Long or Short Capital

Barney Frank is in full regulator, politician-in-need-of-something-to-yell-about mode. Unfortunately, I must note that Mr. Frank is among our most financially-savvy elected officials (gulp) as well as one of the leading advocates of Zimbabwenomics. In this interview with the Economist, he discusses his misguided rationale for dealing with the current financial mess and, as any good politician should, proposes to 1) increase government regulation and 2) increase taxes.

1)

“[Hedge funds and unregulated pools of capital] caused the problem by making a wide ranges of loans that shouldn’t have been made. Now some of the borrowers shouldn’t have borrowed… but there was no regulation to prevent abuse.”

“If only [banks and credit unions] were the originators, there would be no subprime crisis and no recession today.”

Now every major US bank I can think of – Citigroup, BofA, Wells Fargo, etc. — has written down billions in losses from the sub-prime, Alt A, sub-crap, and moderate-crap mortgages they held. Additionally, they are still trying to unload the billions of remaining debt still on their books from their loans to the only group more levered than sub-prime borrowers: private equity firms. These banks were regulated but they still participated, enabled, benefited from, and ultimately suffered as a result of the sub-prime fiasco. Why? Because the problems that the financial system has suffered over the last 18 months are the result of an expansionary credit cycle. Credit begat credit until temporarily insane lenders gave cash to un-worthy borrowers. Sub-prime were the symptom of this craze rather than the cause and while regulation may have been able to stem some of the more egregious abuses, an expansionary credit cycle will find a way to wreck damage.

Here’s Warren Buffet on the subject:

There are significant limits to what regulation can accomplish. As a dramatic illustration, take two of the biggest accounting disasters in the past ten years: Freddie Mac and Fannie Mae. We’re talking billions and billions of dollars of misstatements at both places.

Now, these are two incredibly important institutions. I mean, they accounted for over 40% of the mortgage flow a few years back. Right now I think they’re up to 70%. They’re quasi-governmental in nature. So the government has set up an organization called OFHEO. I’m not sure what all the letters stand for. But if you go to OFHEO’s website, you’ll find that its purpose was to just watch over these two companies. OFHEO had 200 employees. Their job was simply to look at two companies and say, “Are these guys behaving like they’re supposed to?” And of course what happened were two of the greatest accounting misstatements in history while these 200 people had their jobs. It’s incredible. I mean, two for two!

It’s very, very, very hard to regulate people.

LoS prediction: Frank and his legislative cohort will find a way to prevent any of the abuses of this cycle from recurring. Say good-bye to pick-n-pay, Freedom, and pay option loans. However, this regulation will do nothing to prevent the excesses of the next expansionary credit cycle, scheduled to start in 2012 which may include Magic Loans, Money Tree Triple-Reverse Amortizing ARMs (if it works in old-time college football, it can work in loans), Collateralized Magic Loan Obligations, Ultra-SIVs and our favorite, Chocolate Covered Mortgages, which will not not only be affordable but delicious.

2)

“First, try to pay as little as possible [to bail people out].”
“I’m willing to give [homeowners who can’t afford their houses] some help. Not direct taxpayer assistance but some other type…”

“They didn’t bail out Bear Stearns. [The Fed] bailed out the people who did deals with Bear Stearns.”

Now for the classic politician’s sleight of hand. When people won’t tolerate direct transfers of wealth, make the transfers indirect. The First Law of Bailouts is that Someone Must Pay. So when Barney says that he’s willing to give homeowners who speculated on housing (and lost) “some help” but that won’t involve direct taxpayer assistance, he’s not quite lying. Instead of giving these people straight cash, he will find some other ways to transfer taxpayer dollars to these people (voters).
Similarly, it’s true that the Fed didn’t bail out Bear Stearns. After all the company was sold to JP Morgan and the employees lost most of their equity. However, he failed to mention that the Fed DID bail out the Bear Stearn’s bondholders [see John Hussman’s insightful analysis] who did nothing to deserve the preferential treatment.

Recommendation: Stop voting for politicians who cannot think more than 2 steps ahead of themselves. Stop voting for politicians who have never heard of the 2nd (forget about the 3rd) order effects.

Dear Future Child of Mine [Chase or Madison depending on your gender],

Thank you for the tax rebate. $600 was a very generous gift for such a small child. I know that, at some point in the future, you will have probably have to work a full week — taxes will be higher — to pay for this gift. So I want you to know that I really appreciate it. I have been frivolous lately and made some bad decisions (the 2nd home with the pik-n-pay mortgage, the jacuzzi, the viking kitchen) that I really couldn’t afford. So I’ll probably use the $600 to pay off some of my personal debt. That will leave less debt to eat into the estate I’m planning to leave you (post-tax, of course)!!

Sincerely,
Dad

Citigroup (NYSE: C) announced first quarter fiscal earnings. The results were incredibly good and the stock has subsequently surged almost 10%. WSJ article on Citi’s Q1 release:

The loss of $5.11 billion, or $1.02 a share, was deeper than Wall Street had expected and took the bank’s total loss over the past two quarters to nearly $15 billion.

…

Citigroup’s first-quarter revenue plunged 48% to $13.22 billion amid the write-downs. Analysts polled by Thomson Financial had expected a loss of 95 cents a share on revenue of $12.77 billion. A year ago, Citigroup reported net income of $5.01 billion.

They also announced, via brain-wave subversion transmitters, that they have developed a Reality Distortion Field, a device long-rumored to have been in the possession of Steve Jobs but which has only actually been developed and effectively utilized by Citi.

Recommendation: If you can get the financing to buy a large truck, which may be difficult since no banks are lending money to anyone at the moment (but don’t worry, their future results will still be killer because the business of banks is not actually the loaning of money to people and stocks don’t consist solely of a company’s future earnings), we recommend backing that truck right up to the biggest pile of Citi stock you can find. The Write-Down Rally has been one-upped by the Write-Down AND Miss Expectations Rally.

Wellbutrin is an antidepressant prescribed to people who are depressed. Normal run-of-the mill stuff. But Wellbutrin is also a source of endless amusement for the pharmaceutical engineers who created it. These guys went way long humor. Most drugs have side effects such as nausea, loss of appetite, loss of sexual appetite, etc, but it’s a trade-off that is usually worth it. Wellbutrin’s side effects are…that it can cause anxiety and panic attacks. PANIC ATTACKS.

The production meeting must have gone something like this:

Pharma 1: God, work is so stressful here sometimes. We develop great ideas and then we have to subject to a time-extensive testing, FDA regulatory approval, my god, I can’t take it anymore.
Pharma 2: Sounds like you need to blow off some steam good buddy.
Pharma 1: But how?
Pharma 2: Me and the boys, the other pharmaceutical engineers, every once in awhile we have ourselves a little bit of fun. We use spectroanalysis, chromatographic distillation and other processes to create a drug that cures a condition, say hair loss, for most people. I stress the most people because in a certain random group of people, the drug actually serves to aggressively exacerbate the condition, in this case by causing the complete death of all the hair follicles on the body. It’s like roulette with people, just spin the pill and see where it lands.
Pharma 1: What about a drug that can soften depression, but in a certain subset of people will spur an increase in anxiety and a higher likelihood of panic attacks?
Pharma 2: Now you’re thinking like a pharmaceutical engineer!
*Pharmaceutical Engineer high-five (like a normal high-five, but more awkward, and while wearing funny suits)*

Recommendation: Long practical jokes, especially when they are in the form of an anti-depression pill. Short people who can’t appreciate jokes and/or who are crazy.

In this time of financial uncertainty, we have experienced heretofore unseen volatility in our portfolio. Assets that were previously uncorrelated are now correlated, assets that were previously correlated are now uncorrelated, write-downs are good, the recession either didn’t happen or is already over, LIBOR is possibly a figment of a banker’s imagination and it’s always the best time to buy. As such, management has decided to allocate a significant amount of our cash on the balance sheet into a fixed income product that shows no correlation with any of our current holdings and is not in any way sensitive to interest rates.

Our new favorite fixed income product is barry bonds. We have invested a meaningful amount of our cash into this asset and the maturity is one year. The yield is 0% on a cash basis, but approximately 25% based on our performance enhancing risk model.

We think barry bonds will help dampen the volatility we have seen in our portfolio as the only thing they correlate with is steroids, perjury and racism. In turn, this should allow our subscriberholders to benefit from more stable returns. Yet again, we say, “You’re welcome.” We considered a pair trade with a short of roger clemens so that we could effectively short the racism spread, but that trade looks to continue to be volatile.

Inspired by this incredible expose about oil prices hurting kids via increasing operating costs of school buses all over the country, we decided to survey other demographic representatives to see how higher oil is affecting them.

Middle-aged white woman in the midwest: “Gas prices are so crazy I had to buy a second car, one for when gas is cheap and one for when gas is expensive. But sometimes I drive the wrong one just to be bad, I’m a naughty girl on the inside, I go wild!”

A London debutante: “12 months ago it was so posh to be shagging a banker, but now I can’t be bothered if he doesn’t come from oil money. Russians, Iranians, MAYBE a Norwegian – but only if he has that Viking look. Also unrefined crude oil makes for great lube – it’s so hot when they put it on you, and the fact that it’s getting more expensive and they still just keep using a lot of it- that only makes it hotter and shows they care about you.”

A common dragon on the street: *FIRE!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!*

A baby: “You would be alarmed at the rate of inflation I’m seeing in breast milk. Most people wouldn’t believe it but the persistently rising crude oil price has a direct impact on mommy juice. I estimate 2% of the input costs for breast milk are oil and oil related products. How do you think mommy makes milk? She gets in her car, goes to Olive Garden and eats pasta, you can’t walk to Olive Garden, you can’t crawl either — I know, because I tried. Shit’s like an ultramarathon of crawling, and with my job, my kids and the commute, I don’t have the baby-time to be in that kind of baby-shape.”

That oil-eating bacteria (which may or may not exist): “I don’t think you understand how hungry I am and what it takes to feed a family of four oil-eating bacteria. I’ve lost thousands of micrograms and my entire asexual family, also known as me and those who are indentical to me on a cellular level, we are all doing horribly. But boy does Gail (who is also me (this is getting meta-creepy)) look fabulous in her skimpy bacteria-lingerie! The government always says it will stand up for the little guy, but apparently this little guy is too little. Vote Obamoeba!”

Please tell us how oil is changing your life.

Anytime is the best time to buy.
-Kieran Quinn, chairman of the Mortgage Bankers Association

Past Quotes Entirely Relevant to Investing

The whole point of being an entourager is a display of power, wealth and ultimately, desirability for procreation. The whole point of being an entouragee is to ogle women and not have to take care of yourself. Thus it concerned us when we read this WSJ piece on the economics of entourages:

Underperforming security guards, personal assistants and coordinators can be fired for offenses like ogling women or falling out of shape. “It’s no different than working for Xerox,” Mr. Ellerbe says.

If you are no longer getting to benefit from the whole point of doing something, is that a long-term viable enterprise?

Recommendation: While there are certainly attractive elements about entourages, especially when modeling the models and female groupies, we are concerned about the burgeoning business model drift. As entourages move the experiences of their core entouragees from that of “ogling women” to that of “working at Xerox” we think there is a significant risk that the entire premise will face significant diminution. That some firms, such as Thomas Howard, are already being forced into outsourcing is another red flag. When we have done sufficient modeling of the models with the help of our own entourage, the Doo-Dilly Gents, we will issue appropriate guidance.

People are concerned about an end of existence event that may be caused by the Large Hadron Collider and there is talk when the LHC is turned on in July 2008, that a super-collision here, a super-collision there and *bam*, no more Universe. This would doubtless be an event from which most investors have not adequately protected their portfolios. That is why Long or Short is now offering LHC End of the Universe Puts. It’s a simple put option wherein the buyer retains the write to sell the Universe at a strike price of “Existing”. Based on our Black-Holes model used to value all “end of the world” options, the July 2008 vintage options are currently priced at $20.

Link to purchase

Recommendation: These options are literally the only way to protect your portfolio from the possibility that when the LHC is turned on mini-blackholes will form, come together and have a blackhole party that literally rips the (cheap) fabric of universe asunder.

Don’t let this

Turn your portfolio into this

Politicians are generally great at what they do. We know that. It’s a group that self-selects for blowhards and megalomaniacs with a thorough understanding of Zimbabwenomics. And certainly, Massachusetts politicians typify these tendencies. But even by the Mugabian standards of politics, things are getting out of control (in a good way).

[Barney] Frank’s idea is that, for mortgages originated between the start of 2005 and mid-2007, a lender and borrower would be able to agree on a federal refinancing plan. Lenders would have to write down their loan to no more than 85% of the current appraised value of the property – which means the banks will use this opportunity to unload the biggest stinkers in their loan portfolios.

For the borrower, the deal is even sweeter: a low fixed monthly payment and a reduction in the principal to market value. The Federal Housing Administration would then guarantee the loan, up to a total of $300 billion in total Frank Refis. The deal is so sweet that even Mr. Frank is concerned that otherwise reliable borrowers may “purposely default” to be eligible for assistance.

Just to be clear, what Mr. Frank is proposing is to bail out anyone who took risk on a house they couldn’t afford. Many of these people will have, smartly, put little to no money down to take that risk and benefit from the potential upside were the house to appreciate. How is he planning to finance this proposal? Taxes, of course. So those who dumbly did not take risks with large potential upside will now pay those who did. This is an extremely Mugabe efficient proposal and will be a resounding success with no downside.

Recommendation: Long excessive risk-taking, just make sure to do it in a group large enough to form a voting bloc. Also, I have found that Zimbabwenomics is much funnier when it is not happening in my country.

I don’t get him, his relevance or why he continues to amuse people. But Tim Sykes certainly exists. I know this because he emailed me.

Hey there, how are you? I’m blogging like a madman and loving every second of it! I’m putting together a huge list of money/finance/trading/investing blogs/websites to be called ‘TIMlinks’ so I wanted you to join. It’s free and once I start promoting this baby, you should get dozens or even hundreds of daily visitors to your site—kinda like FeedTheBull, Entrecard or Blogrush, but for our target audience only Check it out:

http://timothysykes.com/timlinks/index.php

After your join, to get ranked, you’ll be emailed code for a ‘TIMlinks’ badge, just add it anywhere on your site and you’ll be set!
– – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – –
Timothy Sykes | Author of An American Hedge Fund
T 407.xxx.xxxx| F 407.xxx.xxxx | www.timothysykes.com

It’s telling that his system is identical to every splog and SEO-only oriented link trading request we get. They link you from their non-main page, you link them from your main page. A great deal! We should get hundreds of links a day from a separate links page buried within a mediocre site! Seems probable.

We don’t do reciprocal link trading or such things. If it’s a site we read and if it’s one we think deserves to be linked, we link it. Feel free to do the same but we won’t be adding a badge or trading links.

Regardingly,
Mr. Juggles
longorshortcapital.com

You will agree with me when I say that I tried to be polite.

Haha ok

His repsonse naturally raised the question to me “What was funny in that?” As a master of humor, normally these things make themselves aware to me. In this case, it did not. Naturally my reply was:

What was funny in that?

From Timmy:

u just sounded so serious, i’m just trying to help increase the popularity of the sites i like by giving them this badge of honor

More like a scarlet letter.

A badge of honor, Tim? Really? We take everything we do very seriously, that’s one of the reasons we do it better than anyone else. Maybe you should start practicing your seriousness and take your site to the next level. Again, you are free to link to us and we encourage you to do so — it is likely to your readers benefit. We won’t link to you until you have created a site worth reading, one that we also happen to read.

I expected more laughing and something non-intelligent from his next reply. I was not disappointed.

LOL, being serious and the best is the exact opposite of what I’m going for, all I wanna do is teach and entertain, aka actually help people understand this stuff better! All you finance snobs forget 99% of the people out there have little to no education and thanks to the ridiculous importance you place on always being the best, people believe mistakes are just about the worst thing you can do. Wrong! I like some of your articles, but take it down a notch, you’ll live a happier and more fulfilling life!

My reply:

Teaching and especially entertaining are both things which benefit from being taken seriously. No one learns anything from someone who is taking a half-ass dimwit approach to teaching. Worse, no one is entertained or is made to laugh by people taking a half-ass dimwit approach to humor.

Mistakes are ok, but mistakes that should have been avoided but weren’t because of sloth or lack of diligence are horrible and should be treated as such. They are entirely avoidable by people who take things seriously. Life is a very serious thing. We are all dying. Asset management is even more serious than life.

Regardingly,
Mr. Juggles
longorshortcapital.com

Timmy’s reply:

Solid reply but you forget that the vast majority of people out there are lazy and dim-witted. For them, the very thought of long complex calculations and ramblings from boring finance people is equatable to prison. What do we do, ignore those people and laugh at how much better we are?

No, I believe those people can and should learn about the stock market and since Penny Stocks are pretty simple things to understand, it’s a great intro. And, I can help them avoid the mistakes I’ve made, lessons I was forced to learn alone because there was nobody in the entire snobby/stuck up world of finance who ever detailed their stupidity for all to learn from. Again, stupidity/mistakes–nothing to be ashamed of, we all make stupid mistakes at one time or another, the key is learning from them and sharing them right alongside our greatest victories. Welcome to my business model: brutal honesty. It’s sad that this is revolutionary, but thanks to the kind of people in this industry, there’s a massive window of opportunity. Thanks again!

Recommendation: Timmy is a blackhole. A blackhole of knowledge, understanding, financial acumen, reason, emails and time. If you have not yet crossed the event horizon of Timmy, keep back. At best, he is played out. At worst, you will lose brain matter as it is stretched to infinity, taken to the speed of light and crunched into a superdense nothingness.

Blessed are the young, for they shall inherit the national debt.
-Herbert Hoover

Heston Addendum:
Get your stinking paws off me, you damned dirty ape!
-Charlton Heston in Planet of the Apes

Past Quotes Entirely Relevant to Investing

I’m calling the top on the bottom. So many people have been calling the bottom. For instance, today non-farm payrolls were down 80k and unemployment jumped to 5.1% (both are clearly trending negatively) and yet the market is rallying (S&P500 up 11pts, Nasdaq up 26pts). This must mark the bottom!
Other bottom-marking rallies:

• Bear Stearns bankruptcy rally
• UBS $19bn writedown rally
• Fed liquidity injection rally (several)
• Doug Kass, Bear turning Bull rally
• Sovereign fund injecting enough capital to achieve solvency rally (several)
• Commodity bubble bursting rally

That’s a lot of rallies based on various factors that certainly, definitely, surely mark the bottom. Unless they don’t. Which they don’t.

Recommendation: Short the bottom. Go long the top.

From a tweet I put out immediately when the jobs report was released this morning:

Rally time! The new paradigm is not bad news = good news, it’s everything bad has already happened, only good stuff ahead!

Recommendation: Nothing on Heaven, Hell nor Earth can or will make the S&P 500 go down. It has been immunized against negativity.