NOTES FROM THE FRONT

WHAT I KNOW ABOUT THE EUR0
December 12, 2011

What do I know about the Euro that you might not and I can share with you? It is certainly not as much as many experts and others in the financial business, but a fair amount more than some. I can tell you that the Euro currency was created as a result of the Maastricht Treaty, which formed the European Union, and began its official life on January 1, 1999 as an accounting currency and came into daily use on January 1, 2002 with the introduction of coins and bills. The initial value of the euro in January 1999 was established based on agreement by the members, and exchange ratios agreed to for the respective currencies (franc, mark lira, peseta). During January 1999, 1€ was worth about $1.17. The euro traded below $1.00 at the end of 2001 and averaged in the $0.88 cent range in early 2002. Beginning in 2003, the value of the euro has traded comfortably over a dollar and trended upward during the decade. As a result of the present crisis of confidence, its value is presently about $1.34. Most of what I know I remember from our widespread travel to Europe, and in every year since, as it crept up in value, American travelers have faced rising prices and much more expensive tourism abroad as well as increasing prices for imports from Europe.

In pre-Euro days, Carol and I traveled to Greece when the drachma was Greece’s currency. I recall that we stayed in the Athens Hilton, perhaps the top 1st class hotel in Athens for something like the equivalent of $125 per night, and had a series of great meals on the Plaka with wonderful fresh grilled fish at around the equivalent of $10-15 per person. Today, the Greece that we read about daily is in crisis and in a state of economic collapse and uses the euro just as they do in Paris, Madrid, Rome and Berlin. The Hilton, still one of the top hotels, now starts at 350€ equivalent to $475 per night and the same grilled fish meal is apt to run at least $50 per person. Greeks now buy Mercedes Benz’s instead of old Datsun’s (pre-Nissan) like the one we rented on Crete and drink Champagne rather than the Retsina wine that we drank. The average Greek citizen can come to New York for shopping and stay first class and eat well using the euro as a strong currency as we did with dollar/drachma. One regret I have is that when I visited Delphi, I failed to ask the Oracle of Delphi about euro economics and made the mistake of relying on our Oracle of Omaha for his Americentric view.
When I made my first trip to London, Madrid and Paris as a college student in 1959, which was only 14 years after the end of WWII, I relied on the famous guidebook of the day, “Europe on $5 A Day.” It could be done. We had fewer dollars but they went a long way. Measuring purchasing power, roles have been reversed over the last 20 or so years, with Europeans (and Asians) now traveling to the US for budget vacations and cheap shopping while average Americans have pretty much had to retire their passports. I guess that’s why people enjoy the “Bellagio” in Las Vegas rather than the real one on Lake Como in Northern Italy. Turkey, a non-Euro country with its weaker currency and lower prices, now attracts American tourists much as Greece did years ago. I imagine that they are contemplating joining the EU as well.
The overall description of the European financial crisis includes weakening economic conditions and the inability of certain member states of the EU running large deficits to refinance their debts and borrow money at acceptable rates. Declining sovereign bond values have created losses for financial institutions and investors holding those bonds, and have damaged bank balance sheets. The crisis surfaced in the spring of 2010 in what are known as the PIIGS countries – Portugal, Ireland, Italy, Greece, and Spain. Now, the crisis has grown to include virtually all of the 27 EU members, and the future of the EU and the Eurocurrency is questioned. The European banking system is believed to be in great distress with a number of French and German banks rumored to be near insolvency. Lenders and investors are demanding that sovereign governments reduce their deficits and are pushing severe austerity measures, which are causing woes for citizen consumers.
The US stock market has been on a rocky road for the last year and spent November and early December in an extremely volatile trading pattern with days of huge gains and losses trading places as news and rumors about the Eurozone crisis were aired. The problem seemed to receive some good news and a victory on Friday the 9th as the European Summit reached an agreement to provide unified support to the EUR currency as well as a commitment to rework the EU treaty to correct some of the initial deficiencies in the structure. Unfortunately, both the perennial euro skeptics and deal-skeptics are equally disappointed in what is perceived as a deal which seems to be just another promise to do something while that something remains elusive.
It’s all quite complicated to explain and understand, but a major criticism about the creation of the European Union has always been that it was: a treaty of economic union only, without the binding political structure to insure unified action; a club relatively easy to get into but impossible to get out of, voluntarily or involuntarily; an organization inconsistent in its composition where some member countries such as England, Sweden, Norway for example, kept their own currencies and therefore had independent economic and monetary mobility, with currency actions open to themselves, while most of the others, such as Greece and Spain as prime examples, were tied to the Euro currency and realistically, tied to the German economy. In my view, the current economic crisis demonstrates unequivocally that Germany has accomplished the domination of Europe in peace, what Hitler failed to do in a terrible war, and is now facing what I believe could be viewed as a paraphrase of Secretary of State Colin Powell’s Pottery Barn rule. They (Germany) broke it, they own it, and they are responsible for fixing it.
George Soros wrote a piece in the October 13, 2011 New York Review of Books entitled “Does the Euro Have A Future” in which he presented his primarily negative views of the difficult crisis that was then still playing out and obviously before the action undertaken just a few days ago. Basically, his conclusion shares the general pessimism of many, and states that “without a common European treasury, there is no clearly visible solution to the Euro crisis.” There is nothing that I have read of the summit accord that establishes that common treasury. Moreover, Soros wrote, “Even if a catastrophe can be avoided, one thing is certain: the pressure to reduce deficits will push the Eurozone into prolonged recession. This will have incalculable political consequences. The euro crisis could endanger the political cohesion of the European Union.” It is fairly obvious that the ball is solely in Germany’s court and in my opinion, the euro is really the Deutsche Mark under another name,
As a result of a recent German Constitutional Court Decision prohibiting certain actions including infusions of new money and new arrangements without the authorization of the Bundestag, Soros writes that “there is no alternative but to give birth to the missing ingredient: a European Treasury with the power to tax and therefore to borrow. This would require a new treaty…” which he admits “presupposes a radical change of heart” and is unlikely. He goes on to say “The German public still thinks that it has a choice about whether to support the euro or abandon it. That is a mistake. The euro exists and the assets of the financial system are so intermingled on the basis of a common currency that a breakdown of the euro would cause a meltdown beyond the capacity of the authorities to maintain.”
What did come out of the meeting on the 9th was an agreement by 26 of the 27 members of the EU signaling a strong commitment to the currency and to the continuance of the organization by effecting a major change in the treaty to strengthen supervision and control by the majority over the individual members’ economic and fiscal controls and programs. This agreement falls short of Soros’ view of a new taxing authority and amended treaty. England was the lone dissenter and did not agree to the final agreement. Since the inception of the EU, England has always held itself aloof as an island nation, preserving its independent currency and sovereignty and generally afraid of diluting English culture.
I am certainly not expert enough to know if this agreement to agree, or commitment to commit, or however one might describe it has sufficient hard cash behind it to do what it takes to avert the collapse of the EU, and assuage the fears of the bond vigilantes. Nonetheless, people in good faith have, in fact, committed to a course of action to preserve the union. That has to be taken seriously. On the other hand, this agreement will have to be approved by the member governments through changes to their constitutions or through new laws. This issue and the question of the survival of the euro is not yet solved, as evinced by today’s (Monday, 12/12) market action. But what I think and even what the respected George Soros writes in NYROB are unimportant in the investment world compared to the action of the markets. And when Soros puts his words into actions such as what he is alleged to have done in shorting the British pound a number of years ago, the markets move. And when markets move, big things happen. In fact, one of Soros’ maxims in his theory of reflexivity that I adhere to and respect is that markets drive fundamentals, rather than the conventionally believed opposite, that fundamentals drive markets.
Through the action of the bond markets, the European crisis has most recently driven two established elected leaders from office in both Greece and Italy with possibly more to come elsewhere until a plan is established and implemented to restore confidence. These leaders have been driven from office by market movements without elections, carried out by bond traders in bond trading pits using the Credit Default Swap (CDS), rather than being forced to go on the streets such as was done in Cairo or Benghazi.
Our Omahan Oracle, Warren Buffett, has characterized the CDS, as a WMD, i.e. a financial instrument of mass destruction. The powerful, market moving CDS is a derivative financial product which enables big money positions to create a highly visible expression of fear or panic, of disgust and disapproval, just as a child might wail when troubled, or an unruly mob might set fire to a car on the street. In fact, the CDS is the instrument that converts the financial markets into a casino much larger than Las Vegas. More than that, the CDS is the perfect instrument not only to place a bet, but to almost guarantee the outcome of that bet. Neither financial market nor insurance regulators are currently empowered to regulate the CDS and it remains under no regulatory jurisdiction despite the advice and recommendation of experts and efforts by Democrats.
The CDS is essentially an insurance policy covering bonds and debt obligations. In theory and practice, a large investor owning a bond and seeking to manage risk, could insure that holding against default by buying a CDS from an opposite counter-party willing to take the other side of the risk in exchange for a financial premium. At this point, it all sounds pretty legitimate, much in the same way that Chubb or Allstate would offer a homeowner a $1 million fire insurance policy on the home he/she owns. “Insurable interest” is the terminology used in the insurance business that defines the homeowner’s right to purchase insurance on the owned home against loss. Generally, insurable interest is established by ownership, possession or direct relationship.
But suppose, hypothetically, that thirty strangers came along who each wanted to buy a $1 million fire policy on that same house, that they didn’t own, but to collect the same payoff if the house went up in flames. Under existing law, insurance companies would not sell the policies to those strangers because they had no insurable interest in the property – the house belongs to someone else - and if they did, they would be exposed to $31 million in losses on a $1 million dollar house. Under those circumstances, leveraged 30 to 1, it would represent more of a wildly speculative bet than actuarially-based insurance, and it seems pretty likely that, in an unregulated market-driven situation, that house would somehow soon mysteriously go up in flames.
Using Greece as an example, in the case of CDS’s on any specific debt instrument, it is permissible and standard practice today that anyone can buy a CDS in any amount that selling counter-parties are willing to sell without owning the underlying debt security, even in amounts far greater than the entirety of the particular issue of debt outstanding. The buyers of specific CDSs need not own underlying bonds of the issuer, i.e., have no insurable interest, but instead be using the CDS as a method of creating a short position in the specific instrument or class. Thus, the CDS could be considered to be a security rather than an insurance product. As buyers buy the CDS, the price action will rise reflecting demand, and as the market price of these signal instruments rise, implying an increase in the perceived risk of credit default, all hell will break out. Feed the fire with rumor, and you could easily see companies like Bear Stearns, Washington Mutual, AIG, Merrill Lynch or Lehman Brothers bite the dust whether through shotgun marriage or bankruptcy, which was exactly what, happened during the fateful week of panic in September 2008. All those companies were victims of the same fate as sharp increases in the prices of their CDSs set in motion a self-fulfilling downward spiral. It appears that the similar CDS trading pattern is in play today. I can remember that in 1981, the US Treasury issued 15 year bonds due in 1996, carrying a 16.125% coupon. I shudder to think what would have happened to the United States if the CDS product was then available to bond traders in 1981.
The failure of the markets to respond favorably to the EU agreement reached last week is an ominous sign and is likely to usher in a new period of market turmoil. Bond traders are not likely to sit back and do nothing for six months or a year or more awaiting concrete action promised under the agreement. CDS spread prices could rise sharply and be heralded by cable financial media as implying further weakness in vulnerable countries and suspect banks. Rumors may fly, unnamed sources may issue provocative headlines and the emotions of crisis may continue to roil markets. In the meantime, austerity measures and spending cuts are sapping the vitality of European economies, damaging consumer confidence and affecting world trade. All eyes will be and should be on Angela Merkel and Germany and everyone should raise their voices in unison like Tom Cruise in the 1996 film “Jerry Maguire” and shout: Hey Angela, “SHOW US THE MONEY!”
Peter R. Mack
December 12, 2011

KICKING THE CAN DOWN THE ROAD

In the last few weeks, the hands-down winner for the most used, hackneyed cliché in financial and political speech with respect to the federal debt and deficit has been “kick the can down the road” which is a folksy way of saying procrastinate. The expression probably derived from an old children’s game and appears to be the one thing that both Republicans and Democrats agree on, that they don’t want to be accused of doing. It seems that many politicians would rather be accused of emulating DSK rather than be called a can-kicker. DSK’s behavior has been seen before in DC.

The children’s game has been described as an active, energetic, happy game played by a few children at the same time, while the verb to procrastinate means “to put off until tomorrow what we could do today.” During this period leading up to reaching the nation’s debt limit, the anti-can kickers all want to be seen as serious men and women. They’re thinking of our grandchildren they tell us, forced to make the hard austere decisions that will bring tears to people’s eyes; profligates no more. Cutting benefits, yes, we must do that; raising taxes, no, we will never do that, better to kick the can on that one. Even President Obama joined the conversation declaring that he too would kick no can down the road and suggested he would kick something else in an attempt to get something passed.

All the posturing is the attempt to fashion a complex, long-term “permanent” solution to America’s operating deficit and outstanding debt problem, appending it onto immediate legislation that would extend and raise the ceiling imposed annually by Congress on the amount of US Treasury debt that can be issued and outstanding at any one time. The debt ceiling problem is an immediate one – Secretary Geithner claims that the Treasury cannot function and pay America’s bills after August 2nd.

Some Republicans, especially those representing “Tea Party” backers, including Michele Bachman, are opposed to any extension of the debt ceiling. In her new campaign ad she declared that she would not now nor ever vote for any plan to raise the limit. Many view the date of August 2nd as just a ploy by the administration to raise a false alarm. One senator contended that even without Congress raising the debt limit, the Treasury would have plenty of cash available to pay interest to bondholders first, and then could delay without consequence, Social Security, Medicare and other benefit payments, and government salaries. The dystopian view that bondholders must always get their interest paid before retirees or veterans or even soldiers can get their checks sounded like Marie Antoinette’s famous “let them eat cake” moment..

There are two issues at play – one an immediate problem, the other long term - and both are poorly served by a false linkage done for political leverage for both parties going into the 2012 elections. In my opinion, the debt ceiling extension is mandatory, immediate and must be passed. Without it, I believe that we risk a catastrophic event potentially equal to the market crash and enduring financial crisis that began with the major miscalculation by Secretary Paulsen that led to the Lehman Bros. bankruptcy filing. Extend the debt limit, I say urgently, and kick the the longer term problem down the road.

Realistically, no worthwhile, decent legislation can possibly be debated, understood and passed by the two branches of Congress before August 2nd. A poorly constructed long-term spending bill will be like the healthcare bill, controversial, reviled and propagandized from the start. The best outcome for the American people at this time would be for this can to be kicked and re-kicked down the road until the 2012 elections are over. After the elections, we should have a clear picture of true voter sentiment and political power in the country, whether it’s from the likes of an extreme Michele Bachman, a moderate Mitt Romney or Jon Huntsman, or the neo-centrist President Obama.If power shifts after 2012, any legislation enacted today will certainly be renegotiated or repealed

The consequences of Congressional inaction, of kicking the can, could, in fact, be quite beneficial and result in a balanced budget by 2015 says the CBO. I will repeat what I said: If Congress does nothing, the budget can be balanced in 2015 based on legislation currently in place. Surprisingly, this has not become part of anybody’s debate, probably, I guess, because it doesn’t serve the political strategy for 2012 of either party. It would by definition be kicking the can.

A few weeks ago on June 23rd, the CBO (Congressional Budget Office) issued its 2011 Long-Term Budget Outlook. The extensive report is fact-filled with accurate, non-partisan information and is generally considered to be reliable. Readers can access the report at www.cbo.gov .

The CBO presents the long-term budget outlook under two scenarios that embody different assumptions about future policies governing federal revenues and spending. Neither of the two scenarios is offered as a prediction of future events, since each scenario depends on a specific course of political action and prospective legislation that may be enacted. Following are the two scenarios:

In The Extended-Baseline Scenario, if current law is permitted to stand – which means that there is no repeal of the healthcare legislation; no further extension of the “Bush tax cuts” which have already been extended once and are scheduled to expire at the end of 2012; no repeal of the current health care legislation; and no new fiscal legislation - there is no immediate crisis. The budget deficit would disappear beginning in the crossover year of 2015 and continue balanced to 2035. In the CBO’s words: “That significant increase in revenues and decreases in the relative magnitude of other spending would offset much – though not all – of the rise in spending on health care programs and Social Security.”

This scenario offers the best reason in the world to kick the can down the road: A balanced budget with no new legislation. Adjustments can be made down the road as political conditions improve and events dictate.

On the other hand, the alternative is not so good. Under The Alternative Fiscal Scenario, the situation becomes “much bleaker” according to CBO. CBO assumes that there will be tax cuts, (changes to existing law such as a further extension of the tax cuts due to expire); the “reach of the alternative minimum tax will be restrained;” and that Medicare payment rates to physicians will remain at present levels rather than be reduced as called for under current law.” The CBO concludes that the “explosive path of federal debt under the alternative fiscal scenario underscores the need for large and rapid policy changes to put the nation on a sustainable fiscal course.”

A picture is worth more than all my words, so following are two charts prepared by the CBO that graphically depict the two scenarios.



The air of political uncertainty and constant talk of debt crises in Europe and the United States is infusing the stock markets with a sense of uncertainty. Fears of a double-dip recession are back on the front burner as growth slows. Yet, in spite of the psychological climate, the markets have produced gains for the year. Through June 30th, the S&P 500 is up 4.9% for the year to date, while the narrower Dow Jones Average is up 7.2%. In the second quarter, the S&P was down by 0.4%, while the Dow rose by 0.7%.

Much of the slowdown in second quarter economic activity can be attributed to shortages caused by the Japanese earthquake; a continued slowdown and double dip in housing sales; rising gasoline prices; rising local and state taxes; and slower consumer spending arising from continued high unemployment. Additionally, I continue to see correlation between consumer spending and stock market performance within the investing/savings class i.e., a rising stock market enhances economic activity; conversely, should the market decline if the debt limit is not raised, a new recession or worse may could begin.

A year ago (June 26, 2010), I wrote a piece called Reckless in which I expressed concern that political sentiment was pushing Washington towards austerity on a grand scale and simplistic assumptions by an uninformed public were pushing Congress towards a premature deficit reduction program. Unfortunately, it appears that the Federal government is aligning with the states and cities and beleaguered European countries in broad austerity thinking at a time when we need spending and stimulus. Today’s report of a rise in unemployment to 9.2% is throwing a chill on expectations. It is very interesting that at this same time last year, the economic problems of Greece, Portugal etc. and trading in the credit default swaps were in the headlines and rankling the markets, just as they are again this year. This is the story that keeps on giving. No CNBC day would be complete without worry for Greece or Portugal, and one year later, we’re still talking about the same things with neither a resolution nor catastrophe having taken place.

It is very difficult to maintain an optimistic short-term investment posture amid the complications of election politics at its worst and constant media focus on the direst outcomes. Aside from the very real possibility of political miscalculation, and financial accident, I am confident that the debt ceiling will be extended. Who could possibly believe that our political leaders would play games with the credit standing of the country? Through it all, I remain positive about the investment potential in our great country and I think the best way to approach capital growth and preservation in a zero-to-low interest rate climate and an inflationary future is to pursue equity investments in growth industries through what is now known as single-stock investing.

I continue to be optimistic about investments in health care. We are entering a period of personalized medicine using genetic identification to design of medicines and treatments on an individual case basis. This change could bring about smaller, shorter and thus cheaper clinical trials that will finish sooner and benefit the patient, the sponsor, and the public by reducing time and costs. Separately, human health needs are growing at a rapid rate: results of a recent study of diabetes showed that the present estimate of diabetics in the world now numbers 350 million, and accelerating rapidly, compared to just 250 million in the last study done just a few years ago. I and clients are invested in a publicly-held company that is awaiting final FDA marketing approval on an ultra-rapid acting mealtime, powdered insulin for both Type 1 and Type 2 diabetes delivered to the patient via a miniature inhaler (about the size of the pinkie finger): faster, unobtrusive, disposable, convenient and inhaled rather than injected. Its global potential could be significant. We also are invested in a publicly-held company, one of the pioneer stem-cell research companies that has recently received FDA approval and commenced human clinical trials using stem-cells to treat spinal cord injury and concomitant paralysis. The same company is conducting Phase II clinical trials of a novel peptide-drug conjugate that attempts to deliver anti-cancer drugs across the blood-brain barrier to enable the treatment of primary brain cancers and metastases. The blood-brain barrier prevents most medication from delivering to the brain.

I continue to be interested in the growth potential of electric-hybrid vehicles, and the stimulative effect the adoption of these vehicles will have on expansion of the power grid. Electricity usage is rising from the widespread growth of rechargeable gadgets, devices and autos. Hybrid electric vehicles available now can offer as much as a 100 mpg equivalent or even more depending on driving conditions.
One final thought: It is virtually impossible for the economy to attain an acceptable growth rate and satisfactory employment levels until housing begins to recover. It’s my feeling that the Financials are gearing up to become more proactive in dealing with foreclosures and seeking to work things out with troubled borrowers. We may see improved news in the next months.

Current consensus estimates of 2011 earnings of the S&P 500 companies are around $99.00 per share, placing the price/earnings ratio at roughly 13.5 times, and the earnings yield at 7.4%. Both measurements compare very favorably to the 10-year Treasury bond yield of 3.1%. The S&P 500 has risen 28% from 6/30/2010 to 6/30/2011 when I published Reckless. I concluded then as follows: “Investing in this economic maelstrom is as difficult as at any prior time in my 47 years in Wall Street. However, I do believe in a long term and I do believe that equities rather than bonds are the way to participate in the evolutionary process towards that long term. The continuation of a low-interest rate policy provides low income returns and I continue to believe that selling short-dated covered calls against an underlying quality equity portfolio is a low risk method of income generation. In retrospect, it was a good call last year and with caveats for unforeseen political accidents, I’ll stick with it again.

Peter Mack
July 8, 2011

RECKLESS

As early spring arrived, the prevailing mood was optimistic. Most technicians were bullish and fundamentalists were encouraged by a growing number of signs that the U.S. was healthy. It had been nearly a year since Fed Chairman Bernanke’s vision of “green shoots” that would transform the scorched earth of the market into a lushly verdant, flowering market rally and recover much stock market wealth that had been lost.

Investors who stayed invested through 2009 participated in the bull market and regained enough confidence to resume an almost normal level of living and spending. The stench of the Madoff scandal was fading and the promise of a new administration began to restore trust. According to official measurements, the recession had come to an end. Investors, who were frightened, fled equities for bond funds and missed the recovery but may now have the last laugh.

The market has now given up earlier gains and stands about 3% below the end of 2009. Recent weeks have been a gloomy time throughout the world, with the global financial crisis gathering new steam and raising doubts in the minds of investors as to whether we are going to once again descend to the desperate days of late 2008 and early 2009. Many believe that we are not out of the woods, as unemployment continues at high levels, housing remains depressed, and auto sales remain at an annual sales rate still some 30% below pre-recession highs. Wall Street’s mood now matches Main Street’s pessimism.

Market volatility has risen sharply as global focus centers on Greece, Hungary, the future of the Euro, a slowdown in China and North Korean war mongering, while two huge acts of nature – the Icelandic volcanic ash cloud and the BP oil spill damage serve as the coda to this unhappy symphony of fear and despair.

Added to the problems with economic fundamentals were market technicals. On May 13th, the market experienced a “flash crash”, falling by about a thousand points on the Dow Average within a 12 minute period. Some stocks plunged to a penny, while the blue chip Procter and Gamble fell from $62 to $39 per share in a matter of minutes. This hideous gyration was originally blamed on human error – a trader typing “Sell” instead of “Buy”, or “Billion” instead of “Million” – but as of now, a single cause has not yet been established, despite intensive scrutiny by regulators. Their failure to figure it out has diminished confidence in those regulators yet again. What’s going on?

Many investors and the public at large believe that the markets have turned into a giant gambling casino where uninformed bets rather than careful investments can be made on almost anything. The capital markets have mutated into computer action games.

Gambling is one of America’s pastimes. People play poker; bet on games and races, in person and on-line; participate in office pools; everyday golfers play for money called a Nassau bet; and states use lotteries and off-track betting to supplement income to pay for education and other social needs in lieu of higher taxes. Today, Las Vegas is trying to change its image from a sin-city to a family theme park. People may like to gamble and have fun with their own money but clearly fail to see the fun when banks and financial institutions put customers’ funds at risk and lose it, thus endangering the economic health of the world. No one wants the Federal government to use taxpayer money to be forced to rescue reckless institutions.

New products and activities including Exchange Traded Funds (ETFs), Credit Default Swaps, High Frequency Trading as well as other derivatives coupled with computer facilitated on-line trading have stepped the pace up a notch. A few weeks ago, the Commodities Futures Trading Commission (CFTC), the Federal regulatory body overseeing commodities, allowed the creation and future sale of new derivative futures contracts based on movie revenues. Institutions and individuals will soon be able to bet on the future attendance of a given film before it’s released, wagering whether a new Johnny Depp film will outdraw Shrek. Promoters of this product believe it will help movie production companies to hedge risk, but for the public it will be just be another reckless gamble rife with potential fraud and insider trading.

“High Frequency Trading” (HFT), conducted by large firms such as Goldman, Sachs as well as small firms unknown to the public, apparently represents a large part of daily market activity and was heavily involved in the flash crash of May 6th.. Responding to that event, The New York Times ran an article which described a “humdrum office of a tiny trading room …..workers in their 20s and 30s in jeans and T-shirts quietly tend high-speed computers that typically buy and sell 80 million shares a day. But on the afternoon of that May day …someone walked up to the computer and typed the command HF STOP, which meant: sell everything, and shutdown.” According to the article, across the country similar firms did the same thing which sent chills through the financial world.

With practically all trading on world markets now done electronically, large high-speed computers can be programmed to read accumulated buy and sell orders (order flow) seconds before the trades take place, anticipate whether in the next few seconds a stock is likely go up or down, and quickly and instantly enter an order. Some call it “front-running”, a hitherto illegal industry practice, but regulators look the other way. Most people would agree that this is not the way markets were designed to function, and it is reckless to allow a situation where these “accidents” happen. In past times, it was panicked human investors who would react to bad news by dumping stock and selling en masse, but in today’s markets, it’s the technicians who program the computers to feel the fear and emulate the same knee-jerk human behavior.

It’s thought that high frequency trading (HFT) now accounts for 40-70% of all trading in the market, with some of the largest firms trading as much as 1 billion shares a day. The founder of one of the largest trading firms called them short-term bets and said that his firm typically held stocks for 11 seconds and had not had a losing day in four years. This is clearly not the buy and hold investment strategy that guest experts on CNBC traditionally propound. Investors who talk of the long term and fundamental values embedded in well managed companies are living in a parallel but extremely different universe.

Defenders of unbridled laissez-faire capitalism justify every market product and function as being essential to market liquidity and economic growth. This reckless thinking to support reckless behavior threatens to destroy the capital markets as they were purposely designed: to efficiently facilitate liquidity, stability, economic growth and to allocate private capital to industry. On the contrary, we see some periods of severe illiquidity, instability, economic stagnation, and biased allocation of capital.

Increasingly over the past decade, markets and the stocks and products within them have taken a dramatic turn to short-term rather than long-term investments as hedge funds and quantitative traders have replaced traditional long-only mutual funds as the source of greatest market liquidity. Warren Buffett, who has the reputation of being the market’s most respected practitioner of fundamental long-term value investing, seems to be to have had his best recent investments as the bottom-fishing buyer of last resort in a panic-driven market – being the buyer when computers were sellers.

Responding to the confusion and volatility in the markets, generalized public anger has created upheavals within both Republican and Democratic parties. The modern financial system seems unintelligible to the public and to many members of Congress and their staffs as well. The size and complexity of global financial markets presents an enormous information gap.

In response to the Crash of 2008, and to the mini-depression that continues on Main Street and around the world today, Congress crafted a new financial regulation package (FINREG) aimed at insuring that an event of this past magnitude will never happen again. A compromise bill will be voted on soon by each body of Congress. What has emerged obviously has both supporters and critics. The New York Times says it all: “ACCORD REACHED FOR AN OVERHAUL OF FINANCE RULES: Historic Deal Expands Federal Authority to Curb Risky Wall St. Practices.”

The new bill tries to take aim at the root cause of the Crash of 2008, and throws in a bunch of other ancillary features, but I remain skeptical that that root cause has been correctly identified. The established narrative of the Crash includes excessive leverage, sub-prime mortgage lending abuses, consumer fraud, and reckless proprietary bank trading, but the new bill does not appear to deal with financial institution leverage and capital requirements, nor does it establish clear jurisdiction and regulations over Credit Default Swaps. In my opinion, these and their interrelationship were the principal forces that brought about the destabilization of the financial system. As I wrote in 2008, it is my very strongly held opinion that Secretary of the Treasury Paulson’s push of Lehman Brothers into a bankruptcy proceeding was the straw that broke this camel’s back, and was in itself reckless, hasty and politically motivated. It compressed what might have been a long-term workout problem into an uncontrollable short term cataclysm. No one should forget that Madoff was able to perform a 20 + year massive customer swindle despite being subject to SEC and NASD/FINRA regulation. Those with a will can often find a way.

No other country in the world to my understanding embraces unbridled, unchecked, free-market capitalism with the religious-like fervor as we do in the U.S. We have a society that seems to worship money and celebrity as its core value. Our society thrives on and our economy depends on excessive and conspicuous consumption, and produces a mindset of greed and entitlement that goes unchecked and unregulated in this new FINREG bill.

Public fury now being directed at politicians and business leaders alike seems to have broken the political structure of each party and threatens to replace incumbents with a weird and motley assortment of political newcomers with radical views. Unpredictable, inflexible and un-manageable may describe the political climate in our current environment.

Thus, the economic and market environment is likely to see an increase in volatility and uncertainty as we move forward in this current election cycle. There is some softness developing in the consumer sector of the economy and small business is thus far failing to fulfill its role in job creation. We read that banks are not lending to small business. Now that we are emerging from the depths of the recession, common sense dictates that we keep going forward with programs that will stimulate job creation and keep the economy on track to recovery. No one knows this better than Fed Chairman Bernanke, whose reputation is based on his expertise about the Great Depression and the serious consequences that occurred when economic fiscal and monetary stimulus was stopped prematurely.

Unfortunately, political sentiment is moving towards “austerity” on a grand and international scale. Simplistic assumptions by the general public are forcing Congress along a path of rabid fiscal conservatism, pushing towards a premature deficit reduction program. Just last week, the Senate rejected an extension of unemployment benefits leaving 1,000,000 unemployed with nothing; an extension of the housing credit; and aid to beleaguered states now in the process of discharging hundreds of thousands of employees. The Federal Government can not be run like a household in Iowa or Maine, or a town in Connecticut, scrimping and saving to live within the weekly paycheck or annual revenues. It’s got to reach out to all 50 states and towns within them, and keep spending on the necessities. Both the ratios of federal and external debt to GDP rank far below most other countries of the world and the situation is less dire today than the media and fiscal conservatives would have us believe but, yes, it is a long-term problem.

Economic life in a global economy is extremely complicated and it is clearly beyond the comprehension of the electorate. We all love our Democracy, but people who vote really have to understand what’s going on and what they’re voting for. A recent respected poll proves, contrary to widespread views, that citizens overwhelmingly want an active government in controlling the oil spill and running Social Security and Medicare for example, but the media runs with the story and old video clip of someone screaming “Keep the Government out of my Medicare!” It is my great fear that because of the threat of not being re-elected and trying to appeal to the vague, undefined and uninformed anger of their constituents, Congress is soon to embark on their most reckless behavior yet, with serious consequences for the future.

Investing in this economic maelstrom is as difficult as at any prior time in my 47 years in Wall Street. However, I do believe in a long term and I do believe that equities rather than bonds are the way to participate in the evolutionary process towards that long term. Changes in economic and civil life offer adaptive ways through innovation to participate in advances in health care, energy and communications to name but three sectors, and emerging markets allow an involvement with the world outside of the United States. The continuation of a low-interest rate policy provides low income yields and I continue to believe that selling short-dated covered calls against an underlying quality equity portfolio is a low risk method of income generation.

Peter R. Mack
June 26, 2010

Peter R. Mack is a principal of a SEC registered broker/dealer firm. The ideas presented here are his own personal thoughts and are offered for educational purposes only. Mr. Mack makes no representation as to the accuracy or completeness of the information contained herein and the reader should not rely on any information as the basis for any investment decision. Mr. Mack may, from time to time, have long or short positions in any security mentioned herein.

SAILING WITH TEDDY

PETER R. MACK & CO. INC.

MEMBER FINRA/SIPC

19 EAST 71^ST STREET, SUITE 3

NEW YORK, NY 10021

TEL: (212) 744-3939  FAX (212) 744-8484

E-MAIL: PRMCO@AOL.COM

 

NOTES FROM THE FRONT

September 3, 2009

 

SAILING WITH TEDDY

 

Just about 16 years ago in August of 1993, early in the days of Peter R. Mack & Co., Inc. I published Notes From the Front about my expectations of the then new Clinton administration and their proposed new health care reform legislation.

 

It seems like 1993 redux. Barack Obama was inaugurated in January of this year and is vacationing at Cape Cod. Bill Clinton had been inaugurated in January of 1993 and was also vacationing at the Cape. Just like Bill, who faced a determined Republican party opposed to health care reform, portrayed in the fictional TV characters Harry and Louise, Barack is also mired in an endless and confusing debate about reforming health care, meeting tremendous opposition from the traditional forces of status quo, as well as from renegade Senatorial and House members of his own party. The Republican Senator DeMint of South Carolina has led the charge with his statement that if they can defeat Obama on health care, they will bring down his Presidency, just as Newt Gingrich in the spring of 1991 declared “the need for hard-line Republicans to begin positioning themselves now to keep Democrats from winning in the future.”(PBS.org) 

 

Some believe that because of the failure of the Clintons’ initiative, the subject of health care reform became a political deathtrap for the Democratic Party, dooming the subject from consideration for sixteen years.

 

I remember quite distinctly, and now with great sadness, the widely-published news photo of Bill and Hillary sailing with Teddy Kennedy and his wife Vickie, and Jackie O., on the calm waters of Nantucket Sound. Teddy, it was known, loved sailing, finding calm in the silent power of the wind and traveling by compass. It gave me a thrill back then to see them all together, with so much optimism invested in Bill and Hillary and the promise of change, and the iconic photo of the passing of the torch from one leading political family to another. One could not see or especially hear Teddy’s voice without arousing the good, though painful, memories of Jack or Bobby.

 

 In the intervening years, I don’t recall seeing any photos of George and Laura sailing with Teddy. They had their own dynastic political family but preferred the speed and bustle of motorboats, rather than sailboats, to ply the waters off the coast of Maine.

 

Barack and Michelle did not get their chance to sail with Teddy and have an iconic photo taken, or even get to visit with him in his last few days as they vacationed on his turf. For so many years, the Kennedy compound at Hyannis was the scene of some joy but mostly sadness, and that aura and era has now passed. But if there was one political figure in America for these last 16 years and even pre-Clinton who championed and worked for health care even to his very end, it was Teddy.

 

In my own mind, I see Teddy not as the troubled soul of his earlier years, with his personal transgressions ‘so out there,’ but as a champion of the weak and powerless, who through his strength, heroism, faith and dedication to public life helped me and the country to survive the assassinations of his brothers and Martin Luther King and the destruction of our innocence and dreams. In Puccini’s Madam Butterfly, Butterfly sings “even a mighty oak can be felled in a storm” but Teddy proved otherwise. Knocked down and almost out in 1968 with Bobby’s untimely death, and after Chappaquiddick in 1969, Teddy rose from the ashes to lead the Kennedy family out of grief back to life. He died as a grandfather – something none of his brothers could claim – and a beloved husband, father, uncle, friend and American legend. I and many of my generation and political beliefs will certainly miss him.

 

Some now believe that his passing will unite the divergent voices of health care in a broad, sentimental reconciliation leading to compromise. In spite of differences, there were many in the Republican Party such as an Orrin Hatch who were known to be Teddy’s dear personal friends. I am convinced that there will be a health care reform bill enacted into law, and it may be called the Kennedy bill, but whatever is coming, it will be devoid of soul and likely missing the key elements of change that a healthy, tireless politician like Teddy Kennedy might have accomplished with his oratory and political gifts and passion.

 

I think that the debate over health care has become confused, with most average citizens including me having little understanding of what’s being discussed. To me, there is just one main issue: Health care in America is too expensive for average people to afford. Those individuals who work for corporations or government are provided health care through a variety of insurers and plans and generally contribute some portion of salary towards the overall cost. For many, even that partial payment is barely affordable. The cost to employers is also very substantial and punishing.

 

In my own small company, we have a small group plan through Oxford Health Plans, a division of United Health Group. Premiums have risen in every year since we started in 1991, and in the plan year that began on May 1, 2009, premiums rose by 17% over the previous year, while the level of coverage including deductibles, co-pays, and freedom of choice decreased. The premium for a single person in the current year is approximately $600 per month, over $7,000 per year. The cost for family coverage is approximately $20,000 per year, an amount that is clearly unaffordable for most wage-earners.

 

I am certain that because of their size and negotiating strength, large corporations have plans that cost considerably less than our own, but it is virtually impossible to get a good plan for family coverage for less than around $12-15,000. Unemployed people or even self-employed people can’t afford any insurance at all, and that includes people who leave the security of the large corporation or government job and have to pick up insurance under COBRA. Two income families generally are affording health insurance but at a great cost and sacrifice.

 

In recent years, we have seen corporations shed full time employees in favor of outside consultants, not only with global outsourcing, but in the domestic US as well, in order to avoid adding new employees to the health cost roster. As insurance costs continue to escalate, this trend will grow and employment numbers will worsen, leaving more people without health insurance. General Motors was forced to declare bankruptcy in large part because of employee health care costs.

 

As we listen to the public debate, the implication seems to be that the uninsured are mainly members of the “illegal immigrant class”, rather than actually often being students, young workers and working class citizens. At the rate costs are increasing, growing numbers of ordinary, working people and their children outside of Medicare and Medicaid will be without health insurance because they just can’t afford it.

 

In my opinion, the only solution to controlling costs and providing health care to most people, would be to include every citizen under Medicare even if they are below 65 years of age, or Medicaid if their income levels fall below the “Federal Poverty Level”, which   is currently around $23,000 of annual income for a family of four including two children. I assume that these programs come under the “universal health insurance “or “public option” nomenclature that everyone is talking about. 

 

As one who participates in Medicare and a supplementary private insurance program, I feel that my wife and I have the best medical care available in today’s world at a highly affordable price. All those in the media and on the political right, and people selected for TV news seen screaming at town hall meetings to “keep the government out of my Medicare” don’t know what they’re talking about. Even “the money honey”, Maria Bartiromo on CNBC doesn’t seem to understand that Medicare is a voluntary program open only to older people. (In an interview, she stridently demanded to know of Rep. Wiener of New York why he wasn’t in Medicare rather than the Congressional plan. Wiener appears to be in his early 40’s. She had no clue!)

 

In fact, none of the CNBC broadcasters seem to know much about the subject at all, even though they lead a daily debate actively seeking to preserve the status quo. They, of course, are covered by General Electric’s health care insurance. (GE owns CNBC). I’m certain that they have no idea what it costs or any details. For those of my readers who might not be familiar as well, I will explain. Under the present Medicare system open only to people over 65, those of us who are eligible pay premiums to the government for our basic health insurance which is a very generous program, and for those who wish to expand the basic coverage of Medicare, private insurers such as Blue Cross/Blue Shield, and United Healthcare (through AARP) provide different plans at variable rates to get coverage in excess of Medicare’s. These plans are known as “Medigap.” In my own personal experience, the cost for my wife and me is less than half of that of the plan available under my company, and the coverage includes everything. Adopting Medicare for all would allow for private insurers to stay in the game and to compete with each other to gain “Medigap” business. Medicare premiums are also adjusted by incomes, so that there is some needs-based adjustment, which seems very fair.

 

There are those who say that the Government can’t run a health care program, but from my own experience, I see that Medicare claims are processed quickly and seamlessly integrate with the private insurance companies. I think even Doctors I talk to share the same feelings. From my own experience with Oxford and other private insurance companies in the past, I would have to say that the U.S Government does a better job.  

 

This seems like such a simple solution that I remind myself of Ross Perot who ran for President in 1992, and probably cost George H.W. Bush his re-election and brought us the Clinton Presidency. Perot would stand before the camera in front of an easel displaying charts, and in his Texas twang would say “it’s simple” and then go on to explain his own simplistic solutions to pretty complex problems.

 

Well, to me, it is simple. The best way to control costs is to have individuals involved in the purchase of their own health insurance, rather than having to deal with insurers through their employers’ corporate benefits’ departments,  under plans and coverage chosen for them by others. It should be obvious to everyone that publicly held corporations are in business to make money for shareholders, so when conflict and tension arises between profits and management compensation on the one hand, and medical costs for Mr. Jones’s illness on the other, Mr. Jones loses. Contrary to the odds of flipping a coin, Mr. Jones will lose every single time. It always comes up tails.

 

Anyone who feels that insurance medical board personnel, who work for a for-profit corporation and whose own compensation and advancement within the insurance company depends on increasing profits - i.e. being a good employee - will look out for patients’ interests first, is badly mistaken. Government medical boards acting under properly proscribed legislation, however, would carefully adhere to the law, and if compassion and discretion is written into the law, those government appointees will administer the law properly and fairly (unlike those imagined “death panels” of Sarah Palin’s nightmares which are more likely to be located in the private sector rather than Washington). As much as I like my solution, however, I am pretty certain it won’t be the plan that gets passed by Congress and signed into law later this year. Incremental change is less threatening in this confused, difficult time.

 

President Obama has announced a speech to a joint session of Congress on Wednesday, the 9^th of September, in which he will presumably lay out a new strategy to regain control of the debate and the initiative. I hope for the market and the country that we can get some meaningful change and that the struggle does not diminish the Obama Presidency. I believe that improved and less costly health coverage is a very important element in stimulating economic recovery and employment growth and will satisfy the markets. On the other hand, an inability to make any meaningful progress on a health reform plan and a rebuke to President Obama will undoubtedly stun the markets. Now that Congress is coming back into session, events will unfold very rapidly.

 

 

Peter R. Mack

September 3, 2009

Peter R. Mack & Co.,Inc. and any of its principals including Peter R. Mack may have an investment position, long or short, in any security mentioned herein. Furthermore, although the information contained herein is believed to be accurate, neither the author nor the author's firm makes any representation as to its accuracy and the reader should not rely on the statements contained herein for any purposes. Opinions mentioned are subject to change without notification. Material contained herein is for educational purposes only.

 

A Plan of Action to Chairman Bernanke

Copy of letter sent to Chairman Bernanke - March 2, 2009

PETER R. MACK

 

 

March 2, 2009

 

Chairman Ben. S. Bernanke

Federal Reserve Board

Constitution Ave & 20^th St.

Washington, DC 20551

 

Dear Chairman Bernanke:

SUMMARY:

The economic recovery depends on 1) stimulating the economy and 2) repairing psychology and restoring confidence. The Fed and Treasury have been working on stimulating the economy but restoring confidence against a barrage of bad news is proving elusive. In order to repair psychology and restore confidence to the markets, and to provide a better future rate-of-return to all American citizens than an investment in Treasury Bills, I suggest that the Federal Reserve Bank invest $1 Trillion into the domestic equity markets through periodic purchases of large, mid and small cap index funds through the leading fund distributors. 

 

RATIONALE:

 

The markets decline almost daily, setting new multi-year lows. Fears are being stoked by rampant rumors about troubled banks and nationalization, putting stocks into free fall. In recent days, rumors and speculation in the media about nationalization of Citicorp and Bank of America have driven shares of those stocks to low single digits, putting the value of their preferred shares and the continuance of the enterprise in great jeopardy. Managements of both institutions have publicly tried to assure shareholders about their long term viability but the markets are disbelieving. President Obama and Secretary Geithner have publicly stated their opposition to nationalization but again, the markets aren’t listening. Your own recent testimony to Congress, which I thought was a powerful affirmation, failed to stabilize the markets.

 

As a small and quite recent stockholder of Citigroup, in particular, but many other  industrial companies as well, and as an executive in the brokerage industry for 45 years, I

am fearful that shareholders of common and preferred stocks in these institutions are about to get wiped out. It is my strong belief that a nationalization of the

two large institutions most commonly mentioned, together with the prior catastrophic and ill conceived bankruptcy of Lehman Brothers and collapse of AIG, Wachovia, WaMu, GM and the like of our widely held corporations, will sound a death knell for the equity markets until long in the future. Individuals will flee common stocks and equity mutual funds. Today, GE broke the $8 level – a grim omen.

George Soros has long held and publicized his view that markets drive fundamentals, rather than the other way around, producing bubbles and crashes – a dynamic he calls reflexivity. In my view, stabilizing the markets is the key to recovering household wealth and creation of economic recovery. Following is my idea about how this can be accomplished while the world waits for Government action to take effect.

 

THE PLAN:

 

The Federal Reserve must become an equity investor by deploying $1 trillion into the equity markets through periodic purchases of broad-based large, mid and small cap index funds through the leading fund distributors. The Fed can operate under its normal procedures to minimize impact on the markets. Because of the market sensitivity of prospective Fed actions, leakers and leakees of Fed market actions under this program should be dealt with under criminal rather than civil statutes, under Justice Department rather than SEC jurisdiction. The public is sick of front running and other abuses done by insiders and hearing rumors in the financial media that turn out to be true.

 

These operations should be conducted on behalf of the account of the Social Security Trust Fund. For those who believe that privatization of Social Security into self-directed accounts was, and continues to be, a good idea, this plan should get their support. For those who feel that current aid to banks and financial institutions is a bailout for “fat cats” and incompetent and spendthrift financial executives, this plan is inclusive and benefits all citizens equally. If the US economy ever is able to emerge from its current squalor, these investments should become quite profitable. Purchases of equities for the Social Security account will also provide a hedge against inflation, which many fear as inevitable following the current period of money creation and growing deficits. There is no reason why equities should not co-exist with low interest T Bills in the Social Security account and no more appropriate time than now. Over the past weekend, in his letter to Berkshire shareholders, Warren Buffett described the market in US Treasuries as an investment bubble.

 

Were the Fed to conduct these open market equity operations, the playing field would be more leveled in the equity markets. Bear markets occur when there is an excess of fear over greed, when sellers overwhelm buyers, in this case, because of a weak economy. Because of relaxed rules regulating short selling and other market changes such as decimalization and the growth of leveraged short ETFs, short sellers and hedge funds have had relative free rein, as normal buy side investors such as mutual funds, pension plans and individual households have had much of their ammunition taken by deflation,de-leveraging, and low confidence caused by the weak global economy. In addition, as the markets continue to decline and further, as the hedge fund industry is rocked by recent scandals, additional deleveraging by hedge funds is expected as investors withdraw funds. Weakness in the markets has driven fundamentals lower. It is not coincidence that as household wealth and investment portfolios have declined, economic fundamentals have deteriorated as consumers stop spending.

 

As you are known as a scholar of The Great Depression, you know far better than I how,   on Black Thursday during The Crash of 1929, Richard Whitney, J.P. Morgan’s broker came to the floor of the Exchange and placed sizable orders in blue chip stocks for Morgan’s account. As word spread of Morgan’s intervention, prices firmed, effectively stemming the crash. Several months ago, legendary value investor Warren Buffett emulated Morgan by stepping in to snap up shares in Goldman Sachs and General Electric, hoping to set a confident example as well, but he was far too early and has lost enormous amounts of money, an experience shared by many.

 

Fed participation in influencing equity markets is nothing new, having that ability through its authority in setting margin requirements. Although I can’t recall any Fed action since at least the early 1970s, margin requirements were a tool used to encourage or discourage equity investments. Aside from just quaintly complaining about “irrational exuberance” a number of years ago, Chairman Greenspan could have used the Fed’s authority to try and curtail speculation if he thought it important enough to do something other than to comment, but he did nothing. If this were a normal recession, now might be an appropriate time to lower margin requirements, but with the volatility and illiquidity in the markets, and the fact that this is more a depression than recession, lower margin requirements would probably accomplish little at this time.  

 

Again, I believe it’s time for the Fed to act - to be the Morgan of today and buy stocks on behalf of the people - to do what I and so many others would do if we had any money left and weren’t so fearful of losing everything. If we as a nation have any economic future at all, these purchases will turn out to be great investments.       

 

Thank you for your attention.

 

 

 

 

 

 

 

 

 

Letter to SEC Chairwoman Schapiro

PETER R. MACK & CO., INC.

19 EAST 71^ST STREET, SUITE 3

NEW YORK, N.Y. 10021

TEL: (212) 744-3939     FAX: (212) 744-8484     EMAIL: PRMCO@AOL.COM

MEMBER FINRA & SIPC

 

SENT BY E-MAIL

February 27, 2009

 

Chairwoman Mary Schapiro

The Securities and Exchange Commission

 

Dear Chairwoman Schapiro:

 

In looking at the pre-market trading in Citigroup (C-NYSE) and seeing its descent by over 60% or so from its previous close on the NYSE on high volume in response to the Treasury department’s news, it would seem a safe assumption that much of the pre-market trading involved high amounts of short sales done electronically without pre-borrow or other stock loan arrangements, which, if I understand the SEC rules correctly, would be a violation of those rules.

 

Extraordinarily high short selling, whether in pre-market or during regular trading hours, causes extreme  volatility in a market where individual investors, pension funds and mutual funds have had their portfolios devalued and available funds depleted, The weakness in the economy and equity markets and decline in consumer confidence, down to 25% at last reading, has created an un-level playing field and enabled a condition of extreme volatility, allowing the markets to be easily manipulated. In my view, the Commission has a responsibility to ensure orderly markets.

 

Late last year, I wrote to the Commission regarding re-institution of the uptick rule and received a response explaining that, with decimalization and price increments commonly one cent a share, the judgment was that the uptick rule would be inconsequential and hard to implement. The solution, then, in my opinion would be to limit decimalization to identifiable units of perhaps five cents a share, or in any amount that would once again permit the effective implementation of the uptick rule and permit the Commission to regulate markets.

 

Moreover, although I personally have very little knowledge of how leveraged “ultra” short index funds work, there must be some contribution to extreme downside market volatility from these vehicles as well, perhaps involving short selling, and if so, they should be subject to regulations and not exempted. But, again, I really am ignorant about that product and how it works.

 

I have worked in the financial markets for almost 46 years and I lament the fact that I and my clients and the majority of the population now believe that the equity markets are a giant casino, that they are manipulated and that they are too risky for responsible allocation of assets. The markets need prompt and effective regulation to insure their stability and viability in these troubled times.

 

Thank you for your attention.

 

Sincerely yours,

Peter Mack

Secretary Geithner Speaks

Just checking in with some comments on Secretary Geithner’s plan.

The popular narrative is that the market was so unhappy with the lack of specifics in the plan that it sold off 5%. I understand that the public and the media want everything spelled out, even though reality dictates that solutions to the economic plan have to be dynamic.

I think the major take away from the plan is that big banks are not going to be permitted to fail, that the government will not nationalize and will not own and operate banks. They have been saying this under Paulson, but no one seems to believe, necessitating its constant repetition.

I think the plan is ok. First, it uses existing $350 million left in TARP to partner with investment groups to acquire what everyone calls “toxic assets.” There has been a deafening din about valuation under the good bank/bad bank debate in Congress, television, on blogs, etc. Nobody wants the government to pay too much and reward those rotten bankers. Everybody, including Nobel Prize winning economists Krugman and Stieglitz blithely demand that the valuation be based on market price, but it seems that only Geithner and the bankers (and me) know that there is no market, that there is no one to trade with, no one to put up capital. By partnering with private capital and guaranteeing a valuation based on long-term returns rather than fire-sale prices, the Treasury can revive a moribund market. I think this will succeed and put a floor under these assets and trading will resume.

Secondly, under the plan, TALF sets aside $100 billion of Treasury money which creates $1 trillion of money available to buy credit card, auto and student loans. This is really significant and will start soon.

Thirdly, a “stress test” for banks to see if they can be restored to health, if they are curable. Who can complain about that?

Finally, a promise to set aside $50 billion for foreclosure relief to homeowners – ok to have no specifics – because Congress is involved in the formulation of the plan, not Treasury alone.

There’s a tremendous amount of national anger and ignorance. Legislators themselves are unable to process the amount of information required to understand this very complex problem, and all are quoting constituents who are angry but have absolutely no understanding of what’s going on. They rail about corporate jets, and bonuses etc. – legitimate perhaps – but representative of a greater societal problem which has gone on for a long time.

The Geithner plan is a middle-way solution that deserves much more credit than it has received but it will require time to be implemented and to work out. As you know, the markets generally want instant gratification which they didn’t get yesterday, but things should stabilize as people learn more about it and as it kicks in.

The key takeaway: The large banks will not be allowed to fail! Taxpayers will be protected, somewhat.

 

Pfizer + Wyeth?

NEW YORK (MarketWatch) -- Pfizer Inc. is negotiating to acquire rival drug maker Wyeth in a blockbuster deal potentially worth more than $60 billion that could alter the global drug industry, the Wall Street Journal reported Friday.

News of the possible deal sent shares of Wyeth up 13% in premarket trading Friday, while shares of Pfizer slipped about 2.7%.

Positions: Long Wyeth & Pfizer

GERON CORP. - HUMAN STEM CELL TEST

GERN 5.21, -0.08, -1.5%) said Friday that the U.S. Food and Drug Administration has granted clearance for it to begin trials for what it said was the world's first study of a human embryonic stem cell-based therapy for people. Geron said it will begin a Phase I multicenter trial designed to establish the safety of its treatment, currently referred to as "GRNOPC1," in patients with complete Grade A subacute thoracic spinal cord injuries.

Positions: Long Geron Stock

FIGHTING BACK

PETER R. MACK & CO., INC.

19 EAST 71^ST STREET, SUITE 3

NEW YORK, N.Y. 10021

TEL: (212) 744-3939     FAX: (212) 744-8484     EMAIL: PRMCO@AOL.COM

MEMBER FINRA & SIPC

 

 

 

January 18, 2009

 

 

FIGHTING BACK

 

 

On October 28^th, in Restoring Trust, I wrote of the need for trust to be restored in many facets of our life and society including the economy, the markets, financial institutions, political systems, our fiduciaries and advisors, and lastly, our own self-confidence.

 

Now, less than three months later, the need to do so is even greater. We had then just seen completed a first round of bank bailouts and government forced corporate mergers and suddenly last week witnessed the unraveling of the Bank of America/Merrill Lynch combination so confidently put together in September, and now requiring another major infusion of aid from the Treasury Department. Bank stocks which had recovered and rallied upon the passage of the TARP (Troubled Asset Relief Program) are once again at record lows.

 

In December we learned that the three domestic manufacturers of automobiles were likely to imminently file bankruptcy if they did not receive direct and quick aid from the government, and lest we believe that the phenomenon was restricted to the much-reviled big three, the foreign companies manufacturing in the US such as Toyota and Honda (known as transplants) were also seeing sales and profits plummet.

 

And finally, giving authenticity to the loss of trust in financial advisors and institutions, came the December revelation about the widespread swindle by Bernard Madoff purportedly estimated (by him) to be around $50 billion. Since then, other Ponzi schemes have been reported, and just yesterday came a news report of a Florida money manager disappearing and an estimated $350 million of customer funds missing.

 

Economic statistics being reported for the fourth quarter are truly dismal. Retail sales were sharply lower, housing prices continue to sink, and foreclosures rise. On the jobs front, unemployment rose to 7.2 per cent and is widely expected to continue for some months well into 2009. It should be noted that corporations and organizations make budgets and plans at the end of the prior year based on expectations for the coming year, and generally stick to the plan. The recently-announced layoffs have been in the planning for quite some time and are both a manifestation of the current state of business as well aspart of strategic decisions as corporations restructure and redirect activities. The economic climate in the fourth quarter was quite negative and budgets going forward

were fashioned to be quite austere. Just at the end of last week, GE Capital announced cuts of 11,000; Pfizer by 2,400, Conoco Philips 1,500 and the liquidation of Circuit City will cut another 30,000 jobs.

 

These numbers are almost certain to keep ratcheting upward until the “official” unemployment rate exceeds 9 per cent or more from its present level. To those without jobs and with dim prospects in the market, despair will set in. To the 90 per cent of people still employed, caution and fear will abound and for most of those people, from the self-employed to corporate titans, salaries and compensation will be lower in 2009 than 2008. The mood of conservatism will be entrenched. Yet, a 90 per cent employment rate is still a powerful economic force that can keep the economy from entering a depression, as so many doomsayers suggest.

 

According to recent CNN polls, only about 27% of American people believe that President Bush did a good job in his eight years in office. Aside from most Democrats, that polling figure suggests that more than half of Republicans voted thumbs down. Hendrik Hertzberg writes in The New Yorker (January 19, 2009) that during the last eight years, “the unemployment rate went from 4.2 per cent to 7.2 per cent and climbing; consumer confidence dropped to an all-time low; a budget surplus of two hundred billion dollars became a deficit of that plus a trillion; more than a million families fell into poverty; the ranks of those without health insurance rose by six million; and the fruits of the nation’s economic growth went almost entirely to the rich, while family incomes in the middle and below declined.”

 

That’s the past, but there can be little question that ultimately, the negative mood has to change and the inauguration of Barack Obama and a new team on Tuesday, January 20^th will go a long way to starting us on the way back. The election of Obama was an affirmation of the country’s will to restore trust and demonstrated the ability of the people to overcome centuries of inherent racism and, to a lesser degree, partisan politics.  The nation continues to evolve.

 

On the positive side, many factors are in play that can turn things around. The government, through the Federal Reserve and Treasury Department has unleashed a torrent of funds through the $700 billion TARP program and through Fed lending that has backstopped the banks and financial services. Interest rates on Treasury bonds are at record lows, and have worked through the system, bringing about the lowest mortgage rates in 30 years or more.  Rate cuts are not just in the US. We have seen The Bank of England just reduce interest rates to the lowest levels in 300 years, a lower rate than even George Washington might have borrowed at when he was a farmer in Virginia and an English subject. The ECU is lowering rates as well. Skeptics of the interest rate moves

point to Japan where low, almost negative interest rates, failed to provide any stimulation to the economy over a decade and suggest it could happen here – that Americans will change their habits from consumers to savers – basically a new trick for an old dog. 

It just doesn’t seem likely.

Energy costs have dropped dramatically, with gasoline, home heating oil and natural gas prices far below (over 25 per cent) the levels of a year ago. This drop represents the equivalent of a sizable tax cut for consumers.

 

Finally, President Obama and the Democratic Congress will pass a stimulus package probably in the area of $1 trillion to help move the economy and advance aid to states and municipalities for infrastructure projects. China has recently announced its own stimulus with an additional $600 billion in infrastructure projects to augment their already significant budget.

 

Money will certainly begin to flow with the inauguration of a new administration.

 

More than money, the change in government should bring about effective changes in leadership. I have been a severe critic of Chairman Christopher Cox at the SEC. I hold him personally responsible for changes in market regulations that have harmed – maybe permanently – the workings of markets as we have known them. The Bernard Madoff scheme appears to have been conducted in spite of “whistle blowing” evidence provided to the agency many years ago. As the story unfolds, more evidence of regulatory failure will be revealed and histories will chronicle the collapse of the financial industry under Cox’s watch.

 

 The incoming Chair of the SEC, Mary Schapiro, is an honest, dedicated, non-political public servant and fiduciary. She has been the Chairman of FINRA (Financial Industry Regulatory Authority) the agency that regulates the brokerage industry and our firm. Under Ms. Schapiro, I expect that certain significant remedial actions will be initiated, I hope soon after taking office. I expect her to reinstate the uptick rule regulating short selling, to strengthen and enforce rules prohibiting naked short selling, to  revise certain requirements of FAS 157, and, over time, to put CDSs (Credit Default Swaps) and hedge funds under new regulatory authority.  I think these actions, if taken, will go a long way to restoring trust in the markets and reducing chaotic volatility.

 

With new leadership, I expect a new tone at the FDA (Food and Drug Administration) that will revive an almost-moribund agency and place a premium on science and health for all Americans rather than an agency that has been transformed into one that advanced and promoted the religious ideologies of conservatives. This will encourage the biotech and pharmaceutical industries to rev up their search for new treatments for our major diseases.

 

I foresee an economic revitalization, and an expansion of domestic manufacturing after years of disinvestment and job export to foreign shores.

 

On the other hand, while I am optimistic, nonetheless we are a country at war with an economy that is dangerously weak and depleted. The road to recovery is bound to take a longer time than most would hope for, and the shape of the new economy will look somewhat different from what has gone before.

 

But I certainly wouldn’t sell the economy short – to bet on failure - especially with all the positive forces arrayed against it. In short order, someone will refinance a house and go to Home Depot and buy some paint and a new sink. Someone else will finance a new car.

Money will begin to flow, one transaction at a time, until the cumulative effect changes the statistics and produces better reading and better news, thus giving others the courage to act as well. And so it goes.

 

Hope is on the way and no one should be so cynical as to not share in some optimism. Maybe it will work, maybe not, but it’s what we’ll see kick in very soon, thought out by some of the best minds that America has to offer. One year ago today, I was in the ICU at Yale - New Haven hospital and here I am today, still among you.

 

I will close by adding a poem that I particularly like by the Welsh poet, Sheenagh Pugh, which I think sums it up better than my text.

 

 

SOMETIMES

 

Sometimes things don’t go, after all

from bad to worse. Some years, muscadel

faces down frost, green thrives, the crops don’t fail,

sometimes a man aims high, and all goes well.

A people sometimes will step back from war,

elect an honest man, decide they care

enough, that they can’t leave some stranger poor.

Some men become what they were born for.

Sometimes our best efforts do not go

amiss; sometimes we do as we meant to.

The sun will sometimes melt a field of sorrow

that seemed hard frozen; may it happen for you.

 

-Sheenagh Pugh, “Sometimes”

 

 

 

Peter R. Mack

January 18, 2009

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