Out of the Box and onto Wall Street

Unorthodox Insights on Investments and the Economy

Mark J. Grant

• Publisher: Wiley
• Year: 2011
• Print ISBN: 9781118018101
• eBook ISBN: 9781118056653
• Edition: 1
• Topic: Negocios y empresa
• Subtopic: Inversiones y valores

A guide to thinking outside the Wall Street box

Part memoir, part investment strategy guide, Out of the Box and onto Wall Street presents a revolutionary, alternative look at the world of finance. Revealing the essential rules for preserving capital and making long-term profits, the book provides timely observations on the current and future state of the world economy and investment markets, which are sure to be of interest to anyone considering alternative and time proven ways of making money.

• Written by Mark J. Grant, Managing Director of Corporate Syndicate and Structured Products for Southwest Securities, Inc
• Provides observations on the current and future state of the world economy and investment markets
• Offers detailed analysis of investment trends, common investor mistakes, and the simple investment strategies that most people are unaware of
• Designed for professional managers but also applicable for use by individual investors wanting a better understanding of the economy and how to pick smart investments for their own portfolio

This is a must-read for anyone who wants to think about investing outside the Wall Street box.

Part I

The Wizard Calls the Ball

Chapter 1

The Implosion of the Housing Agencies

It was in 1938, during the Great Depression, that the U.S. Congress, in its wisdom, established the Federal National Mortgage Association (FNMA). Its sister agency, also a federally chartered corporation, Freddie Mac, is also a government-sponsored enterprise (GSE), as is FNMA, and to truly understand these housing agencies you must bear in mind that they were created by the government no matter what hallucinations our politicians bring to us so many years later. I would say that, since inception, these two corporations have been mismanaged, used as whipping posts by one party and the other and carefully kept off the books of the country so they will not directly impact America’s balance sheet.

These two congressional creations have been a convoluted scheme since inception, and while they do not carry an “implicit” guarantee of the government, they do carry an “explicit” guarantee so that they always trade right on top of United States Treasuries.

This gives them lower costs of funding, but what this guarantee is actually worth has been anyone’s guess since the companies were first created.

For 72 years, Congress has been involved with all kinds of shenanigans with these corporations, which has even included allowing the banks to buy them—prodded them to buy their debt, in fact—and gave their bonds a zero risk weighting so that the banking system in America is loaded up to the gills with their debt. Now what happened over time was that these two agencies became quite powerful and had big lobbying organizations, and they have been prime examples of public/private entities, as they had publicly traded stock and their own preferred stock plus both senior and subordinated debt. Finally, in a fit of angst, Congress turned against its own creations, much as the creator in Frankenstein turned against the monster it had created, and in 2008 began severing limbs. What took place, in my opinion, was a travesty that caused not only the unnecessary loss of wealth for individuals and institutions alike, but actually caused the bankruptcy of a number of banks as the result of quite capricious actions by Hank Paulson, then secretary of the Treasury, and others who made decisions that effectively bankrupted these entities as they threw out most of the management of these companies based on the fact that they were losing money, even though Congress and the administration were issuing policies and writing laws that were the cause of the losses.

In some kind of fit of rage and one of the worst financial decisions made in this century, the secretary of the Treasury decided to quit paying the preferred dividends of both agencies, which caused irreparable harm to both of the companies and brought into question, quite unnecessarily, the guarantee of the country which sent a tidal wave of doubt and suspicion throughout the world.

These two housing agencies may not have carried the “full faith and credit” guarantee of the United States, but it had always been thought that the “explicit” guarantee was close enough so that when the choice was made to quit paying the dividends of the preferred stock issues, some of which were brought to market just months before, all hell broke loose and the denizens of doubt were unleashed on the plains. The situation can only be described accurately by imagining Sauron, in The Lord of the Rings, emerging from his black castle and wreaking havoc with absolute abandon on all of the people of Middle Earth.

It is a strange fate that we should suffer so much fear and doubt over so small a thing. Such a little thing.

—Boromir,

The Fellowship of the Rings,

J.R.R. Tolkien

The travesty for the United States, which represents the safest bonds in the world and is the reserve currency of the world, was that our international reputation, centuries in making and protecting, was thrown under the bus by the actions of one man and his minions, who in one fell swoop tossed the reputation of America close enough to the edge to make everyone shudder and to question the financial viability of the nation. If you think I am being too strong in my presentation, I am not; Henry Paulson utilized some of the worst judgment that has been seen in the history of our country. What he did was absolute idiocy, in my opinion, and from that day to this one I hold him accountable for the reverberations that are still being felt from this decision. He may go down as one of the worst secretaries of the Treasury since its inception—and he should!

Get Back to Where You Once Belonged

August 11, 2008

I would like to take up the issue of the FNMA and Freddie Mac preferred issues once again, along with their subordinated debt. It is my belief that many people have this wrong and that these two federally chartered agencies will make good on their obligations—all of them. The United States can ill afford for any of its agencies to not pay their debts. As I have said all along, the dividend of the common stock is one issue that is not a stated commitment to pay, but all of the other classes of securities that are senior to the equity carry an obligation of the agency and now, perhaps, the government. For the paltry amount of the preferred dividend, do you think America is going to damage its credibility with its citizens and the rest of the world? Secretary Paulson is not that that moronic!

Let me state that I personally own some of these securities, my mother owns some, and there are some in the money I personally manage. Now, if you take the time to look at the indenture of, say, the FNMA 8.25 preferred (FNM.S), you will find that it is stated quite clearly that this preferred is Tier I Capital. You may also wish to note that in the recently passed legislation and in all of the comments from the Treasury, all of the statements refer to backing the agency and there is no discrimination as to the kinds of debt. The ratings agencies may well make proclamations about the financial condition of these two agencies and then look at the various classes of debt and regard the preferred as compared to the subordinated debt or senior debt, but, in my view, that path does not lead to Rome. These are agencies of the government, not private corporations, that were asked recently to expand their lending to help American homeowners, and now we are not going to pay their obligations? Even in the drop-dead scenario that the United States would take over FNMA and Freddie Mac, it is my opinion that the government would continue to pay all debts—preferred, subordinated, and senior. If you make the assumption that the preferreds would then be trading to the 2010 call at the 5-year +200, then you get a yield of 5.20 percent and a dollar price of $26.94. While it is certainly true that the preferred dividends are subject to certain capital requirements and a declaration by the board of directors, it would be a travesty for all of the U.S. agencies not to pay the debts of these GSEs, and I believe this card will trump the short-term economic weakness that is taking place in the housing markets. It hardly makes any kind of rational sense to ask these agencies to expand their role and then have them not pay their obligations. It is quite obvious, given the price of the preferred, that there is another viewpoint here, but this is mine, and I see the present pricing as an opportunity to enhance Grant’s Rule 2: “Make Money.” Over the weekend, Secretary Paulson announced that the government has no need to invest money into either of the housing agencies at this time, and given that there is still a common stock dividend, this is one more sign that the preferred dividend is intact. I would even make the argument, given the scope of problems in the housing sector, that the recent losses reported by FNMA and Freddie Mac are fairly paltry given the size of their portfolios.

Finally, let me make this observation: If I am wrong and FNMA and Freddie Mac do not pay their obligations, then all of the agencies’ subordinated debt and preferred debt will be no more than commercial obligations. The federally chartered sponsorship will have lost its meaning, and you can expect to see all of these classes of debt for all of the agencies descend into a sinkhole.

Watch the Euro Zone

The dollar has now appreciated almost 8 percent from its low point against the Euro. Oil is down to $115.20, and the entire Commodity Research Bureau (CRB) Index is down 18 percent from its highs. The long commodities, long oil, and long euro trades have now turned into major losers. The game is changing as Europe is at the starting blocks for higher inflation, devaluing housing markets, and weaker economies. If you take the conventional wisdom that the equity markets are leading indicators, it is interesting to make some observations. For the United States the Dow Jones is now down 11.54 percent for the year, with the Standard & Poor’s (S&P) Index down 11.72 percent and the Nasdaq is down 8.98 percent. Not good numbers, but let us put this in perspective: The DJ Euro Stoxx is down 22.53 percent, with the Financial Times and London Stock Exchange (FTSE) down 14.99 percent and the CAC 40 down 19.99 percent and the German DAX down 18.66 percent, so America is not doing quite so badly by comparison. Even in the Far East, the Nikkei 225 is down 13.98 percent while the Hang Seng Index is down 21.31 percent.

GMAC

Let me quote from their recent statement released on Friday, August 8, 2008: “There continues to be a risk that the company will not be able to meet its debt service obligations and be in a negative liquidity position in 2008.” The rest of their press release was full of hype and hope, and this proclamation, I would certainly guess, came from their legal advisers as a prelude to several possible outcomes of their financial situation and none of them good. On July 31, GMAC posted a $2.48 billion second-quarter loss, including a loss of $1.86 billion at ResCap. The mortgage lender has lost money for seven straight quarters, losing $7.2 billion over that period. Caveat emptor!

Write-Offs

In the first quarter of 2008, I said that the majority of the write-offs would be done by quarter three. I have vacillated in my own mind about this since then, but think I will be close—it could be quarter four, but the end is coming soon. The worst of the hits have already been taken, and those are the most severe of the catastrophes, the ones where the bet was leveraged and the equity has already been wiped out. What will happen next is the appearance of markups where the market has stabilized and the value has bounced off the bottom. It will appear first in some bank or investment bank, and you will get the initial look at credits that have begun to appreciate and then all kinds of good numbers will show up. If you wish to profit from the turn, then I think we are very close to a jump-off point to get back into the game!

The Cost of Not Honoring Obligations

August 19, 2008

The financial world is currently under siege. I am not sure if there is a better way to put it, but it might as well be an economic jihad fostered by some terrorist group. There is certainly no letup in the press, and I wonder who is making what bets after reading some of the commentary provided by the tribal leaders and warlords of the global marketplace. Some of the more recent articles such as the ones recently in Investor’s Business Daily and Barron’s struck me as so shortsighted as to lack common sense.

On the agency front, the mistake is this: These are not totally private companies, and yet the mentality of these and other articles are treating them as if they were no different than GE or IBM. The viewpoint is also so skewed, in my opinion, that they do not understand the ramifications of what they are suggesting. If a GSE were to default on one of its obligations, anywhere in the debt structure, the trust would be broken. This could be at the preferred level or the subordinated debt level because if an agency were to default there, then why would any person think their promise to pay was valid at any other place or point in time? The point is clear to me: If an agency of the U.S. government does not honor its obligations, then there is no value in the federal charter. Further down the path of rational thinking, if one American agency does not honor its commitments, then why would any investor expect any other American agency to honor its commitments? It seems to me that the fallout from FNMA, as an example, of not paying its preferred dividend would be disastrous for not only the credit of FNMA but also Freddie Mac, Federal Farm Credit Bank (FFCB), and the home loan banks. The violation of a payment of debt by any agency will forever invalidate the meaning of a GSE and, in a larger sense, the reputation and honor of the U.S. government, and yet that is what recent articles have suggested to minimize the short-term difficulties of agencies that support and fund housing in the United States.

Common sense is not so common.

—Voltaire

In my opinion the viewpoints recently expressed in these and other articles take no consideration of the extreme fallout that would accompany an agency not paying its debts—any of its debts. The price of the equities of FNMA and Freddie Mac were down 22 percent and 25 percent just yesterday, and the falling knife has become the meat cleaver in a nosedive. I have noticed in life that it may seem like the easiest course not to meet one’s obligations. There seems to be a rather large group of people who feel that temporary setbacks can allow you to not stand up to your responsibilities. I have always felt that our government and the agencies represented by federal charter followed a higher standard, and I pray that I am correct in this assumption because the notion that they should not pay their debts would be a travesty for America—an absolute and final statement that the value of a GSE was null and void.

All the perplexities, confusion and distress in America arise not from defects in their Constitution or Confederation, nor from want of honor or virtue, so much as downright ignorance of the nature of coin, credit, and circulation.

—U.S. President John Adams

If some U.S. agency does not pay its debts, then the greater sadness will not be in the loss to portfolios but in the loss of common sense of our political leaders and the resultant loss of trust by investors in America and in the rest of the world who will learn quite conclusively that the United States does not honor its obligations. If you think that is too harsh, then so be it, but I choose to believe that a GSE has a meaning and that a federal charter invokes an obligation of the federal government. To be more pointed, I am ashamed and disgusted that Bernanke or Paulson or the president has not stood up and said, unequivocally, that the American government will support, if necessary, all of the debts of a U.S. agency. The rhetoric to date has been jumbled and unclear and misleading, either by attempt or construction, and I find it disheartening as an American citizen. I am happy to share the burden of increased taxes if necessary to support an obligation of my government, any obligation, as I expect the politicians that represent our country to be honorable in their statements and actions and to pay the bills of the federally chartered agencies as they would pay the direct obligations of the debt that is guaranteed in our Constitution.

Congress has asked FNMA and Freddie Mac to assume a greater role in housing given the current difficulties, and then the government is supposed to abandon them when they have financial issues as a result? There is no claim of fraud or mismanagement beyond the normal political barbs of those of different stripes, and yet supposedly responsible people in national publications are calling for the abandonment of obligation under fire. To be honest, I am greatly saddened by the rhetoric of many of these people and amazed at their lack of judgment and inability to grasp the stark reality of what they are suggesting.

Government loses its claim to legitimacy when it fails to fulfill its obligations.

—Martin L. Gross

The Agencies and Uncertainty

August 25, 2008

FNMA and Freddie Mac: The Uncertainty Principle

In quantum physics, the Heisenberg uncertainty principle states that locating a particle in a small region of space makes the momentum of the particle uncertain and, conversely, that measuring the momentum of a particle precisely makes the position uncertain. This postulate in the scientific world seems to have some relevance to the present state of affairs with these two agencies. The paradigm is convoluted by the structure, privately owned corporations with federal charters, government sponsorship, and a congressional mandate to provide affordable housing to the citizens of the United States. Allow me to point out that it was Congress that created this structure, which, in my view, makes the government responsible for the obligations of what they have created. The exact location or specificity, then, of these entities’ obligations has become increasingly uncertain, as there are large and pertinent questions about what their obligations exactly mean to any and all parties who accepted the notion of a federally backed agency. One could argue, with some validity, that the notion currently bein...

Table of contents

• Cover
• Contents
• Title
• Copyright
• Dedication
• Acknowledgments
• Introduction
• Part I : The Wizard Calls the Ball
• Part II : Learning to Dance Until It Moves
• Part III : Market Issues
• Part IV : The Great Game
• About the Author
• Index