This past weekend, The Lamb returned to his alma mater to watch his Michigan Wolverines take on the ninth-ranked Wisconsin Badgers. Along with 109,832 others, he watched as Michigan pulled off the biggest home comeback in school history in what was the 500th game at Michigan Stadium.

The great thing about comebacks, assuming that you are the on the right side of them, is that they are not only such exciting experiences, but they are also so surprising. The bigger the comeback, the greater the excitement and the surprise.

Though the odds seem long and sentiment keeps vacillating between negative and dire, many of the major asset classes are crossing their fingers and hoping for a comeback of their own.

“Markets hate uncertainty” is a common refrain in financial circles. But the proposed Bailout Bill, christened “The Emergency Economic Stabilization Act of 2008,” currently slugging its way through Congress may remove some of the uncertainty hanging over the markets. A look at the 52-Week charts of some asset classes is not for the faint of heart, but these assets may just be setting the stage for their own comebacks.

Equities (S&P 500 Index):

Source: www.bigcharts.com

Investment Grade Corporate Bonds (LQD Exchange-Traded Fund):

Commodities (Dow Jones AIG Commodity Index):

Real Estate (S&P/Case-Shiller Home Price Index):

Source: Standard & Poors

… and while C is for “Comeback,” and many of us are hoping for these charts to begin making a U shape, let us not forget that above all C is for…

 
Disclosure: The Lamb owns SPY, LQD, GLD, USO, DBA, and a New York City co-op.

Though the fat lady has yet to sing, The Lamb can hear her warming up her vocal chords in the backrooms of Congress.  Treasury Secretary Paulson is on the verge of getting his way and being allocated up to $700 billion dollars with which to purchase assets that no one else seems to want.

The proposed Troubled Asset Relief Program (TARP) struggling its way through Congress likely will have several parts.  Yet, the guts of the plan boil down to this:  you, The Lamb, and every other taxpayer will become the proud owners of some $700 billion of assets which the current owners no longer want.  Actually, that’s not quite accurate.  We may shell out $700 billion, but it is highly unlikely that we will receive assets worth anywhere near that amount.

Let’s, for a moment, give Mr. Paulson (and Federal Reserve Chairman Ben Bernanke) the benefit of the doubt.  They argue that in addition to steps already taken to bail out, insure, shore up (or whatever other term they want to use) the country’s most critical financial institutions, taxpayers must now help more of these companies rid themselves of so-called TAs (troubled assets).  The rationale, it goes, is that these TAs are impairing companies’ balance sheets and restricting their ability to lend money to other companies and to Joe and Jill Taxpayer in the form of credit lines, mortgages, car and student loans, etc., thus crippling the economy.  Therefore, the only way to get the economy back on its feet is to remove these TAs from Corporate America’s collective balance sheet, or at the very least, to provide insurance for them, which is a distinction without a difference.

OK, fine.  The Lamb might not like or agree with this, but he can live with it.  What infuriates The Lamb is that we are going to be asked to pay above-market prices (via insurance or outright purchase) for these TA’s, a clear violation of The Lamb’s Rule #4– “An asset is only worth what someone else is ready, willing, and able to pay for it.”  The Treasury appears “ready” and “able” to overpay for these TA’s, but The Lamb will certainly not be going along “willingly.” 

And as any economics professor will tell you, when the price paid for an asset is greater than the market price, there will be a surplus supplied by sellers.  Think about it– if there was someone willing to pay 125 cents for a dollar bill, how many dollar bill sellers would there be?

Via CNBC.com:

Ben S. Bernanke, the chairman of the Federal Reserve, told Congress on Tuesday that the government should avoid paying a fire-sale price, and pay what he called the “hold-to-maturity price,” or the price that investors would bid if they expected to keep the bond till it was paid off.

The government would buy the troubled investments with the intention of eventually selling them back to the market when prices recover.

What the esteemed Fed Chairman calls a “fire-sale” price, The Lamb calls the market price.  Call it whatever you want, but The Lamb doesn’t feel like paying 125 cents for a dollar bill, and then having to try to turn around and resell it for 125 cents or more to some other sucker.

And “selling them back to the market when prices recover?”  The Lamb doesn’t want to be too annoying, but what if prices don’t recover?  What happens then?  What happens after we’ve paid 125 cents for all the dollar bills in sight on the advice of Helicopter Ben and then aren’t able to resell them to the next guy? 

To whom will we turn for our 7 trillion dimes?  Maybe to these guys:

This summer, Congress passed and the President signed the Hope for Homeowners program, providing for the insuring of up to $300 Billion in new home loans.  As the FHA Factsheet states: 

“From September 2007 to June 2008, FHA has guaranteed more than $93 billion of mortgage capital, [helping] more than 290,000 families obtain safer, more affordable mortgages.”

The above math works out to over $320,000 per family in loan guarantees.  While The Lamb is not in favor of this program, he believes that if the FHA is going to provide these guarantees, there is a better way to put the money to work.  Using this same arithmetic, the $300 Billion (not to mention any further aid that Congress is threatening to add to the currently proposed overall Bailout Bill) from the Hope for Homeowners program could provide this same $320,000 for each of over 900,000 first-time-buying families that have been fiscally prudent and not yet purchased a home that they (correctly) deemed was overpriced or potentially beyond their means.

Assuming a relatively conservative 20% down payment, the FHA could help each of these 900,000 families to purchase a home costing $400,000, nearly double the July 2008 median national home price, or aid 1.8 million families in purchasing $200,000 homes.  This would have the additional benefit of helping to alleviate bloated inventories from the nation’s housing stock– a far greater economic lift than the refinancing of existing mortgages that may eventually default anyway.

The Lamb sympathizes with those at risk of losing their homes.  However, he believes that if this $300 billion is to be spent at all, families that made the difficult decision to delay their American Dream of home ownership are the more deserving of what is essentially a loan guarantee backed up by everyone’s future tax payments. 

Even Otter should be able to sympathize with that:

Before you get worked up into a panic about a dire prediction that there will be no oil left next month, let The Lamb put you at ease.  As long as you were not a futures trader at the New York Mercantile Exchange (NYMEX) today, you’re probably OK. 

Futures contracts (agreements to deliver a commodity or financial instrument at an agreed upon price at an agreed upon time) for crude oil surged today on the back of a weaker dollar and a general flight to hard assets.  However, what made today’s move striking was the late-day price action in the October contract.  Today is the last day that the October contract trades prior to expiration; tomorrow, November becomes the “front month” contract.  The front month contract is the one you see quoted on CNBC and in your morning paper.  Prior to the expiration of a futures contract, all shorts have to cover (buy back) their positions or be forced to make delivery (physically deliver the oil to those that are long the contract).  Usually, as contracts approach expiry, open interest (the number of contracts that has not been covered) tends to decrease.

However, this didn’t happen today.  Numerous traders had been playing the trend that oil would continue its downward path of the past two months and had only grudgingly begun covering positions as oil rose following last week’s financial crisis.  The longs refused to sell the needed contracts back to the shorts throughout the day and kept raising their prices like a mean child holding a treat just out of the reach of a hungry puppy.  In the final hour or so of trading, oil for October delivery, which opened the day just above $107, rose as high as $130, the biggest one day rise EVER!

*Click for Better View:

"Wait, I need those!"

*9/22/08 October Crude Oil Futures Price* 

Adding insult to injury, the shorts watched as the November contract, the one that everyone will see on their TV screens tomorrow, traded uselessly at around $109 as the final bell rang.

*Graph courtesy of INO.com

The Lamb’s beautiful and brilliant wife scored 770 out of a possible 800 (99th percentile) on the GMAT, the standard entrance exam for aspiring Business School students.  While she would tell you that the above equation solves to:
a = 49,999,999,991, The Lamb sees a deeper meaning.

Money market funds, also referred to as 2(a)7 funds because of the SEC rule number which dictates what investments they can make, have traditionally been seen as one of the safest investments available.  Typically, all money market funds must keep investment maturities to a maximum of 397 days and their overall weighted average maturity must be less than or equal to 90 days.

Following fears of a run on the nation’s money market funds, the Treasury announced today that it will utilize all $50 billion of the Exchange Stabilization Fund (ESF) to ensure that over $2 trillion worth of money market funds does not decline in value, known as “breaking the buck.”  The primary role of the ESF is to maintain the stability of the United States dollar.  This has become even more critical since the country was taken off the gold standard in the 1970’s and now relies solely on “fiat” money.  While one would assume that Congress could authorize the replenishment of the ESF, The Lamb believes that this prospective insuring of money market funds is a dangerous move that risks moral hazard if not accompanied by new limits on money funds’ investments.  If money funds offer large institutional accounts Uncle Sam’s good name along with yields higher than what they can get from commercial bank deposits whose FDIC insurance is limited to just $100,000, where do you think they are going to put their money?  Not in commercial banks.  Sudden outflows from banks could cause a liquidity squeeze that dwarfs that experienced by the investment banks and other funds this past week.

While The Lamb noted in his “Fannie, Freddie, and Sam” post from early last week that a broad failure of money market funds “would all but freeze short-term funding for most global financial institutions” he is nevertheless aghast at this recently proposed bailout.  This is not simply the indemnification from losses on debt implicitly backed by the federal government.  No, no.  This is forcing all taxpayers to make up for any loss of principal on investments that individuals and institutions voluntarily make.  These investors know, or at the very least should know, what assets are held in the funds in which they invested– the information is freely available from any public 2(a)7 fund.  Investors should refer to The Lamb’s Rule #2– Know and understand what you own.

Under this new proposal, what’s to stop every money fund in this country from pushing the duration and credit envelopes in the search for higher yields and greater incentive fees?  Heads, they win; tails, no one loses– except of course for you, The Lamb, and every other taxpayer.

Make no mistake, The Lamb believes that if we had had a run on money funds, as it appeared yesterday, it could have been the beginning of the end.  What’s a better solution?  If the Federal Government decides to insure money market funds because it fears a run and its disastrous ramifications, fine.  But how about getting paid significantly (not just a few basis points) for providing the insurance?  Banks are charged for the privilege of deposit insurance, so why shouldn’t money funds be charged, and charged commensurately with the risk they take?  For the privilege of FDIC insurance, Uncle Sam requires banks to pay a fee, keep adequate reserves on hand, submit to examinations, and undertake other expensive regulatory tasks.  Due to their structure, money funds that want this new insurance should be required, among other things, to take less risk.  For starters, how about forcing them to decrease their average maturity from a maximum of 90 days to just 30 days?  Yes, this will decrease yields for investors.  But if investors want/need to have their investments insured by Uncle Sam, then make them pay for the privilege.  If they don’t want to pay for it, then let them invest elsewhere.

*UPDATE*

On 9/21/08 from bloomberg.com:

The Treasury said in a statement late yesterday it would limit its $50 billion plan for insuring money-market funds to those held by investors as of Sept. 19, excluding any subsequent contributions.

The American Bankers’ Association, which had expressed concern about the plan last week, praised the move, saying it would eliminate an incentive for savers to shift out of bank accounts into money-market funds. The Treasury put no limit on the money-market fund insurance, while the Federal Deposit Insurance Corp. protects bank deposits up to $100,000.

“If all money market mutual funds had been included with the government guarantee moving forward, this proposal would have threatened to take money out of local FDIC-insured banks,” Edward Yingling, president of the ABA in Washington, said in a statement.

In 1989, just as The Lamb’s alma mater was winning the National Championship in college basketball, the Savings & Loan crisis was at its zenith and the federal government created something called the Resolution Trust Corporation, or RTC.  Utilizing $30 billion of cash raised by sales of long-dated bonds, the RTC bought assets from failed thrifts and proceeded to dispose of them in the private market.  Fast forward to 2008.  The University of Michigan’s basketball team is looking for help whereever it can get it following another disappointing season.  Unfortunately for them, 2009 does not promise to be much better than 2008.
 
Fortunately for the commercial banks and for the investment banks (there are still two of them left, right?) who are also looking for help wherever they can get it, 2009 does look brighter than 2008.  The U.S. Treasury today announced plans for another RTC-like bailout of U.S. financial institutions.  Like many newborns, this one has yet to be named.  We could probably just call it RTC2.  The Lamb thinks this an apropos moniker.  However, in this incarnation, the acronym RTC should stand for Ripping-off Taxpayers Covertly.
 
Unlike the 1989 version, let’s call that RTC1, this version proposes to take money from John and Jane Taxpayer on an involuntary basis rather than going to the private markets and selling bonds to finance the purchases.  While it is true that in both RTC1 and RTC2 the taxpayers ultimately pay, at least in RTC1 the private sector voluntarily financed the purchases at the outset, thus taking the upfront risk of the assets.
 
While not orchestrating an RTC-like bailout would doubtlessly have been deleterious to many financial institutions, this bailout only morbidly delays the inevitable day of reckoning, while exacerbating its severity, as firms continue the delevering process and endure the painful but necessary process of marking down positions to current market levels.

The Lamb is often in the minority on his views of things.  That is one of the reasons for the title of this blog site.  Ben Franklin’s quote serves as a warning against tyranny of the majority.  The system of “majority rules” is sometimes wholly unfair to the minority and can have terrible unintended consequences.  The recent limits imposed by the SEC on short-selling, in The Lamb’s opinion, are an overreaction to this past weekend’s bankruptcy of Lehman Brothers, the trials and tribulations of AIG, and the shotgun marriage between Merrill Lynch and Bank of America. 
 
Short selling has always had a certain ignominy attached to it.  Some have said that it is at the very least unethical, if not illegal.  While The Lamb certainly agrees that naked short selling (selling a company’s shares without replacing them by settlement date) should be banned, the shorting of any security and the corresponding repurchase agreement (repo) market with which it is joined at the hip, is an integral part of a smooth functioning capital markets system.  Banning short selling is market manipulation in its purest form– it interferes with a willing buyer’s ability to purchase from a willing seller.  Not only that, the buyer suffers from fewer sellers.  If he wants to buy, he will have to pay a higher price as there are fewer players competing to sell him the asset.  Simply, short sellers add liquidity.  Banning legitimate short sellers, or long buyers for that matter, decreases liquidity and forces both to settle for a worse price.
 
Many have also argued that the Uptick Rule should be reinstated.  The Lamb has always been against this rule.  While this rule may slow price declines, this is not necessarily a good thing.  Securities should find their “correct” price as quickly as possible.  Referring to The Lamb’s Rule #4:  An asset is only worth what someone is ready, willing, and able to pay for it.  Are Uptick Rule proponents also in favor of a Downtick Rule for purchases?  Probably not. 
 
Let’s take this a step further.  Let’s say that you are a market maker for options.  An investor wants you to sell him a put option so that he can protect his portfolio from a market decline.  You both agree on a price for the option.  To delta-hedge your position, you as the market maker would have to short-sell the option’s underlying security.  But wait a minute– the SEC has decided that you aren’t allowed to short sell.  So what do you do?  Well, to compensate you for taking the extra risk of not being able to properly hedge your position, you naturally charge the investor a higher price for his protection, making him worse off and you with greater risk.
 
The Lamb sees this as gross market inefficiency:

“Neither a borrower nor a lender be,” said Shakespeare’s Polonius in Act 1 Scene 3 of Hamlet.  If Senator Joe Biden had his way, being a borrower would be the surest way to riches.  The problem is that there would be no lenders.
 
Joining the chorus of Washington talking heads about the plight of the American consumer, Biden recently threw his two cents into the fray with what he believes should really be done to help alleviate the country’s current economic malaise.  Biden was speaking to prospective voters at a political rally when he proffered an idea on how to help Americans plagued by those annoying monthly debt payments that have been unfairly heaped upon their narrow shoulders by big, bad lenders.  Expounding on recent calls to lower interest rates on outstanding debts for people, the distinguished senator from Delaware suggested that the lowering of interest rates was a good idea, but that lowering the principal amount was an even better one!
 
Hey, this sound great to The Lamb!  Why should borrowers be forced to repay money lent to them at agreed upon terms?  That doesn’t seem fair.  The Lamb agrees with Mr. Biden– let’s have Congress pass legislation that not only slashes the current interest rates of outstanding balances on all loans, but also cuts the principal balance by, let’s say, 80%!  That 7% $500,000 mortgage balance that The Lamb has on his apartment?  Well, just maybe 4% is a much rounder number.  Oh, and he would like to change that $500,000 balance to just $100,000– again, just a much rounder number.
 
The lender won’t mind, will he?

For anyone interested in an extra safety blanket for your money, The Lamb recommends opening an account directly with the United States Treasury at TreasuryDirect.  With this account, one can purchase U.S. Treasuries at weekly auctions and have them kept at the United States Treasury.  The Lamb has a difficult time thinking of a safer place to put money.  Setting up the account takes less time than bidding on Lehman Brothers memorabilia on eBay.  You link it to your bank account, and then you can purchase and roll bills, notes, bonds, and TIPS, or have the maturing cash put back into the same bank account from which you paid for the original securities.  For those that want safety in addition to FDIC/SIPC, The Lamb suggests looking into this.
 
The Lamb does not believe that we are heading into a 1930’s style depression or financial collapse.  Nor does he believe that there will be a wave of large financial institutions that will fail.  However, there will likely be many smaller institutions that will peek into the abyss and the lack of funding alternatives will push many of them into it. 
 
Do not be under the illusion that if you have funds in a money market fund that they are 100% safe.  First of all, they are likely not insured BY ANYONE, let alone the U.S. government.  The Lamb would venture to guess that if he asked you what the top five holdings were in your money fund, you may not know.  Money market funds, technically 2(a)7 funds, can and do carry risk of principal loss.  Yesterday, for the second time since the 1990’s, a money fund “broke the buck.”  This is a fancy way of saying that investors could only redeem their investments for some fraction of “par.”  This was not just some small fund, it was the Reserve Primary Fund, the oldest money market fund in the U.S., and held over $60 billion in assets just last week.  Investors that took the time to look at the holdings of the Reserve Primary Fund saw that it held over $750 million in Lehman paper and, following Lehman’s weekend bankruptcy, decided to withdraw their money.  The Fund saw more than half of its funds redeemed in the 48 hours prior to its announcement yesterday.
 
FDIC and SIPC insurance, to be sure, are great things.  While you can place money at multiple depository institutions to “get around” the $100,000 per account protection limit, the FDIC may have difficulty covering losses triggered by a tsunami of commercial bank defaults.  Yes, the FDIC has lines to the Treasury, but do you really want to count on not getting a financial “haircut” if the FDIC has to go begging to the feds?  Regarding SIPC, their coverage is a heftier $500,000 (including $100,000 in cash protection) per securities account, but they currently have just over $1 billion in reserves.  I realize that these accounts are supposed to be segregated, but the SIPC does not cover fraud.
 
Some investors are beginning to lose confidence.  Credit default spreads on U.S. Treasuries have widened to roughly 15 bps in 5yrs and 20 bps in 10yrs, both record wides.
 
Losing a portion of one’s investments isn’t the end of the world.  Many of us have been invested in equities and commodities the past few months and have the battle wounds to prove it.  However, when investing cash that he simply can’t afford to lose, an extra 50 or 100 basis points (0.50%-1.00%) just doesn’t matter that much to The Lamb, particularly when viewed on an after-tax basis.   With this money, the most important thing to The Lamb is not his return on capital, it’s the return OF his capital (see The Lamb’s Rule #1).

In a move cheered by some and condemned by others, Uncle Sam over the weekend adopted his petulant niece and nephew, Fannie and Freddie, essentially making his longstanding implicit guarantee of their senior debt obligations now an explicit one.  The Lamb is generally against government interference in the capital markets.  However, there existed the oft-quoted systemic risk that if Fannie and Freddie continued to misbehave, others could be irreparably harmed.
 
Who are these “others”?  Well for starters, dear reader, one of them is you.  “Me?” you ask?  “But I don’t own any Fannie or Freddie debt,” you protest.  Well, while that may be technically true, chances are that the municipality to whom you pay property taxes, and the state to whom you pay income taxes (unless you live in a state like Florida or Texas) does own this debt.  Were Fannie and Freddie to go “toes up,” to whom do you think these local and state governments would come calling on to make up the shortfall?  You need only look in the mirror for that answer.
 
Now, let’s look at what some consider to be one of the safest investments available– money market funds.  Many if not most of these funds, which total some $3 trillion dollars, have as a core asset Fannie and Freddie paper in the form of discount notes or short-dated medium-term notes.  These had been purchased as a “safe” surrogate to U.S. Treasuries that came with the convenient feature of a yield kicker, in some cases as much as 100 basis points for similar maturities.  Were Fannie and Freddie to fade away, many of these funds would “break the buck” without their parent buying back these now-impaired assets at face value.  A cascade of failures in this investment area would all but freeze short-term funding for most global financial institutions.
 
Finally, but certainly not least, are foreign central banks.  Countries and sovereign wealth funds from China to Russia, and from ADIA (The Abu Dhabi Investment Authority) to the MAS (The Monetary Authority of Singapore) have bought hundreds of billions of dollars worth of Fannie and Freddie debt.  If they believed that this paper was somehow not “money good” and began to dump it en masse, the effect on domestic interest rates and on the dollar itself could be disastrous.  If this lack of confidence began to trickle into their holdings of U.S. Treasuries, the ramifications could be calamitous.
 
As distasteful as it is, Uncle Sam had no choice but to place Fannie and Freddie under conservatorship.  His treatment of their toys (e.g. the Preferred Stock and Subordinated Debt) can be debated, but the Senior Debt had to be protected.