are glued to the global financial/economic pulse and have always had the Batman like ability to skate to where the puck is going to be. Mr. El-Arian's thesis, to crudely synthesize it in twenty words or less, is that, financially speaking, it’s a whole new ball game for all of us. That means no more Hummers. No more football field sized plasma televisions purchased with a fifty thousand dollar limit Visa platinum card. No more McMansions. Net, net, it'll be a looooooong time before Wall Street slickee boys can drink champagne with hookers in hot tubs full of money again. But, will that really be a bad thing going forward?

Ah yes, the going forward. How bad is it out there? I'm no old salt but I've been around the track enough to have an opinion. It's fairly bad. Ugly when compared to the Pax Romana consumer toga party. Again, I'm a B-league historian and the 1929-1930's similarities are eerie. The market charts sync up. The socioeconomic/political environment was the same: a corrupt, inept, do nothing, deregulate everything Republican administration, widening disconnect between the haves and have nots, the widespread democratization of equity investment where EVERYONE is a friggin' expert, especially your brother-in-law. There are some differences, specifically the Fed's quickness to pull the market liquidity trigger. But like Mark Twain said: "History doesn't always repeat, but it usually rhymes."

I plan to touch on a lot of topics related to how we got here and where I think we're going in future posts and, naturally, those posts will be opinion driven by, well, my opinions. Allow me to clarify some things upfront. I'm not a gun toting conservative. I'm not a bike riding liberal. I hate the Rush Limbaughs, the Glenn Becks, the Anne Coulters, and the other cartoon conservatives who appeal to the lowest common denominator with their racism, bile, and stupidity. I despise the limousine liberals and the Volvo democrats whose pity and guilt create handouts and enablement that seems more condescending then those who actually are condescending, not to mention their P.R. stunt activism. I've never considered the Kennedys national heroes. Based on their conduct and behavior, they might as well build a trailer park at Hyannis Port. I once took an online political quiz. I scored "libertarian". I've been to a libertarian presidential convention. Those people are insane. God help us if they get elected.

I'm certain I will write something that will piss you off. So be it. That's the beautiful thing about America. We can do that to each other and still peacefully coexist. Feel free to leave comments. I might post them. I might not. As long as it's clean (profanity is allowed though, for emphasis and in context), non-violent, and pertains to the topic, its fair game.

That being said and all things being equal, let the game begin.

-Jake Stein