The Diamond Blog

Sent from a friend of ours:


This week the circus took center stage in Washington. Ringling Bros. has three different troops that are performing before thousands of fans this week in Fayetteville, Greensboro and Atlanta. The other circus had a national TV audience as congress did its best to audition for parts in the real circus of life.

The TV ratings might have been high but anyone with an interest in the economy and its potential recovery had to be embarrassed by the performance of our country’s highest officials. On Tuesday (2/10) Treasury Secretary Geithner and Fed Chairman Bernanke testified before the House Financial Services Committee and its chairman Barney Frank. The hearing saw most members criticizing these public officials for allowing the mortgage and credit crises to grow into its now unmanageable state but conveniently forgot that its chairman on July 14, 2008 told the same audience that “Fannie and Freddie are fundamentally sound and in no danger of going under and their financials are solid.” Less than two months later the twins were adopted by the federal government.

Tuesday afternoon Geithner was reprimanded by members of the Senate Banking Committee headed by Senator Dodd. The day ended with the Dow falling 381 points as investors became discouraged that the administration’s plans for getting out of this mess had more headlines than substance. All financial markets hate uncertainty and every day there seems to be less certainty and more confusion about the future of our economy.

The solution is painful and will take more time (years) than most Americans think they can endure. Patience, savings and only spending what we have in our pockets is something that went away in the seventies and is only now making a comeback.

It took years to create the biggest credit bubble of all time and anyone who believes a solution or stabilization of conditions can be achieved in weeks or months is making the biggest mistake of their investment careers. My theme for 2009 continues: Trade the market you have not the one you had in the past. Our biggest enemy is ourselves as we always assume that our past experiences will be repeated in the future.

Scanning the globe

In the 1980’s the Japanese bought thousands of U.S. properties as they “appeared” to be cheap when prices in yen and today the Chinese are coming in tours that are organized for potential real estate investors. Will they meet the same fate as the Japanese that eventually sold much of what they bought at huge losses? (Probably).

The head of the New York city council announced a plan today that would have the city purchase empty luxury condominiums and turn them into subsidized housing for middle-income families. With deflation in full force the middle class is now larger as the wealthy have lost so much of their assets that they have dropped into the middle class.

There has been much worry in the press about a possible buyers strike by the Chinese of U.S. Treasury bonds but a Financial Times story quotes a senior Chinese banking regulator that Treasuries are the “only option” in a perilous world. I clearly remember the middle seventies oil crises when everyone was worried that the Saudi’s would stop buying Treasuries and I wrote that there was no place else for them to put their billions in profits.

One of the best stories of the week shows the desperation level of many state governments as they consider risky bets to close huge budget deficits. New York is considering moving its $1.3 billion fund used for lottery prizes from the safe confines of U.S. Treasury bills to stocks, real estate and hedge funds. They have used an 8% assumption rate for growth each year and Treasuries return near zero so they do what any strung out gambler does they increase the risk and gamble it all in an attempt to stay in the game. If they go through with this proposal the federal government should NOT give them bail out funds and the voters should march to Albany and throw out every politician that approves this ridiculous proposal. Isn’t this kind of decision making what got us in the mess we are in now? This violates one of my key rules of investing: NEVER add to a losing trade.

How does a state that receives so much from gambling revenue allow citizens to drive across the state line to play the lottery? Amazing but true that the Nevada legislature is considering a state lottery because so many are driving to California and Arizona to play the lottery.

From Philadelphia we see that the supply of unsold houses is competing with empty apartments and driving rents lower.

The federal government is trying to give away the bailout money but doesn’t have enough people to process the applications. The backlog is over 2,000 and growing each day and approvals are coming at the rate of 50 per week which equates to a 9 month wait for most banks. The government’s biggest enemy is itself but I’m sure no one is surprised.


Interest rates, gold, the stock market and more…

Long-term (10 yr.) interest rates finally found a resting place this week (3.00% and demand for the three auctions (3 yr., 10 yr. 30yr) went better than expected but these buyers are now gone and who will be there next week when $94 billion of 2yr. 5yr. and 7yr notes are auctioned?

This week Germany held an auction for government bonds and received no bids for the last 20% of the issue. Could that ever occur in the U.S.? Doubtful. but the dollar would be smashed if it ever came close to reality. Gold continues to be the #1 best bet for trading profits and $1000 seems to be within reach in the next 30-60 days. Everyone seems to be long but the old adage that a trend stays in motion longer than anyone ever expects might be true in this case.

U.S. stocks appear to be sold out and bad news doesn’t bring in many new sellers, but the uncertainty created by the circus clowns keeps buyers on the sidelines. Long-term investors should remain in cash with insured CD’s the best bet as a few banks are still offering rates near 3% for one year. The best investment in a DEFLATIONARY period is always cash as its buying power increases as asset values fall.

The Texas Ratio is used to determine the health of banking institutions.

When the examiners add all of a bank’s tangible capital plus the bank’s loan loss reserves, then divide that total by the sum of the bank’s non-performing loans, banks typically fail if that ratio climbs over 100.

There are two basic things that a bank can do control their Texas Ratio to stay alive. Increase deposits, or dump non-performing loans.

When a bank accepts a short sale (takes less than the amount of the mortgage balance in order to get the loan off their books) two things happen:

1. The non-performing loan is gone and deducts from one side of the Texas Ratio.

2. The bank gets cash which adds to the other side of the Texas Ratio. The short sale increase tangible assets (cash) and gets rid of a non-performing loan at the same time.

It is the same if you needed to raise cash at home and start selling off your assets, such as selling your $20,000 car for $10,000. You raise cash and stay alive for awhile, but pretty soon you run out of assets.

Same with the banks. As they keep selling off things for a loss, a different factor kicks in. When liabilities exceed assets that is called bankruptcy. So they can’t sell off too many assets at a loss. It is a fine balance. Some juggle successfully and stay alive, and some don’t.

Another juggle maneuver to stay alive is for a bank to increase the amount they pay for savings accounts and CDs (increase tangible assets = cash). Sometimes a sign that a bank that is about to fail is when they are paying depositors noticeably higher rates than the marketplace average. A desperate move to increase cash to help their Texas Ratio.

But, then their cost of goods (money) starts to erode the banks profit margin. That is the difference between what they pay for money and what they sell their money for (loans). Then another factor kicks in, since a business can only operate unprofitably for a limited amount of time, the reduced profit margin helps them go broke.

This is why so many banks have failed recently. Their nonperforming mortgages drove their Texas Ratio too high, and they couldn’t increase tangible assets or decrease non-performing loans fast enough.

Some Good News For A Change.