A Dash of Insight

How to Make Money on Barney Frank

Barney Frank, (D Mass), the Chair of the House Financial Services Committee, is a polarizing figure.

He is the bête noire of the conservative punditry.  Whenever he does or says anything, there will be a chorus of objections from those who disagree with his politics or his lifestyle.

Over at Zero Hedge, one of the several "Tyler Durdens" managed to work in a couple of offensive remarks in a very brief post.  (We're not repeating them.  It will be interesting to see if the Seeking Alpha editorial team publishes this one!)

The issue?  CNBC scored one of their "First on CNBC Interviews" by getting Rep. Frank on Squawk Box right before the hearing on executive pay.  It all started OK, but then Mark Haines started to weave from straight questions into a discussion of his own opinion.  He often does this, and his viewers like it.  With a rookie on the show, it can be devastating.  With Barney Frank, who showed very little tolerance for this.  In fact, he seemed pretty testy about the questioning.  For CNBC, it just meant that they lost the interview.

You can see it yourself right here:

Why Listen to Barney Frank?

Barney Frank is one of the most polarizing figures in Congress, at least to a national audience.  His constituents think he is great, and he has a very safe seat.  (This means that those who believe that he took various actions for small campaign contributions do not understand the political process).

As a funny-sounding, very liberal, and openly gay member of Congress, Frank is an easy target.  He is no stranger to controversy, providing more ammunition to right wingers and gay bashers.

Our question is the same, practical, relentless one we have been offering for some months:

Do you want to make a political statement, or would you rather make money?

The blog writers who want some boo-yah's from their audience bash away on Barney.  While avoiding explicit criticism of Frank, Mark Haines probably scored points with his own audience by offering his personal viewpoint on executive compensation and shareholder influence.

The Attitude of the Smart Investor

Let us suppose for a moment that you do not agree with Rep. Frank's politics.  Here are a few facts:

• He is one of the most powerful people in Congress, at the epicenter of various decisions on financial regulation;
• He is (perhaps) the smartest person in Congress, according to a poll of Congressional staffers.  (If you do not see this, then maybe you need to review your personal biases.  He regularly runs rings around interviewers, as he was doing with CNBC this morning.)
• He has been accepted by the Street and the GOP (Hat Tip Charles Kirk).

Here is what Crains New York has to say:

Just about everyone in banking wants to be Barney Frank's friend nowadays......

Mr. Frank ambles around the halls of Congress in the type of pin-striped suit familiar to any banker—although his untucked shirt betrays any notion that he might be one. Yet financial executives credit him with reining in his fellow Democrats' angriest impulses about how to handle Wall Street. He can charm Republicans, too: Last month, he was the only congressman ranked among the “most partisan” and the “most bipartisan” in a survey of members by The Hill newspaper.

“He finds a way to negotiate,” says Scott Talbot, senior vice president of government affairs at the Financial Services Roundtable.

Of course, it also behooves bankers to play nice with Mr. Frank. Asked if bankers have come to grips with new realities, he tartly answers: “I think they understand a new set of regulations is coming. And it's better to sit down and get it right than get it wrong.”

You really need to read the entire article to understand how serious financial executives view Frank.

The Simple Question

So it is a pretty simple question.  When you are watching CNBC do you want to hear the viewpoint of one of the most powerful Congressional leaders, or do you want to hear opinions from Mark Haines?

Do you want to read some politically oriented bashing of Barney, or would you like to make money?

Investors should be agnostic with respect to politics and to life style.  Those who insist on injecting politics as part of their analysis are facing (at least) four tough years of investing.

There are investment stories that will work.  It does not matter if you agree with Frank, or Pelosi, or Obama.  As long as we can predict what they will do, we can find an edge.  Even though we absolutely hate government control of business, we have found winning investments this year.

How?

Be practical, not political.

Street Fighters: Good Information and Good Fun

Kate Kelly's book, Street Fighters:   The Last 72 Hours of Bear Stearns, the Toughest Firm on Wall Street,  now on our recommended reading list, is a great source of information and fun to read.  It is well-sourced, authoritative, and always interesting.

Does it provide, through a look at Bear, the answers to our financial crisis?  We think not, but that is part of the fun.  The reader can collect information -- raw data -- with real confidence.  There will be many accounts of the financial crisis.  Anyone seeking a complete understanding should consult many sources.

The Approach

Street Fighters tells an engaging tale focused upon how a mighty firm was reduced to rubble in three days.  You know the ending before you start reading, but it is no less engaging.  The author has a nice sense of the characters and has done extensive research into backgrounds.  We not only learn about the major players, we learn what everyone else thought about them.

Such an approach is open to challenge.  Kelly provides footnotes for sources, and acknowledges disagreement.  It is convincing support  for her narrative.

The Result

The reader is treated to a view from several perspectives.  It is an insider's take on the politics within an investment bank.  There is genuine conflict over risk and which products to feature. Even the most jaded reader may have some sympathy for a wealthy guy who spent a lifetime building up his company and his position, only to lose it all in a few days.  This is "inside baseball" at its best.

The story is dramatic and well-told.

Assorted Insights

The reader has raw data to draw conclusions on several interesting points.  Here are some that stood out for us.  Yours might be different.  Please consider the following:

• Significance of CNBC.  David Faber had a story about firms not trading with Bear.  It was big news, but it was later denied by those in question.  The damage was already done.   The issue is how much information one needs to go with a story like this, when the story itself can affect the outcome.  Should Faber have verified more completely before going with this story?  Would it have made a difference?
• Significance of Kelly and the WSJ.  Many readers will already be familiar with the three-part series in the Wall Street Journal.  In the book, Kelly asserts that the series itself -- criticizing Cayne's leadership -- had an impact within the firm.
• Hank Paulson's Role.  Paulson is portrayed as dictating a punishingly low stock price for Bear.  Historians will combine this information with additional information, includeing his reversal on the use of TARP funds, the decision to force TARP on all of the major banks, and other similar decisions.  From our perspective as public policy experts, this is an extraordinary and arbitrary use of powers.  It is on a scale that is without precedent for a Treasury Secretary.
• The Fed Role.  The decision of the Fed to expand lending to include investment banks, only two days after the Bear failure, was extremely arbitrary with respect to timing.  We should all be concerned when public officials make decisions about which firms (and which investors) live or die, and do so without clear rationale.  Bear was allowed to die while others were saved.

Conclusions

Kelly's conclusion is that Ace Greenberg built a firm on some principles and Jimmy Cayne violated those and lost it all.  We are not convinced.

We can now see what happened to many other firms.  It would not have mattered if Bear's leverage and risk had been a little less.  Kelly is probably right in suggesting that Bear was an unloved firm on the Street, and therefore first to be challenged.

It was beyond her scope to consider other causes, although there is a paragraph or two on the trading in Bear stock.  This was something we watched daily on our trading screen.  Those betting against the firm could trade in the thin Credit Default Swaps market (CDS), buy puts (where premiums exploded in issues that were far out of the money), short the stock, pull your hedge fund accounts, and spread rumors.

These events were all taking place.  The sequence of causation will never be determined.  What we do know is that any business depending upon confidence and credit can be destroyed in three days. Those aiding the destruction can make millions as it happens.   If that is a verdict on a business model, the entire banking industry is in question.

Final Take

The book is fun to read and has plenty of raw data with authoritative sources.  You should read it, and combine what you learn with other information.  The story of the 2008 crisis is complicated.  We look forward to reviewing other books on the subject.

Should You Own Junk Bonds?

At "A Dash" we think the time is right for high-yield bonds.  We hold profitable positions in these securities in personal and client accounts.  The yields offer an attractive alternative to most of the common shares, and have less chance of default or dilution.  Naturally, we are very attentive to comments on prospects for these securities.

Our attention focused on this item from Zero Hedge:

...everyone is ignoring that 20% of these names will be bankrupt by year end, unless Obama and TTT nationalize everything, in which case look for the first 5 year plenary session some time in December, complete with parades by the 91st and 341 Missile Wings showing off their Minuteman III arsenals (reduced to single warhead delivery to comply with START I).

Unlike most readers, we click through to the source, which reads as follows:

“Champagne might be a little premature,” Gregory Peters, head of credit strategy at Morgan Stanley in New York, said yesterday in a Bloomberg Television interview. “You’re still facing the biggest distressed default cycle that we’ve ever seen.”

Moody’s is forecasting the default rate among high-yield companies globally to soar to 14.8 percent by year-end from 8.3 percent in April as companies that financed a record amount of high-yield, high-risk debt leading up to the credit crisis struggle to refinance.

Our Take

A key skill for investors is to verify the accuracy of sources and their evidence.  We highlighted this problem, and noted the difficulty when readers uncritically accept the summaries provided by popular sources.  The summary from this author is not accurate when one looks at the source material.

The other key point in this case is the intermingling of a political viewpoint with investment advice.  There is plenty to analyze about the Obama Administration.  We work on this daily at our sister site, ElectionStocks.com, where we link policy proposals and decisions to stocks.  Our approach is strictly analytical.  We note successes and failures, and did the same for various candidates and the Bush Administration.  Our approach is not partisan -- strictly oriented to investment success.

Those who start with the conclusion -- an attack on government policy -- and then look for evidence, may be in for a long four years of bad investment decisions.

Long  PGF

Does Blogging Enable Market Manipulation?

The greatest strength of financial blogs is also a potential weakness.  There is so much information that readers frequently rely upon the interpretation of the writer.  Most people do not click through to the supporting links.  They go to their favorite sources for information, and generally rely upon the interpretation of the writer.

We know this is true from our own stats, even when we strongly encourage readers to check out an entire article.  Readers rely upon us to make accurate representations of source material.  We are expected to provide a fair summary and accurate illustrative quotations.

Fair enough.  No one has time to check out all of the sources, no matter how carefully we try to document.

This is in sharp contrast with mainstream print sources, where editorial procedures review material before it is published.  Not so in the blogosphere.

The issue can be simply stated:

Blogs with a wide following have a special responsibility to check and re-check accuracy before posting.  If the authors do not do so, there is an easy means of manipulation.

Step one:  Get a dubious story out there somewhere -- anywhere.

Step two:  Get a noted blogger or pundit to mention the story.

Step three:  Mainstream media sources race each other to be first with this news.

Trust in link sources is vital.

Strong Sources

We feature several blogs where the authors provide plenty of links and summaries.  Some of the sources are anonymous bloggers.  We believe this conveys a special responsibility, since the reader does not know the background or skill of the writer.  It takes more evidence to be convinced of these sources, but the proof is evident in the work.  If one checks out the links, the accuracy proves out.

Here are examples of sources where the links are fairly interpreted with very high reliability:

• Abnormal Returns.  The summary tells you what you will see.  You can choose whether to read it.
• Charles Kirk.  Always interesting, always accurate.  Many interesting links.
• Alea.  Anonymous, but with special insight on credit markets.
• Calculated Risk.  Respected by everyone -- earned through accuracy.
• Paul Kedrosky.  Especially useful in finding interesting academic papers.
• The Big Picture.  Barry has a viewpoint, but his sources are always carefully documented and accurate.
• Muckdog.  We like the "everyman" viewpoint, which often captures the spirit of the market.  The links support his statements.
• Dr. Brett.  Unchallenged authenticity, with widely varying interests.
• David Merkel.  What you see is what you get in links at The Aleph Blog.
• Adam Warner.  The quotes are always representative.

We are leaving out many, of course, but this is designed to illustrate.  The WSJ blogs, for example, are carefully sourced.

The Jury is Out for Some

Like many others we follow the work of the anonymous blogger "Tyler Durden."  Seeking Alpha assures us that this person is an authority. He has rocketed to a high level in the new Seeking Alpha rankings -- a position of influence and responsibility.   Many of the articles display interesting and informative insight concerning the inner workings of big firms and hedge funds.

Since there does seem to be a viewpoint in the Durden work, we have great interest in the sourcing and evidence.  Let us look at an example of links from the prolific Durden.

Must read on CNBC propaganda: "Immelt and NBC Uni CEO Jeff Zucker supposedly told top CNBC executives and talent to be less critical of President Obama and his policies" This explains why nobody with half a brain watches CNBC anymore (THR hat tip Guest)

Since we have opined on CNBC politics, this was of great interest.  Our viewpoint is that opinion shows like Kudlow's in the evening are interesting and informative.  Viewers know what they are getting, and it is a lively debate.  We do not like the intermingling of politics and journalism during the business day, when CNBC anchors get to interview authoritative guests.  We are not very interested in the opinions of the journalists, and viewers should not be either.

If one reads the link, one can readily see that the quoted section does not accurately represent the article.

First up was a woman asking about a reported meeting in which Immelt and NBC Uni CEO Jeff Zucker supposedly told top CNBC executives and talent to be less critical of President Obama and his policies.

Immelt acknowledged a meeting took place but said no one at CNBC was told what to say or not say about politics.

During the woman's follow-up question, her microphone was cut off.

The key point is that Immelt denied the charge in the Durden quote.  Perhaps he suggested that journalists should be journalists in non-opinion shows.  We do not know, of course, but that would be a good thing.  Helping investors to separate political decisions from their finances is good advice, as we have frequently suggested.

Even more telling is this section from the rest of the article:

Later, during the umpteenth question about MSNBC, another shareholder's microphone was cut, according to multiple attendees.

"The crowd was very upset with MSNBC because of its leftward tilt," one attendee said. "Some former employees said they were embarrassed by it."

One specific complaint about MSNBC concerned Keith Olbermann's interview of actress Janeane Garofalo, who likened conservatives to racists and spoke of "the limbic brain inside a right-winger."

We spend very little time on MSNBC, but from what we have seen, we can understand the criticism.  Once again, the key is whether the program purports to be journalism or opinion.  This part of the article is exactly the opposite of the theme of the Durden quote.

Briefly put, we do not think that the Durden summary of the link is a fair and accurate representation of the article.

Another recent  example is the unsourced claim that SPY is hard to borrow.  This was challenged by Doug Kass (full disclosure -- Kass is a valued colleague at TheStreet.com).  Kass checked this out and found no problem with a borrow.  Here is the Durden response:

Update 4: Doug Kass disagrees:

I have received emails from several trading sources, stating that the market is rising because the SPDRs (SPY) are hard to borrow now and arbs are being squeezed.

This story is hogwash, as I just tried to borrow 500,000 SPDRs and had no problem doing so!

Position: Long SPY; short SPY puts and short SPY calls

Maybe Doug can disclose at what term and rate he got the borrow. Doug - I am dead serious - can I borrow 5 million SPY right now at 0% from you? Hell, will give you 1%

We expect to hear more about this dispute.  Meanwhile, anyone wanting to short the market can do so through a futures account.  There is no problem in "borrowing" e-mini's to go short, the method favored by those of us in Chicago.  There is an arbitrage opportunity with SPY.  The claim of a problem in shorting does not have face validity, so we look forward to some evidence.

Our Take

It is easy for investment readers to be swept up by apparent authenticity, especially from a source that everyone seems to follow.

We hope that "Tyler Durden" will balance frequency of posting with accuracy in representing links.

We have a continuing concern about the "leaked stress test" story, where he is a supporter of a dubious source.  That is a question for another day.

Interpreting Government Data: Is a Conspiracy Afoot?

Nearly everyone agrees that there are many economic issues and that government policies are an important part of analysis and forecasting.

So much for the non-controversial statement.

Investors Need to Know

As investors, the key questions we all face involve interpreting data.  We want to know whether there are signs of a change in the economy.  We want to know what data can be trusted.

When it comes to interpreting government data, we find three different groups:

1. Those who see a conspiracy around every corner.  They believe, to take a prominent example, that the Bureau of Labor Statistics (BLS) is a pawn of any President.  They watch too many "B" movies and have never taken a class in political science.  They have a ready audience of those who already share their opinions.  It is like the Rush Limbaugh of financial blogging.  We have no idea how much market power these folks have, but we have no hope of convincing them, whatever our evidence.
2. Those who are intent on serving investors and have the purest motives, but who suspect BLS data.  This is an honorable group of commentators.  We disagree with them.  We should all understand that disagreement is OK.  It gets issues out in the open for forthright discussion.
3. Those who are political science and/or public policy experts.  As far as we know, we are alone in this category.  The Street seems to feel that there is nothing special to learn from those who actually know about government.  We note the many blogging economists and the dearth of  blogging public policy or poli sci types.

The Public Policy Perspective

In understanding government data, there are a few key points to keep in mind.  Let us begin with a story from our days in Wisconsin.  We were once invited to a meeting in the office of a key legislator, the Chair of the key committee with oversight of the state's Department of Revenue.  On the wall of his office was a row of pictures -- many pictures.  One of us inquired about them.

"These are all of the Revenue Secretaries who served while I have been the Chairman."

If you understand this statement, you have taken a long step to understanding how government actually works.  For example, President Obama cannot dictate to the executive agencies on data, nor to legislators on policy.

The BLS

The single most important concept to grasp about those generating government data is that it is NOT like a private company.  The government workers have tenured civil service jobs.  The administrations come and go, but they have career positions.  If you talk to them, as we have, you would understand that their career objectives are geared to a high standard of professionalism.  They do not flip around with each new administration.  They certainly do not sit around tweaking data to fit the needs of "bosses."

Anyone who suggests this is showing a lack of experience with actual government agencies.  As part of our service to government, we worked with these people.  They all knew that they would be around long after the political leaders were gone.  They were doing a job as well as they could.

Investment Conclusion

Now more than ever it is a time to understand economic data.  There are many who disparage official reports.  It empowers them to use non-quantitative evidence.  Following this lead is a mistake for investors who are wondering when the economy will turn.  If one is free to reject actual data, the field is open to opinion and preconceived notions.  It empowers those who do not do quantitative research, relying instead on impressions.

It is one of our missions at "A Dash" to engage those whose disagree, but have who have pure motives.  We seek to convince them, and through them, their readers.  We often send emails to economic observers whose well-intentioned efforts miss the mark.

We will have some future specific posts where we cite those who disagree.  This should be interpreted as a mark of respect.  If we did not think that these influential pundits sought the truth, we would not bother with them.

We look forward to some constructive discussions.  Those who want some good background should revisit this article, where we discussed the conspiracy issue.

Why There is No Bottom: Politics

Here at "A Dash" we have argued that resolving the problem of troubled assets, called "toxic" by most and "legacy assets" by Geithner, was Job One for the Obama Administration.  We understand that a new President has many jobs, including in this case, the stimulus package, dealing with auto companies, a housing program, proposing a budget, and presenting to a joint session of Congress.  This agenda is dictated for a new President--dictated by circumstances, tradition, and the budget process.  It is not really a matter of choice.  The market does not distinguish between the broad agenda, which may or may not happen, and immediate plans -- those completely under the control of the Obama Administration.  Market participants are woefully ignorant about the norms of politics.  As a result they misinterpret many routine actions.

Unfortunately, a normal transition does not fit the current times.  Compared against other transitions, this one has been fast.  Given the crisis circumstances, it is still too slow.  It will be a great dissertation topic for doctoral students in public policy and political science.

Our take is that Geithner came in with an idea about troubled assets, got involved in his own confirmation issues, could not staff up quickly enough, and is still working on the details of a plan.  We like what we have seen so far, but the market will be very skeptical given the mis-steps and the delay.  We still await the details.

The failure to deliver on the most important issue has opened the door to criticism.  As the stock market declines, it is viewed as a referendum on the economy.  The average person interprets the stock decline as strong evidence about the economy.  It is a negative feedback loop.

Persuasive Presentation

While we are not regular viewers of Jon Stewart's The Daily Show, perhaps we should be.  (Thanks to a helpful reader for alerting us!)  It would be nice to have a great audience and a staff that could dish up some exciting video clips.  We also lack the wit and skill of Stewart.  Let us compare his take and ours.

The Santelli Tea Party

In our pondering professorial style, we suggested that Rick Santelli was playing to an atypical audience.

Jon Stewart, who invited Santelli to the show, made the same points.  We especially like the cheers from his audience, in contrast to the cheers for Santelli from our friends at the Merc.  Some of the comparisons and clips are unfair and out of context, but the concept captures the idea.

The Stock Market as a Tracking Poll

We characterized the market as a demanding, self-centered girlfriend.  Jon Stewart shows the ticker in the background in every Obama appearance, and even suggests that it be super-imposed upon his forehead!

Multiple Bailouts

We have suggested that it is past time to deal with troubled assets once -- and move on.  Jon Stewart, interviewing Joe Nocera of the New York TImes, does a funnier and better job using the AIG example.

Conclusion

We hope readers will watch the segments cited, or watch the entire show.  We enjoyed it, and so will you.

So what is the investment take?  This is Part 2 of our projected four-part series on why we cannot find a stock market bottom.  Each segment provides a clue about what might change, and how we might find a catalyst.  (Valuation and Technical Analysis on the agenda.)

For now, the failure of the Obama team to deal with troubled assets at banks has opened the door for criticism from all sides.  This failure has extended the attack on financial stocks and the overall market.  This allows critics to suggest all sorts of alternative causal models that do not really fit.

Like all investment managers, we continue to watch for more details on the Geithner plan.  When we get it, and when it is understood, it will be a winning trade and investment.

Parsing the President

In a state of economic crisis, it is natural for investors to pay attention to any public statement by President Obama.

There is a natural sequence of timing to the moves of the new administration.  Some policies can be changed by the stroke of a pen, through Executive Orders.  These are Presidential directives that have the force of law.  They state how the government will implement existing law.

Today's News and Market Action

The President issued some widely-expected executive orders today.  These involved some changes in signs at workplaces and relatively minor rules on how union informational costs were allocated.  For example, one of the rules has bounced back and forth -- from the first President Bush, to Clinton, to the next Bush, and now to Obama.  It is a natural partisan shift.

The announcement, symbolically important to organized labor, was made to an audience including labor representatives.  The President was speaking to the audience in front of him, including core supporters, and not to the market.  In a typical over-reaction, the market commentators flipped out as President Obama talked about the importance of organized labor.

Separating Rhetoric from Substance

The real market test of the Obama Presidency will come on the key issues of taxation of dividends, capital gains, and free trade.  We believe that the course will be a moderate one.  Our conclusion is based upon the Cabinet appointments and the strong overtures to Republicans.  We shall see.

Those with a bias, perhaps anti-union, are hard-wired to see the worst in any statements, no matter what the significance.  There were many such commentaries today.

The Bad Bank Plan

A similar scenario is playing out on the so-called "Bad Bank" plan.  We are encouraged that the Obama Administration is looking to a root cause -- the hard-to-value assets held by many financial institutions.  There are several ways of addressing this problem.  Regular readers of "A Dash" know our priorities:

1. Best -- a suspension of mark-to-market accounting.  Provide plenty of footnotes.  Heaven knows there will be plenty of attacks on the footnoting firms, so investors will be informed.  The key is that there will not be the destruction of regulatory capital, so "sensible lending" can resume.
2. Second Best -- a method of price discovery.  Since the securities on the balance sheets are complex, we need a good method of finding a true market price,  one which reflects the value if held to maturity.  This is not reflected in existing markets.
3. Third Best -- the "good bank, bad bank" idea.  If this concept is to get traction, the participants must quit thinking of the taxpayer as an investor, trying to make an astute buy.  The only justification for taxpayer involvement is the systemic effect.

Conclusion

There is a valuation for troubled assets that is both fair for the taxpayer and also acceptable to banks.  There is no more important problem for restoring economic strength.  There are many wise people on the Obama team, and they are consulting with key players.

We expect a favorable conclusion, but it will face a skeptical audience.  This helps to explain why we continue a generally bearish short-term market stance, while believing that the entire year will be quite positive.  The heavily biased Wall Street audience will remain skeptical.

The Madoff Scandal: Where was the SEC?

Regular readers of "A Dash" know that we are generally more sympathetic to government actors than the investment punditry.  We think this stems from more direct experience with those in government and our disciplined effort to look at a problem from all perspectives.

Despite this perspective, there is one institution that gets a consistently low grade:  The SEC.  A few days ago we suggested that investors monitor potential changes at the SEC.  We continue to believe that this would be important to the long-term health of the market.  If the new leadership were to suspend mark-to-market accounting rules pending clarification, it could even have a short-term effect.

Likely Changes at the SEC

Here is what we wrote earlier today on RealMoney:

The Madoff scandal is yet another black mark for the SEC and Chairman Christopher Cox. In past comments I have noted that his official term of office extends until June of 2010, although Obama could appoint a new chairperson. In fact, several top SEC staff members announced their resignations right after the election. Cox himself has indicated plans to step down at the end of the Bush term, although he is willing to serve longer until a replacement is found. Gary Gensler (Treasury and Goldman Sachs) is the transition official in charge of the search. Some think that he might also be a candidate. Others mentioned include former SEC Commisioner Roel Campos, also on the transition team. Some speculate that Robert Pozen (former Fidelity vice-chair and now Chairman of MFS Investment Management) is a leading candidate.

The issues facing the SEC are deeper than just the personnel. There will be some effort at comprehensive reorganization to get rid of the gaps among the SEC, the Fed and the CFTC.

Charlie Gasparino just reported that the SEC is saying that they get many tips like the one received on Madoff. One of the critcisms of Cox is that he did not go after the budget authority needed to fulfill the enforcement responsibility.

Conclusion

This upcoming change is a market positive that is not yet on most radar screens.  A good dissertation topic for someone in political science and public policy would be the study of Presidential transitions and why timing created over 200 years ago no longer works.

We give President Bush high marks for his attempts at handling the crisis and turning over the reins.  Despite the "country first" attitude, the delay in implementing new programs is contributing to the economic distress.

Election Day Rally

When two events happen at the same time, there is a strong psychological basis for connecting them.

Today is such a day.  The widely-expected end of the election and Obama victory is somehow getting linked to the stock market.  We discuss this, and future investment opportunities, at our sister site, ElectionStocks.com.  Please check it out for a more detailed analysis.  This will be the source for future stock-specific recommendations as we analylze the emerging Obama plan.

The key issues are still ahead of us.  Our read is that Obama is constrained by the economic environment.  We are very interested in his first decisions.  These will include the following:

• How to handle the funds approved for the "rescue plan."  Our hope is that there will be continuing attention to establishing accurate pricing for distressed assets, not just investments in private companies.
• The approach to fiscal stimulus.  There is widespread agreement on the need.  The implementation is open to debate.  Will something emerge from a lame-duck Congress, or will Democrats wait for the new term to get a package they like.  The trade off is delay versus a plan they really want.
• The attitude toward taxation.  An Obama administration is expected to increase taxes in a way that will affect capital gains and, perhaps, dividends.  We will be watching closely to see how Obama, as a President-Elect, views these issues.  Our forecast (based on better insight than most) is that many proposed tax increases will be deferred, perhaps for two years until the expiration of the Bush tax cuts.

Investment Notes

Somewhat to our suprise, the TCA-ETF model has already indicated some sector buy signals and more are imminent.  The climate is more positive, perhaps validating the signal from our Gong model.

While the Democrats sing Happy Days are Here Again, we have no such illusions.  There are continuing issues.  We will closely monitor the plans for dealing with the acknowledged housing and credit problems.

Are we there yet, Daddy?

There is a chorus of opinion concerning government actions to deal with the economy.  It is a chorus, because nearly everyone agrees, and they are all wrong.  It brings to mind the question that every parent has heard at the start of a trip:  "Are we there yet, Daddy?"

Let us start with a brief history of events.

What Happened

First, and very importantly, we allowed various private market actions and government facilitation to create a dangerous and highly leveraged environment.  There are plenty of people analyzing this, and we are as well.

Second, the needed process of deleveraging took place at WARP speed.  There was no one at the helm.  Existing structures were pro-cyclical, making the changes occur more rapidly rather than dampening effects, and giving everyone a chance to adjust.

Third,  those seeing the money sought the losers in the Credit Default Swap Market.  Option players purchased put options that could profit only if the company went out of business in a week or two.  When this strategy worked in the Bear Stearns case, many observed the pattern and piled on.  There are now investigations about this pattern of trading.

Fourth, distress sales at one company became the new standard, via mark-to-market accounting, for other companies.  The market bulls eye moved from one victim to another.

Fifth, the government, far too slow to recognize the problem and to act in advance, was forced into a reactive mode.  The decisions about which companies to save seemed completely arbitrary.  The decisions about whether to punish common shareholders, preferred shareholders, or bondholders were equally arbitrary.

The Result

This sequence of events created a complete freeze in the credit markets.  Why lend to a counter party who might not be there tomorrow?  The decision to allow Lehman to fail made this worse, much worse.

Events also highlighted the housing market as a cause, rather than an effect.  If we had done a better job of addressing the credit problems, qualified buyers would be part of the demand curve for housing.  Since we have not addressed the issue, the market remains dominated by sellers.  This imbalance generates continuing concern about what bottom, if any, exists for housing.

The Government Plan

The Bush Administration, led by Treasury Secretary Paulson, sought to address the key issue, the death spiral of write downs from complex securities.  Their "plan" was an outline, not a specific proposal.  It requested broad powers without specifics or limitations.  It violated the norms of Congressional and Judicial oversight.  In addition, the plan was poorly sold as a "bailout" rather than something that would establish rational markets.  The attempt to sell it embraced fear as a motivation.

The fear "worked", the market reacted, but the plan did not pass.

Everyone in government went back to work, developing a more flexible approach that provided many alternative methods.  A coalition was built.  This proved to be essential.

The immediate step was to provide a direct capital infusion for financial institutions and various government guarantees for lending.

The Result

Here are the big issues and the positive impacts -- pretty good so far.

• Counter party risk.  This has been addressed.  Our monitoring of the put markets shows no targets.

• Thawing the credit markets.  This has been addressed.  LIBOR is declining.  Credit default swaps and other risk measures are declining.  Financial institutions are resuming normal lending.

• Commercial paper.  This market, vital to business activity, is returning to a normal state with plenty of help from the Fed.  There will be an interval of decline in business activity, but the actions have prevented the worst case.

And here is what remains to be done.

The meat of the Paulson Plan, better explained in the hearing by Bernanke than by Paulson, was to establish normal trading and realistic marks in securitized markets.

And here is the key point...

Even the most astute market observers do not seem to understand government.  Paulson and Bernanke repeatedly stated that they wanted to "get this right" before deploying funds.  People should listen to this and understand, yet they do not.

What they hope to do is establish what we call a win-win-win situation.  This means that realistic marks on assets will be better than the current accounting standards.  Meanwhile, the purchase price will be attractive to investors (taxpayers and others joining in).  Finally, the overall economy will benefit by stabilizing assets, improving capital ratios, and permitting new lending.

Can this succeed?  No one knows yet, because they are still working on the plan.  Kashkari has explained what they are doing, and it includes price discovery, direct purchase of securities, and perhaps direct help to borrowers.  Other government programs, already passed, will help.

The unrealistic expectation was that this would start happening the day the plan was passed.  This is just silly.  Even operating quickly, the government needed to establish teams, consider the alternative methods, and get ready to launch the program.  Those believing that action should have been immediate just do not understand government or any large organization.  The expertise required must be identified and organized.

Spending money before the plan and the team was in place would have been foolish.

Our Conclusion

Regular readers of "A Dash" know our basic position.  Much of this could have been avoided by calling a "time out" on mark-to-market valuation of assets, ending the death spiral.

In the absence of this, it will take a little time for the Paulson Plan's important elements to come into play.  We expect better markets in credit default swaps, and therefore in the ABX, which trades off of these instruments.  We also expect a more stable market in CMO's and CDO's.

Since no one seems to understand either the issue or the potential in the solution, our readers have something to watch, and a source of profit.