More Gloomy Data

While initial jobless claims declined by 24,000 to 467,000 in the week that ended January 3rd, the total number of people collecting benefits rose to 4.6 million, the highest number since 1982, indicating that those who have been laid off are having trouble finding jobs.  If ever there was a year that the US did not want to revisit economically speaking, 1982 might be a contender after say, 1929.

Meanwhile, retailers all trimmed earnings forecasts after an extremely disappointing holiday season.  Even the great discounter Wal-Mart announced its profit would miss earlier forecasts after sales rose a meager 1.7% last month.  Sales at the Gap, the largest US clothing retailer fell 14%, while revenues at Macy's dropped 4%.  Although a dismal holiday season at most retailers was not necessarily unexpected, the announcement from Wal-Malt was a shock and the stock is getting pummeled this morning.

Speaking of shopping and malls, REITs are having a lousy day, more than likely thanks to the dismal retailing update coupled with a fairly bearish article in the Wall Street Journal that reports on a sharp rise in delinquencies in commercial mortgages in the fourth quarter.  The article makes three important points in my opinion:

• The commercial real estate market is $3.4 trillion dollars, larger than the $2.6 trillion market for consumer credit.  Rising delinquencies in this market is no small matter for the market. 
  
• Many of the loans made in the past three years were based on unrealistic cash flow estimates and may default as cash flows fail to adequately cover debt service.
• Banks and thrifts own nearly 50% of all commercial mortgage outstanding.  In particular some 1,400 commercial banks and savings institutions had more than 300% of their Tier 1 capital in commercial mortgages.  This implies that if and when the delinquencies really hit a fever pitch, there will be many more bank failures.

As usual, there is a nugget of humor in the otherwise beak assessment.  A chief credit officer of a small bank in Illinois that has commercial mortgages outstanding representing 752% of its Tier 1 Capital is quoted with the following: "The economy caused the situation to a great extent.  When the economy rectifies itself, the bank will see a great improvement in its balance sheet."  He speaks of "the economy" as if it were perhaps a person who, as a chief credit officer, maybe had some say over how much risk the banking institution would take with its depositors' money.  But I suppose if Mr. Chief Credit Officer had his head in the sand when he allowed his institution to take so much risk, it makes perfect sense that he'd just wait around for "the economy to rectify itself."  Because hope is always a component of any solid risk management plan.  

Tomorrow will bring the big Kahuna of economic numbers: the employment report.  If you aren't quivering in your boots yet, you should plan on starting right about now.

Another Day, Another Fraud, Another Suicide

If a severe economic downturn is good for anything, it is unveiling fraudulent organizations that have been operating for years in an easy money bull market.  Today brought another shocking revelation of a large-scale financial fraud, when the founder and Chairman of one of India's largest technology companies, Satyam Computer Services, admitted that he had concocted key financial results for several years.  Among other things, B Ramalinga Raju claimed that the company's cash balance of more than $1 billion was a mirage (around $60 million.)  Furthermore, Mr. Raju overstated profits for the past several years, overstated the amount of debt owed to the company and understated its liabilities.  In other words, he was just making that accounting stuff up.  Granted Satyam was an Indian company, and we can all write it off as one of the dangers of investing in emerging markets.  This kind of thing never happens in the US (if you don't count Enron, Worldcom and all those telecoms that were engaged in revenue inflation at the turn of the century.)  The curious part of the story is that PricewaterhouseCoopers was Satyam's auditor and several high-profile independent directors including a Harvard Business School professor served on Satyam's board.  I understand that it is tough to root out fraud when a very motivated person is doing everything in his power to hide the truth.  But is it asking too much for an accounting firm to look at a copy of a bank statement to make sure that the amount of cash sitting in the firm's bank account actually ties out to the firm's balance sheet statement?  If you're billing $250 an hour (or whatever it is these accounting firm's charge) for your services, I think not.  Interestingly, the word Satyam means "truth" in Sanskrit.  But in the language of accounting and auditing, it apparently means "fools!"

Perhaps the saddest byproduct of the severe credit crisis and economic downturn is the increase in the number of suicides.  I am not speaking in the statistical sense, because I don't have any actual statistics to support this claim.  What I can say for certain is that the Wall Street Journal has had a few too many reports of businessmen facing financial problems that have chosen to take their lives.  Today brought the unfortunate story of Steven Good, the CEO of Sheldon Good & Co, one of the nation's largest real-estate auction firms, who took his own life earlier in the week.  Yesterday, the suicide of Adolf Merckle, one of Germany's wealthiest men, was attributed to mounting financial woes at his sprawling conglomerate.  Thierry Magon de La Villehuchet, manager of one of the feeder funds that invested in Madoff's ponzi scheme took his life the last week of December.  Early December brought the suicide of Alex W. Widmer, the head of private banking at Julius Baer.  Although Mr. Widmer's death wasn't linked to problems at the bank, according to a statement from Julius Baer, it's easy to assume that possible financial difficulties may have contributed to his decision to take his own life.  Several other finance executives reported in the press in the past few months have chosen suicide as the preferred method of dealing with what is either the loss of a significant amount of wealth or a complicated business situation that will take years and many lawsuits to resolve.  Prior to his suicide, Mr. Villehuchet was certainly at the center of a significant amount of fury from investors in his fund that were wiped out due to the Madoff fraud.  Suicide may have seemed like the most rational choice when confronted with the alternative: the loss of his own personal fortune coupled with angry phone calls and accusations from investors and regulators for the rest of his life.

I happen to believe that the purging of fraudulent enterprises from our economy is healthy, albeit very painful for those ensnared.  It's hard enough to sustain a healthy and aboveboard business in this economic environment, much less prolong a ponzi scheme or accounting fraud.  So if you're looking for a silver lining, it is the following: any company making it out of 2009 alive is probably worth an investment.  As for the increase in suicides, well, it's just sad.  One can only hope that those who are facing extraordinary stress and depression choose to get help and work through this tough period rather than taking the seemingly easier way out.  For it is most definitely not easier on the the families that they leave behind.            

Economic and Earnings Roundup

First the bad news:

• Intel, in its second pre-announcement related to the miserable fourth-quarter, reported a 23% drop in fourth-quarter sales.  Revenue was $8.2 billion in the period, down from $10.7 billion in the same quarter a year earlier.  Two months ago, the world's largest chipmaker warned that revenue would be around $9 billion, down from an earlier estimate of $10.1 billion.
  
• Time Warner will take a non-cash impairment charge of about $25 billion before taxes in the fourth quarter.  Somehow it only took Time Warner nine years to figure out that it may have overpaid just a tad for AOL.
  
• Alcoa announced it would cut more than 15,000 jobs, halve capital spending and sell four businesses as it reduces aluminum production.
  
• The ADP Employer Services gauge estimated that 693,000 jobs were eliminated in December, the most since records began in 2001.  Also, Challenger reported that job cuts announced by US employers almost quadrupled in December from a year earlier, paced by declines at financial firms, chemical makers and retailers.  Neither of these reports bodes well for the employment report set to be released on Friday.  Economists are expecting a loss of 500,000 jobs.
  

In the good news department:

• Monsanto, the world's largest seed company reported that quarterly profit more than doubled to $1 a share from 46 cents in the year ago period.  The company also raised guidance for the fiscal year 2009.   
  
• Family Dollar Stores' first-quarter net income increased 14% amid sales and margin gains.  The company raised its earnings estimates for the first quarter and guidance for the second-quarter.  
  

Unfortunately, if you're not in the seed or discount retail business, you're probably not having a good quarter.  The economic and earnings news continues to be bleak, indicating that the recent rally in equities can be attributed only to significant improvement in the credit markets.  While it is certainly positive news that credit is moving again, it is extremely difficult to ignore how hard the real economy is crashing.  The Fed, Treasury and the new administration are working around the clock to instigate new measures to blunt the impact of the dreary economy.  But until we have a clearer picture on just how bad things are going to get, it seems hard to justify jumping in to this market with reckless abandon.     

Proposed Tax Cuts To Benefit Banks and Builders

As part of the monster stimulus package currently being cobbled together in Washington, under a new tax break, companies would be allowed to carry back losses for five years instead of only two and get a nice fat rebate check from the government.  Companies that had huge profits during the economic boom had to pay a bunch of taxes on those profits.  Now that they have lost buckets of money in 2008 and stand to lose even more in 2009, they're stuck with all of these pesky losses that they really use, other than to stick them on their balance sheet, call them "deferred tax assets," and hope against hope that someday they will make money again so they can use the losses to offset taxes.  What really irks me the most is that this tax break benefits companies that were the worst risk managers in the corporate universe, those that mismanaged their businesses so poorly that they have wiped out any gains they made when the economy was surging.  Which companies fall under this distinguished umbrella?  Why the homebuilders and banks, of course.  Although clearly cyclical companies who should at a minimum have pulled the reigns in when conditions appeared overheated, the homebuilders can be considered complicit in the housing bubble, as their financing arms were all offering the latest in exotic mortgages.  So, why exactly do these guys deserve a huge tax refund?  Certainly the CEOs who were dumping their stocks in record amounts in 2005 are not being asked to return their gains because the profits the homebuilders posted during those years were an illusion.  Who else would stand to gain from this new tax rebate?  Everyone's favorite bailout candidate Citigroup, who had net deferred tax assets of $13.6 billion at the end of 2007.  After already receiving over $45 billion in capital infusions from the government and another $300 billion in guarantees against future losses, does Citi really need tax rebates from the government?  For the love of God, can we give our tax dollars to someone else?  Please?   

Snippets of Interesting News and Commentary

Welcome to the first full week of trading in 2009.  Equity markets are lower on perhaps a bit too much partying during the holidays.  Very little in terms of hard news released today so I present you with a few interesting highlights:

• Congress is set to review the Madoff fraud and pinpoint exactly why the SEC neglected to discover the scandal despite numerous investigations into the investment firm's operations over the years.  Michael Lewis and David Einhorn wrote a very interesting New York Times editorial explaining, among other things, precisely why the SEC sucks as much as it does.
• The Fed will begin purchasing MBS today.  Details of the purchases will be updated on a weekly basis on the New York Fed's website.
• Obama's stimulus plan will include about $300 billion in tax cuts, presumably to entice embittered Republicans to vote for an ambitious stimulus package.
• The New York Times has a great piece on the the alarming rise in vacancy rates in commercial properties around the country.  You can read a nice summary at Calculated Risk, or just read the entire article in the Times if you really want to be depressed.
• Apple shareholders will be relieved to read that Steve Jobs announced that his drastic weight loss has been caused by a hormone imbalance, rather than a return of the cancer that rumors suggested.
  

SEC Attempts to Look Busy Probing More Ponzi Schemes

Sure it's going to take some time to figure out exactly how one man could misplace $50 billion.  But rest assured that the SEC is not just gonna sit on its laurels while it is unraveling the Madoff mess.  The supposed regulatory agency that has dropped the ball in ways too numerous to count during the financial crisis, has announced that it is pursuing "at least one case" in which investors may have been cheated out of as much as $1 billion.  In fact, just this week, the agency announced that it halted a $23 million scam targeting Haitian-Americans.  Sure it is a travesty that Haitian-Americans were being ripped off to the tune of several million dollars, but I wouldn't parade those numbers around the Jewish community, as they would no doubt be happy about only losing multiple millions instead of multiple billions.  While it's great that the SEC has finally woken up from its slumber and decided to actually do its job of investigating potential scams, it's pretty pathetic that it took a scandal the size of Madoff to light a fire under the agency's hide.  I suppose someone at the SEC has been tasked with finally dusting off the pile of ignored letters from attempted whistle blowers, and might be taking a few of them seriously.  Whether the investigators are capable of unveiling fraud without a preemptive full blown confession from the perpetrators remains to be seen.        

Executives at Citi Follow Other Banks' Lead in Declining Bonuses to Head Off Furor

Pity the poor Citigroup executive who must forego his bonus purely to ward off near-certain flogging by the media and angry taxpayers footing the bill for its bailout.  The Citi chiefs recognized that paying themselves bonuses in a year where they flushed billions of dollars down the toilet and required two bailouts from the government would be political suicide.  The New York Times article quotes Vikram Pandit with: "The harsh realities of 2008, primarily our earnings results, mean that our bonus pool is dramatically lower than last year."    The article goes on to say that bonuses at the top will be down at least 40% for 10 members of its senior leadership team.  Call me crazy, but somehow "at least 40%" doesn't cut the mustard for me.  I would like to recommend "at least 77%" instead, for that is precisely how much Citi's stock was down in 2008.  Or how about "at least 95%?"  For this is the indignity that Wachovia employees were handed for coming in to work in 2008.  Despite Wells Fargo rescuing the Wachovians from their fate as future employees of Citigroup (or more likely just members of the unemployed) after an FDIC seizure, according to the New York Times story, the California bank is refusing to cough up retention packages and bonuses to Wachovia's employees to compensate for Wachovia's stinginess.  A top Wells Fargo executive is quoted with announcing to a group of Wachovia's bankers the following "I know that's very painful to hear, but that's the reality.  It just would have been irresponsible to the company's shareholders to do anything else."  The New York Times managed to find an embittered Wachovia third-year Vice President, who at least had the presence of mind not to identify himself, to make the audacious claim that the bank's decision was putting its employees in "financial extremis" and in some cases, at risk of not making their mortgage payments.  While it is certainly true that if you spent every cent of your bonus money during the biggest boom Wall Street has ever witnessed, and assumed that your bonus was guaranteed ad infinitum, then yes, you are definitely up the creek now that you can't make the mortgage payment on your $(insert a number) million house.  The thing is, that's not really your employer's problem, nor should it be.  

For years, private equity and hedge funds fed the finance compensation boom by poaching already highly paid Wall Street employees and offering them a bigger piece of their profits.  While alternative asset managers rewarded very richly to the upside, they can't pay when they lose money, as 20% of 0% (and more likely negative returns) is still a big fat donut.  After a brutal year for hedge fund and private equity returns, coupled with record redemptions, the competition that was willing to pay up for "talent" is gone.  It seems that several boom years on Wall Street corrupted some executives and employees into thinking that they should get a bonus every year no matter what, even if their employer lost, for example, $22 billion in a quarter (i.e. Wachovia,) was seized by the FDIC, and more than likely would not have been saved by another bank if it weren't for the government's largesse.  

While my thoughts go out to the naive third-year Vice President quoted anonymously in the New York Times article who now finds himself in "financial extremis," I'd like to offer some unsolicited words of wisdom:  First of all, congratulations, you still have a job.  Second, suck it up, downsize, kiss some ass, and keep your thoughts to yourself at work as well as dinner parties, particularly if you happen to go to dinner parties with people who don't have six-figure salaries or are unemployed during a major economic downturn.  And last, never forget that third-year Vice President = Very Expendable.