Long and Strong

Today I bring you three more readings - each of which is relatively lengthy.

James Quinn does a pretty thorough job providing a plethora of evidence attempting to illustrate the paradigm shift in the behavior of the American consumer - and why the spending habits we're used to will not return for many years.

"There's a lady who's sure
All that glitters is gold
And she's buying a stairway to heaven

When she gets there she knows
If the stores are all closed
With a word she can get what she came for

Ooh, ooh, ooh, ooh, ooh
And she's buying a stairway to heaven

Led Zeppelin – Stairway to Heaven

She was buying the stairway to heaven using her home equity line, but now that she is underwater on her mortgage she tried to pay using her Amex card, but her credit score had dropped to 600 and they cut her credit line in half. The stairway to heaven isn’t as easy to achieve as it used to be. Barney Frank and Nancy Pelosi feel bad for the lady. They are going to borrow against your children’s future tax dollars and give them to the lady, so she can buy that stairway to heaven. By making this deal with the devil, the corrupt politicians running this country have put us on an escalator to hell. A straight shooting blunt President from last century described what would destroy America.

“The things that will destroy America are prosperity-at-any-price, peace-at-any-price, safety-first instead of duty-first, the love of soft living, and the get rich quick theory of life.”

Theodore Roosevelt"

Quinn's piece is not nearly as wingnut right wing as that quote sounds - and it's certainly worth reading for what I believe is accurate, unbiased data. I had to quote that whole opening, because he went with a great segue from the great Led Zeppelin quote to an even better and more applicable Teddy Roosevelt quote.

After you're done with Quinn's annihilation of the retailers, check out "The Secret History of Bear Stearns' Collapse, from CNN, excerpted from House of Cards: A Tale of Hubris and Wretched Excess on Wall Street by William D. Cohan

There is a fantastic segment about the valuation of the CDO portfolio, where the managers get marks from multiple Wall Street dealers. While most counterparties valued the assets at 98 cents on the dollar, Goldman Sachs provided a valuation of 50. At first it seems that GS is the bad guy, accused by a former BSC exec of trying to mark the portfolio lower in order to profit on a short position GS had. However, Goldman's Gary Cohn explained the real story:

"He (Cohn) then shared an anecdote about a conversation he'd had with Nino Fanlo, one of the founding partners of KKR Financial Holdings, a specialty finance company started by KKR, the private equity shop. After Goldman sent out the marks in the 50¢ to 55¢ range, Fanlo called Cohn and told him, "You're way off market. Everyone else is at 80, 85." Cohn then offered to sell Fanlo $10 billion of the paper at his 55¢ price and encouraged him to sell that in the market to all the other broker-dealers at the higher prices they claimed to be marking the paper at. In other words, Cohn was offering Fanlo a windfall: buy at 55 and sell at 80. "You can sell them to every one of those dealers," Cohn told Fanlo. "Sell 80, sell 77, sell 76, sell 75. Sell them all the way down to 60. And I'll sell them to you at my mark, at 55, because I was trying to get out. So if you can do that, you can make yourself $5 billion right now."

Cohn had been trying to sell the securities at 55 for a period of time and people would just hang up on him. A few days later, Fanlo called Cohn back. "He came back and said, 'I think your mark might be right,'" Cohn said. "And that mark went down to 30."

Cohn said the market changed dramatically through the course of the year. "We marked our books where we thought we could transact because some of this stuff wasn't transacting," says Cohn. "We sold stuff at 98 and marked it at 55 a month later. People didn't like that. Our clients didn't like that. They were pissed."

Finally, check out Michael Lewis's lengthy Vanity Fair piece on Iceland.

"I spoke to another hedge fund in London so perplexed by the many bad LBOs Icelandic banks were financing that it hired private investigators to figure out what was going on in the Icelandic financial system. The investigators produced a chart detailing a byzantine web of interlinked entities that boiled down to this: A handful of guys in Iceland, who had no experience of finance, were taking out tens of billions of dollars in short-term loans from abroad. They were then re-lending this money to themselves and their friends to buy assets—the banks, soccer teams, etc. Since the entire world’s assets were rising—thanks in part to people like these Icelandic lunatics paying crazy prices for them—they appeared to be making money. Yet another hedge-fund manager explained Icelandic banking to me this way: You have a dog, and I have a cat. We agree that they are each worth a billion dollars. You sell me the dog for a billion, and I sell you the cat for a billion. Now we are no longer pet owners, but Icelandic banks, with a billion dollars in new assets. “They created fake capital by trading assets amongst themselves at inflated values,” says a London hedge-fund manager. “This was how the banks and investment companies grew and grew. But they were lightweights in the international markets.”

The parallels to the United States are startling.

Lewis then explains how Iceland put itself on the map in the early 70's, by transforming their fishing industry:

"Fishermen, in other words, are a lot like American investment bankers. Their overconfidence leads them to impoverish not just themselves but also their fishing grounds. Simply limiting the number of fish caught won’t solve the problem; it will just heighten the competition for the fish and drive down profits. The goal isn’t to get fishermen to overspend on more nets or bigger boats. The goal is to catch the maximum number of fish with minimum effort. To attain it, you need government intervention.

This insight is what led Iceland to go from being one of the poorest countries in Europe circa 1900 to being one of the richest circa 2000. Iceland’s big change began in the early 1970s, after a couple of years when the fish catch was terrible. The best fishermen returned for a second year in a row without their usual haul of cod and haddock, so the Icelandic government took radical action: they privatized the fish. Each fisherman was assigned a quota, based roughly on his historical catches. If you were a big-time Icelandic fisherman you got this piece of paper that entitled you to, say, 1 percent of the total catch allowed to be pulled from Iceland’s waters that season. Before each season the scientists at the Marine Research Institute would determine the total number of cod or haddock that could be caught without damaging the long-term health of the fish population; from year to year, the numbers of fish you could catch changed. But your percentage of the annual haul was fixed, and this piece of paper entitled you to it in perpetuity.

Even better, if you didn’t want to fish you could sell your quota to someone who did. The quotas thus drifted into the hands of the people to whom they were of the greatest value, the best fishermen, who could extract the fish from the sea with maximum efficiency. You could also take your quota to the bank and borrow against it, and the bank had no trouble assigning a dollar value to your share of the cod pulled, without competition, from the richest cod-fishing grounds on earth. The fish had not only been privatized, they had been securitized."

He concludes with a comment that sounds to me like he's talking about America:

"When you borrow a lot of money to create a false prosperity, you import the future into the present. It isn’t the actual future so much as some grotesque silicon version of it. Leverage buys you a glimpse of a prosperity you haven’t really earned."

-KD