Is Analyst Research useless?

Despite reforms after the 1999 bubble, most Wall Street research analysts are still simply “talking the book” for their firms. The so-called “Chinese Wall” between research and investment in most of the firms is nearly worthless.

Still the community of naïve investors appears to eat up every upgrade and downgrade that rolls off the street. Many of the herd are greatly concerned with the average analyst rating for a stock, not recognizing that these figures have nearly no correlation with stock pricing, or at best are a lagging indicator.

Sophisticated investors totally ignore Wall Street analyst ratings and perform their own research. This serves as their edge on the market. The only factor these investors hunt for are the number of analysts covering a stock, less is better.

The press is finally recognizing that most Wall Street research does not hold water, and the recent bear market has brought forward a slew of articles questioning if analyst ratings have any value whatsoever.

Worthless Wall Street Research

One Day Left to Vote: Make your voice heard

Agricultural commodities have been hot over the past few months. Will this trend continue for the remainder of 2008?

Vote Now in HingeFire survey at the top left corner of the Blog.

How will agricultural commodities as represented by the DBA ETF perform in 2008?

Does Cramer still believe that Bear Stearns is just fine?

Jim Cramer is fine for amusement. I rarely watch him, but as a proud Nittany Lion alumnus caught the recent show at Penn State on CNBC. Pure entertainment and nothing more, anyone who takes investing advice from Cramer will not do very well in the market over the long term. Websites that properly track his picks (meaning not TheStreet.com) demonstrate that he has always under-performed the market.

Even worse, the recent sequence of shows where Jim recommended Bear Stearns on Tuesday March 11th and then eliminated the buy recommendation from the Street.com website after the fact makes it clear that there is no integrity in the investing results from his rants. A video on YouTube outlines the BSC stock pick situation and demonstrates the alteration of the website after the stock crashed.



Patrick Byrne the CEO of OverStock..com (also a controversial figure with a public campaign against naked short selling) recently outlined his thoughts on Jim Cramer. The Jim Cramer is a Complicated Man post provides some excellent detail and thoughts.

The lesson here is that you should not believe the buzz from Wall Street pundits about their overall returns. This includes media clowns, fund managers, and analysts – the results for most of these “super-stars” have been spiced-up by the magical elimination of bad picks. The same holds true for most “get rich with my trading system” scams propagated on the web.

Enjoy the Haircut

The Muni Auction Rate market continues to decline. Firms have been scrambling for a solution, but so far none has appeared. The next step is to ask for a Federal government bailout to put liquidity back into the muni auction rate market. If Bear Stearns can effectively be bailed-out for $30B then how about a few billion for the auction rate market?

If this trend continues soon the Fed will be providing liquidity in every sector to hold off financial calamity. This brings up an image of a carter greasing the wheels of the wagon to keep it moving, while in actuality the entire wagon is collapsing without him noticing.

Earlier HingeFire articles discussed the Auction Rate fiasco (see More Credit Turmoil: The Muni Auction Rate market freezes and Auction Rate Stress Continues: Muni Bond Funds Impacted). Today UBS placed a stake in the heart of customers holding auction rate securities when the firm marked these securities to market giving many holdings a 20% haircut. Customers had been told previously that these securities could not be sold at the regularly scheduled auctions but they retained full value.

So much for integrity in the markets, customers were sold these investments by brokers who promised they were a safe alternative to cash offering a slightly higher yield. This markdown of auction rate securities is expected to spread to other Wall Street firms this coming week, leaving a trail of furious wealthy investors in its wake.

Quick Takes: Rising Taxes, Home Equity Crisis

Many people hold the misguided belief that their taxes will go down during a recession. If everyone is spending less then won’t the government need less? Unfortunately it never works out like this. During recessionary periods, government spending is normally in crisis as sales and income tax revenues drop, this leads to outsized tax increases to support rising spending as social program needs increase. The longer a recession lasts, the higher taxes tend to get.

MarketWatch outlines 9 reasons your taxes are going up. Facing a huge national debt load, it is unlikely that taxes will retreat. Irrespective of which party is in office, the entire situation will result in taxes being raised. There is no other possible real alternative to dig out from under the mountain of debt at the federal, state, and local levels of government – except for tax increases. (Nobody should be so naïve to believe that government spending will drop).

Taxes are not the only problem for consumers. The credit crisis is about to fold over to another sector, home equity loans are under pressure. Americans owe over $1.1 trillion on home equity loans. Many of these loans were unwritten during the bubble period with lax standards. Many home equity loans did not require income verification or were combined in “piggy-backing” deals for no cash down. All the questionable practices over the past few years in the mortgage market equally apply to the home equity loan sector.

A good portion of these home equity funds will not be repaid to the lending institutions. Especially in markets where housing prices have dropped significantly, second-lien holders are being left with nothing in short sale scenarios. The percentage of delinquent home equity loans was up to 5.7 percent in December, the figure is expected to be over 7% by the end of March.

Equity Loans as Next Round in Credit Crisis

Consumer Confidence Expectations hits the lowest level since 1973

The Consumer Confidence Expectations measure by the Conference Board dropped to 47.9 from 58.0. This is the lowest reading since 1973. Many will remember that 1974 was a very painful downside year for the U.S economy.

Consumer confidence crumpling proclaims the headlines in many papers across the U.S. today. The commentary from analysts adds a sense of despair to most of the press.

"Yes, weaker than in the last four downturns," BMO Capital Markets analyst Sal Guatieri said of the latest expectations number. "Ouch!"

Consumer confidence, he said, is "now buried deep in recession territory" and it is now "only a matter of time before personal consumption follows suit."

Of all the headwinds facing the economy -- faltering consumer confidence, which will drive a drop in retail sales representing two-thirds of the overall economy, is the largest threat. This has driven the federal government to take tax rebate measures to boost the consumer. However in an environment with a credit crunch, falling home prices, rising unemployment, high fuel prices, and increasing necessity costs --- it is not likely the government action can stop the downward spiral.

Quick Takes: Tax Season Scams, Rogue Traders

Once again, April 15th is showing up quickly. Many folks are busy getting their taxes filed. This is also the season where all the scammers show up once again. A recent Bankrate.com article (Don't Fall for IRS-Related Scams) discusses four of the major scams making their rounds this season.

The rebate phone call, tax refund email, audit email, and check verification phone call scams are simply re-packaged traditional scams taking advantage of modern technology using the tax season as a vehicle. Unfortunately a large number of consumers are falling for these frauds.

Tax payers should also watch out for all the fees associated with refund anticipation loans or deals that put your refund on a debit card. All these type of offers from tax preparation services carry fees that would make most loan sharks blush… or turn green with envy.

There are also traditional frauds circulating on how to avoid taxes. Attempts to declare yourself a church, state that you are not subject to taxes on vague legal principles, or other mechanisms to avoid taxes will only lead to two things --- a huge tax bill with penalties and possible jail time. Stay away from promoters of these types of shenanigans.

As outlined in the article, I would urge everyone to report unsolicited phone calls and emails to the IRS.

While on the subject of swindles, Advanced Trading came out with a recent set of articles about Rogue Trading. The entire set includes an interview with Nick Leeson who brought down Barings, perspectives on improving institutional controls, and an outline of the Société Générale fiasco. The entire set of articles is a worthwhile read.

Weak Local Banks Retreating

Earlier HingeFire articles outlined the financial pressures facing weaker local banks as commercial real estate loans have soured. By no means is the crisis over, in fact the action over the past month is simply the start of the slide.

Building on a earlier article (see Local Banks: Time to Short) which outlined the threats facing these local institutions; the “Just how bad is the situation with local banks?” article presented a list of potential candidates to short. The difficulty in trading many of these stocks is that most are thinly traded and listed on the OTC.

Now that a month has passed, it is time to quickly re-visit these selections and evaluate their performance over the past four weeks.

Bank and one month performance (%)
------------------------------------------------------------
Friendly Hills Bank (FHLB.OB) -3.4%
Fresno First Bank (FSNF.OB) 0%
Folsom Lake Bank (FOLB.OB) 0%
Fremont General Corporation (FMT) -77%
Focus Business Bank (FCSB.OB) -14.3%
Discovery Bancorp (DVBC.OB) -23.3%
Desert Commercial Bank (DCBC.OB) -13.0%
Coronado First Bank (CDFB.OB) -0.5%
Cornerstone Commercial Bank (CRSB.OB) -2.7%
Commerce Bank Folsom (CBFM.OB) -10.0%
Bank of Santa Clarita (BSCA.OB) -2.7%
Charter Oak Bank (CHOB.OB) -10.5%
Bank of Napa (BNNP.OB) 14.3%
Atlantic Pacific Bank (APFB.OB) -13.5%
Americas United Bank (AUNB.OB) 4.3%
Marco Community Bank (MCBN.OB) -1.1%
Old Harbor Bank (OHBK.OB) -6.1%
Gold Canyon Bank (GCYO.OB) -0.8%

As a group these local banks have dropped an average of 8.9% in price over the past month; a time period in which the S&P500 has dropped 1.7% and the KBW Bank Index has declined 2.8%. This is a signficant under-performance for a set of stocks that are not normally volatile and is an example of generating excess alpha from proper stock selection on the short side of the market.

Some of the local banks suffered significant drops; long-suffering Fremont is down over 77% and Discovery Bancorp stock lost nearly a quarter of its value. Only two of the eighteen stocks rose in value.

In the opinion of most local banking analysts the pressure from faltering commercial real estate loans is only going to increase. The drop over the last month is probably just the starting point for the stock price demise for many financially weak banks.

Student Loan Consolidation

The majority of personal finance articles are either light-weight “press fluffs“ or hidden pitches from companies for their financial products packaged by a reporter. Once in a while a very solid personal finance article makes an appearance.

Many consumers carry college loans as a portion of their debt. A recent article from SmartMoney.com outlines some important thoughts regarding the consolidation of student loans.

One of the key points made in the article is that it will be best to hold off on consolidating loans until July 1st. Interest rates have been dropping over the past year with the Fed rate cuts. If you consolidate before July 1st, you will be paying the higher rates from last year. Those who consolidate after this date can take advantage of the new lower interest rates.

Another important point is that it is not advisable to consolidate existing fixed-rate student loans. Only variable rate loans should be consolidated.

There are also issues regarding standard repayment periods and extended repayment that consumers should consider for these loans. Many financial institutions market student loan consolidation as a product to generate fees. It is important that consumers recognize what is in their best interest when contemplating consolidation as an option.

The article provides some solid detail about the various considerations consumers encounter with student loan consolidation.

Consolidating Student Loans Not Always Best Option

Quick Takes: Credit Churn, Bear Stearns

The failure of auction rate securities is still causing angst for the closed end bond funds. The leveraged funds that issue auction rate preferred shares are in serious trouble.

BlackRock and others in this business are searching for strategic alternatives. Over $300 billion in securities are at risk, and BlackRock has 66 impacted bond funds with a value of $9.8 billion.

Despite proposals for re-financing and put features for these instruments, the probability of a resolution appears bleak. By the end of the auction rate failure crunch, there is an expectation that one or more of these fund families will flounder. Most likely the backing company will be sold for pennies on the dollar.

The news is not any better in the subprime sector, the delinquencies on the mortgages issued between 2005 and 2007 continue to rise according to Standard & Poors. The delinquency rate is rapidly approaching 40% for many of the notes issued in these years; the rate of delinquency is jumping 4 to 10% per month. Wall Street expected a delinquency rate of 15% worse case when it packaged the notes in CDOs; so much for financial modeling.

In other news, you don’t have to feel bad for all those executives at Bear Stearns; many of the top insiders sold large chunks of stock in December in advance of the implosion. It appears that these folks will not have to move out of their multi-million dollar mansions.

In related news that will cheer up Bear Stearns employees, JP Morgan raised its bid to purchase the bank to $10 from $2. The question being if Bear’s chairman James Cayne who is probably off-site at either a bridge tournament or the golf course has heard this news yet.

Are Bailouts only for Wall Street?

In an era where the government is spending billions of dollars to bail out Wall Street institutions, Dwayne Powell of the News & Observer gets right to the heart of the matter with a simple cartoon.

As outlined in The Great Mortgage Industry Heist, the creation of billions in liquidity for bank bailouts by the Fed acts as a burden on the entire U.S. population. Consumers see the results every day in rising food costs, soaring gas prices, and increasing local tax burden.

The Financial Crisis is over? Think again!

Banking analyst Richard Bove proclaimed in a report today that the "The Financial Crisis Is Over." He stated that last week’s rescue of Bear Stearns that marked the end – all the upcoming failures are meaningless in comparison.

Many people, including financial specialists, think that Bove has drank too much kool-aid. "I admire a courageous call by Dick Bove," Art Cashin, director of floor operations for UBS Financial Services, told CNBC, but "I’m not sure we’re totally out of the woods."

Maybe Bove missed today’s developments, CIT Group drew down every last dime in available credit ($7.3B) today as it struggles to remain solvent. Shares of the financial mammoth plunged 44%, as the company drew down the bank line as it contends with a floundering $90B portfolio. The company has some $15 billion of debt to pay back in 2008, and nobody is willing to step up to the table and provide re-financing; especially since $9.2 billion of the overall portfolio is subprime mortgages and $11.5 billion is student loans – items that currently make most investors run for the nearest exit.

Both Moody's Investors Service and Standard & Poor's cut CIT’s long and short term debt ratings this week. The cost to insure CIT debt with credit default swaps is also trading at distressed levels, showing that most institutions expect the financial firm to not be able to meet its obligations.

Every day brings new stories of calamity at major financial institutions; it appears that the credit crisis is far from over for the banking industry.

Revisiting: Muni Bond Fund shorts

On February 20th, a HingeFire article urged investors to short several leveraged Muni Bond closed-end funds that hold significant amounts of low grade debt (see Auction Rate Stress Continues: Muni Bond Funds Impacted). These were viewed as low volatility, high probability short plays in the market. Three funds priced in the $13 to $14 range were pointed out as having a price downside of approximately a dollar over the upcoming weeks; MAF, VKQ, and VMO.

Now that a month has passed, let’s take a look at the results. The PIMCO Municipal Advantage Fund (MAF) dived from $13.14 on February 20th to close today at $12.17. The Van Kampen Muni Trust Fund (VKQ) was priced at $14.21 back in February and closed at $13.52 today. The Van Kampen Muni Opp Fund (VMO) crashed from $14.37 to close at $13.14 today. The average drop over the past month for these three funds was 96 cents (minus the six cents in dividends on average paid out during the period). – right on target as per the prediction for approximately a dollar gain for shorts over several weeks.

The TED Spread hits 2.0

An earlier HingeFire article talked about the TED Spread being a leading indicator for market drops caused by credit situations. Historically the TED Spread, which is the difference between U.S. Treasury bill yields and yields for Euro deposit contracts of the same maturity as represented by LIBOR, is a better warning signal than VIX when credit liquidity is tight.

Levels above 1.5 historically preceded declines in the stock market. A recent sharp increase to near 2.0 and extreme volatility of the TED spread demonstrates the market is still at risk. The credit concerns have not ended with the failure of Bear Stearns, in fact they have only increased.

Investors should still be prepared for further fall-out from the credit crunch over the upcoming weeks. It may be awhile before an “all clear” is sounded; in the mean time we can expect more bank failures, liquidity concerns, and continued negative contagion to other credit sectors. The latest word on the street is that Britain's largest mortgage lender, HBOS Plc is effectively insolvent following the earlier example of Northern Rock. The entire situation is reminiscent of Bear Stearns one week ago, the bank and regulatory officials have come out denying these “false rumors” while the bank stock dived 17% to its lowest value ever..

The TED spread indicates that the professionals have positioned themselves for a downside scenario. The current level near 2.0 should act as an alarm bell for stock market investors.

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The Cisco Hat

While running across North Carolina on the weekends coaching and watching soccer, I regularly wear a Cisco hat. It is nothing fancy, a simple tan baseball cap with the Cisco logo – a freebie from my previous boss (thanks BTW). For many years, the hat has been a fixture while I am involved in youth soccer. My original intent was simply to protect my bald dome from the elements, but the hat has also served as an outstanding tool for parents and players to identify me in the distance.

The hat reflects my pride in my former employer of many years, but has also served as a lesson in branding. First let me state that I have no background that qualifies me as any type of expert on branding or advertising. I proudly remain an engineer that dabbles in finance.

When I first started wearing the Cisco hat many years ago, I never received much feedback while running across the state. Most people in communities outside of the RTP area never heard of Cisco, or mistook it for the other Sysco – the company in the food distribution business.

Recently this has changed, when out at soccer games in some far-distant community people come-up to me see the hat and want to talk about Cisco -- something that never occurred years ago, except for the rare “what’s Cisco” query.

What is the difference between now and years ago? During the past couple years Cisco has put forward a branding campaign focused on consumer markets. At the time this effort kicked off, I worked at Cisco. The response across engineering about a “marketing campaign” was dubious at best – after all who needs commercials, a corporate audio identity, fancy ads with models, and all this other stuff -- to sell routers?

The bottom line – despite the skepticism from many of my peers – is that the branding campaign has been wildly successful. The efforts have raised the profile of Cisco across a large nationwide audience and increased the value of the brand. It has also added to my weekend conversations -- when many people come up and ask, “What do you do at Cisco?”

Scores of these people are now Cisco customers, whether they purchased Linksys home routers, Scientific Atlanta home cable boxes, or direct Cisco equipment for their small business. Cisco is firmly entrenched in their minds at the preferred internet and security vendor. The teenagers -- are not only competitive soccer players -- but technology enthusiasts; most want to know what a career is like at company which effectively built the internet.

Things you can buy for two bucks

Now for less than the price of coffee at Starbucks you can get a piece of Bear Stearns. Not that I can think of any reason why anyone would want to buy shares of this effectively bankrupt investment bank. In an astounding remedy for a liquidity crisis, Bear is being purchased by JP Morgan for a mere $2 in stock per share; a deal that values BSC at a minuscule $230 million.

Note that this deal will not be an immediate bargain for JP Morgan; they will need to immediately take $6 Billion in write-downs upon acquisition and probably lose the $30B in loan guarantees made to Bear Stearns by the Fed. It does allow them to acquire a competitor for a measly 1/20th of the price where the BSC stock was a mere ten days ago. The deal also allows JP Morgan to take a slap at other investment banks who own a significant piece of Bear Stearns; the list includes Morgan Stanley (5.37%), Legg Mason (4.84%), and Barclays (3.60%). The deal effectively makes these holdings valueless.

So why is Bear Stearns willing to be purchased for a fraction of their value instead of declaring bankruptcy? The obvious reason is because if BSC declared bankruptcy then the executives would likely have to pay back millions in dollars in 2007 year-end bonuses that they received within the last 120 days. The decision to sell Bear Stearns for pennies on the dollar may not make sense for the stock holders, but it sure makes financial sense for the management. While the banks and government can dress-up the deal in an appealing dress and make bold statements about maintaining confidence in the markets; anyone with an inside track has a better perspective on the realities.

Bear Stearns shareholders can hold-out hope that a white knight competing bid of greater value will be put together by a consortium of other banks. This explains why BSC is trading in the open market near $4 rather than $2 today.

The Great Mortgage Industry Heist

Each evening newscast brings the latest fall-out of the mortgage industry bubble; the credit failures on Wall Street, “sub-prime” as the word of the year in 2007, job losses in the financial and construction industry… the coverage is regularly the lead story. As local homes sit on the market for months and neighbors search for jobs, the crisis appears closer but not directly in our wallets.

The credit crisis triggered by the sub-prime lending caused the Fed to quickly reduce rates and inject huge amounts of cash into the banking system in an attempt to alleviate the financial liquidity issues. An increased money supply makes the cash a consumer holds worth less -- a classic definition of inflation. Reminiscent of Germany printing currency after World War I until a loaf of bread cost millions of deuchmarks. Overall the U.S. government action has led to increased inflation, a falling dollar, and spiraling commodity costs; all in support of bailing out an industry that created its own problems due to its insatiability for riches.

Of course, mortgage executives and Wall Street deal makers are not feeling any pain. Lax lending standards allowed everyone to profit at every level of the food chain. The entire mortgage industry was focused on greed rather than proper lending standards. This includes every level within the mortgage industry from the broker who placed homeowners into improper loans for increased fees to the Wall Street bank executives whose firms packaged up junk mortgage paper and painted lipstick on these CDO pigs as triple-A investments. No thought to proper risk control was given; the entire industry was driven by a voracious hunger for money.

Countrywide Financial Corp. chairman and chief executive officer Angelo Mozilo, former Merrill Lynch CEO E. Stanley O’Neal and Charles Prince, former chairman and CEO of Citigroup, have all been in front of Congress attempting to explain why their multi-hundred million compensation packages were justified while their companies went down the flusher. Certainly the Wall Street bonus machine felt little pain.

In the end, who is holding the bag? Many would state that it is the main street consumer. A number of people may not think that these events impact their pockets; however this is no longer true. Every time a consumer fills up their tank or goes to the local grocery store they are paying the price for the greed of the mortgage industry. Welcome to the Great Mortgage Industry Heist – the greed that placed money in the pockets of a few impacting everybody.

The credit crisis, triggered by the sub-prime fiasco, has driven an inflationary economy with prices for most necessities spiraling at nearly unprecedented rates. Not only are the prices increasing but the associated total taxes being paid on necessities is rising – regressively impacting those who can afford it the least.

Consumers dropping by their local grocery don’t only encounter rising prices for milk, bread, and other basics – as prices increase the total collected sales tax on the necessities rises. While from a county level the total sales tax collected may be offset by the drop in consumer spending on non-necessity items such as clothes, electronics and other items as consumers are more stressed --- the staples needed to live are in the increased collections column.

The situation is no different at the pump, as fuel costs increase the associated gas tax in many states rise, making the commute to work more expensive.

Rising inflation due to action by the government and its agencies can in itself be viewed as a tax on the entire population. Certainly there is an option to let these institutions fail instead of extending liquidity by printing money and lowering rates, but for some reason this is viewed as a worse alternative than effectively taxing the entire population for the greed-driven decisions of the financial industry. “Too Big to Fail” can regularly be seen in print as government decision makers defend their actions to bail out larger banks.

Is it simply a choice between a deflationary depression and an inflationary recession? Government policy can drive either alternative. Either allow the market to wash out the excesses without interference or continually bail-out institutions. A good case can be made that the Great Depression would have lasted a much shorter period of time if the government had allowed the financial markets to run their course.

The sub-prime bubble will act as the historical example of a greed-driven institutional credit balloon which overwhelmed banks and governments. The contagion to other credit markets will drive required systemic reforms in risk management while placing many Wall Street quantitative models into the historic dust bin.
-------------------------------------------------------------------

An excellent overview of the bursting of the Mortgage Bubble can be found at:
http://www.blownmortgage.com/files/presentation3-2008.pdf

The 75 page power-point presentation, put together by T2 Partners LCC, includes many graphs and provides first-rate set of fact & figures about the situation, and demonstrates why the implosion is still in the early innings.

Is Wall Street Close to a Bottom?

A number of analysts claim that Wall Street may be near a bottom. Of course, most of these people are “talking their own book”; their firms make money selling investments to the public. Naturally most investors are jittery about investing right now after watching the roller-coaster of the past few weeks.

Of course these market assertion come around at the same time that the NBER is stating the recession could be "substantially more severe" than recent ones.

"The situation is very bad, the situation is getting worse, and the risks are that it could get very bad," NBER President Feldstein said in a speech at the Futures Industry Association meeting in Boca Raton, Florida.

"There's no doubt that this year and next year are going to be very difficult years."

The response to questions the NBER head stated that the downturn could be the worst in the United States since World War Two.

It is difficult to make a case for the recovery in face of this type of macro-economic projections. The locking up of credit, as seen with the Bear Stearns fiasco this week, is a very negative factor in the outlook.

This leads to the question of who’s next? The situation at Bear Stearns is a classic fear-driven run-on-the-back scenario where the entire investment community loses faith in the ability of an institution to meet its obligations. While Bear Stearns’ may have been the weakest of the big five investment banks; many pundits believe that others will follow the same path. Lehman Brothers, despite getting a new credit facility, and Merrill Lynch are viewed at risk. Other banks such are Citi have only survived with sovereign wealth fund infusions, a spigot that is about to be cut off.

Even power-houses such as Goldman Sachs are expected to reveal $3B in write-downs this coming week.

It appears that the financial sector has not bottomed out. Nor has the downside economic news, leaving the hope for a strong market rally as an improbable fantasy over the upcoming months.

Quick Takes: The Big “R’, California Dreaming

The latest survey shows that 71% of economists believe that the U.S. economy has slipped into recession. Commerce Department shows a deep drop in retail sales in February with an associated drop in consumer confidence. The situation has only continued to deteriorate in March, with faltering payrolls and increasing unemployment demonstrating that the economy has continued to contract.

As a backdrop to this news, the real estate situation in California has continued its decline with no improvement in sight. The median prices continued to drop across the state with Southern California leading with a slide of 17.9%. This does not mean that the Silicon Valley area fared much better; in the nine counties of the San Francisco Bay Area, the median price fell 11.6 percent. Home sales volume continues to hit record lows.

So much for “California Dreaming” - The entire situation is a harsh lesson to many home-owners who thought that housing prices only go up, or that the maximum downside could never be more than 10%. The entire region is likely to see housing price drops of nearly 30% before the end of 2008.

Home prices plunge across California

Warning: Reverse Mortgages

The financial industry made a killing in fees by marketing annuities to senior citizens. These products were not usually appropriate for the people who were urged to buy them, and now many are stuck with them while the financial firm agents padded their bank accounts. Many firms such as MetLife and Prudential were slapped by regulators for their sleazy practices in selling annuities.

What is the new sleaze that is replacing the annuities? – Reverse Mortgages. Even in the down real estate market, the financial industry has found they can make a killing by selling reverse mortgages to senior citizens. Reverse mortgages have high fees, many times well over 7% of the home’s value – making this a very lucrative business for agents on commission.

FINRA (the Financial Industry Regulatory Authority) issued a warning this week about reserve mortgage products, urging senior citizens to carefully weigh their options before using reverse mortgages to tap their home equity for additional retirement income.

Bear Stearns kaput

It is not surprising this morning to see the news that Bear Stearns is in the middle of a liquidity crisis after denying all the reports for over a week. The federal government and JPMorgan Chase have teamed up in an attempt to provide enough liquidity to enable Bear Stearns (BSC) to survive for another 28 days.

A Bear Stearns statement read it "is working with JPMorgan Chase to find permanent strategic alternatives to alleviate the liquidity problems, but could not guarantee they would be successful.” This type of language is not indicative of the probability of a positive outcome. The best case picture has Bear Stearns being merged into another major bank, while the majority of employees pack their possessions into card board boxes.

Considering the previous news out of Bear Stearns (see Is Your Investment Bank Executive a Doper); it is not surprising to see this turn of events. It is obvious to most outsiders that the majority of the executive team was not focused on properly driving the business and attending to risk control.

Most concerning are the broader implications for the banking sector. Citi and others have turned to sovereign wealth funds to capitalize their institutions and remain afloat. This spigot is about to be cut off. The failure of Bear Stearns is probably just the leading edge of a series of dominoes that are doomed to fall over the upcoming months.

Take the HingeBull and HingeBear survey

Have your voice heard on the stocks which should be included on the HingeBull and HingeBear lists. HingeBull is a selected list of stocks that the user community believe will outperform the market over the next 12 months. Inversely, HingeBear is a selected list of stocks that the user community believe will under-perform over the next 12 months. There are currently 10 stocks on each list. Support or pan the current picks in the survey, and suggest new stocks for the lists.

Take the 20 second HingeBull Survey

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The following stocks are currently on these lists:

HingeBull
--------------------
AG (AGCO Corp.)
AOC (Aon Corp.)
BG (Bunge Ltd.)
CNQR (Concur Technologies Inc.)
ISRG (Intuitive Surgical Inc.)
HMSY (HMS Holdings)
MOS (Mosaic Co.)
SIGM (Sigma Designs)
SYNA (Synaptics Inc.)
SNCR (Synchronoss Technologies Inc.)

HingeBear
--------------------
ALTU (Altus Pharmaceuticals Inc.)
AMGN (Amgen Inc.)
C (Citigroup Inc.)
HOV (Hovnanian Enterprises Inc.)
LNY (Landry's Restaurants Inc.)
MRVL (Marvell Technology Group Ltd.)
MBI (MBIA Inc.)
SLM (SLM Corp.)
WM (Washington Mutual Inc.)
RT (Ruby Tuesday Inc.)

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401K: Focus on Fees

Subtransfer agent fees, early redemption fees, custodial fees, wrap fees, investment adviser fees, 12b-1 fees, brokerage commissions, administrative fees, revenue sharing fees and fees for services… The list is so convoluted and endless, the mutual fund firms can’t even create diagrams depicting the fees that can be readily understood. If the industry itself can not even determine how they are fleecing the plan participants then how are the corporate sponsors and employees ever expected to figure it out.

Fortunately the Department of Labor is stepping up to the table with demands that the fees are properly disclosed on the ERISA-required form that every plan must file annually with the federal government. The changes are expected to be put in place in January 2009.

Hopefully these changes will help end the 401K plan practice of finding every possible angle to stick it to investors. A recent HingeFire post (see What is the cost to beat the market?) outlined how mutual funds have found new inventive ways to pick the pockets of mutual fund investors. Fees can make a significant difference in the amount of funds available for an employees’ retirement and it is critical that 401K plans are more transparent with all the expenses charged to plan participants.

Bankrate asks “Why's Your 401(k) Plan Heading South?” -- the answer is Fees.

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What is the cost to beat the market?

Every investor wants to beat the market. Many are willing to spend quite a bit extra in fees, expenses, commissions, and other costs in an attempt to squeeze excess alpha out of Wall Street.

A study, “The Cost of Active Investing”, by Kenneth French, of Fama-French fame, has drawn attention to the price paid by average investors as they attempt to beat the market. What is the total cost? Currently, investors spend for than $100B per year attempting to exceed the returns of a standard low-expense index fund.

A recent NYT article outlined the highlights of the study and associated conclusions. Over time the portion of stocks’ aggregate market capitalization spent on trying to beat the market has stayed near 0.67 percent, demonstrating that the financial industry has continued to find ways to fleece investors over time. Even in a changing environment of reduced transactions costs, reduced sales charges, narrowing spreads, and other beneficial factors – the brokerage firms have found new ways to stick it to normal investors.

Sadly, most actively-managed mutual funds fail to beat the market over time. So in one sense, despite the excess costs burdening investors, non-passive investing normally fails to deliver on the promise to wring alpha out of the market for the average investor.

What is the bottom line? Most average investors would be better off placing their money in low-expense index funds. The fees, loads, and commissions charged by actively managed mutual funds rob investors of more than they gain from the active management over time. It is more important for most investors to think about low-expenses than out-performing the market when creating their diversified portfolio.

One other conclusion not touched on in the article is that only active investors who pay close daily attention to the markets are normally successful in squeezing out excess alpha. Most invest directly in stocks and ETFs rather than mutual funds in order to beat the returns offered by index funds. As a whole, these active investors are more successful than most fund managers over time. Typically these information savvy “power investors” focus on value or momentum for their investment decisions, and utilize advanced computer screening tools that enable them to succeed.

Top media news: Bank Failures Ahead

Regional and local banks are under stress. Previous HingeFire articles discussed just how bad the situation is with local banks, the continuing cycle of downgrades due to souring commercial loans, and asked if it was time to short these institutions.

Today the financial press headlines focused on the probability of upcoming bank failures. (Remember you heard it first at HingeFire). The lead article, Billionaire Investor Wilbur Ross Sees Bank Failures Ahead, outlined a reasonable case of why a number of regional banks were prone to fail as commercial real estate loans turn sour.

The primary lesson is that account holders need to pay extra attention to the financial condition of their local bank at this time. Nothing is more painful then having your money locked up for weeks when a bank goes under or losing all of your funds over the FDIC limit.

So how many homeowners will be underwater?

Sometimes you have to wonder if press headlines indicate the bottom of the economic downside in some sort of contrary manner. The most recent incarnation, It's So Much Worse Than You Think, actually focuses on the number of homeowners that will have negative equity as housing prices continue to fall.

As outlined in the article, currently housing prices are down 8.4% placing 13.5% of homeowners in a situation where they have negative equity in their homes. The downside of housing prices is likely to reach 15% without a recession and 30% with a recession. A 30% decrease in housing prices would leave 39% of U.S. homeowners with negative equity in their homes.

Owning more money than the home is worth; many of these homeowners may simply walk away from their homes. We have seen this occur with local housing crashes in the past, such as Texas during the oil bust. Now the table is set for a nationwide incarnation of this scenario.

This of course will place the banks under additional stress that normally plan for a mere 1 or 2% default rate; rather than the 5 or 6% default rate from prime loans which would be seen with this type of recession.

On one hand the article may be on target that vicious cycle of additional housing driven downside remains; on the other hand it could serve as a signal that it is time to start buying rental housing on the cheap.

Warning: Debt Settlement Firms are Simply a Scam

With an increasing number of consumers under stress with high debt levels amidst a deteriorating economy, many are turning to Debt Settlement firms with hopes of salvaging their financial situation. By having you pay monthly sums to them while withholding payment from creditors, these debt settlement firms claim to have the power to negotiate a lump sum settlement with the creditors. BusinessWeek outlined the problems with these firms in a recent Look Out for That Lifeline article.

The reality is that most of these firms simply collect the money and never contact the creditors. Usually the debtor is left in worse shape with daily collection agency calls, additional fees, penalties, higher interest rates, and bad marks on their credit reports.

Most debt holders on these plans also don’t recognize that most of these firms collect 30% or more of the money as fees for their “settlement activities”. ‘The programs typically require financially strapped consumers to pay fees up front, so they make money whether or not any useful services are performed," says Philip Lehman, an assistant attorney general in North Carolina.’

Most banks including Bank of America and Discover Financial Services refuse to negotiate with settlement firms; this means that in many cases that these firms are promising to deliver a “service” that is not viable. The State AGs in half-a-dozen states are currently investigating a significant number of these debt settlement companies due to the high levels of complaints.

Currently seven states have banned settlement activities; it would be wise to urge your state politicians that these debt-settlement scams be banned in all states. The firms are nothing more than the latest incarnation of predators on stressed consumers.

For those who need financial help, it is better to turn to a credit-counseling agency rather than a debt-settlement firm. Most communities have non-profit credit counseling resources available.

Ring, Ring: Hello, This is your Margin Call for $325 Billion

JPMorgan Chase issued a report on Friday that Wall Street banks are facing a "systemic margin call" for $325 Billion due to their weakening subprime mortgage exposure. "A systemic credit crunch is underway, driven primarily by bank writedowns for subprime mortgages," according to the report co-authored by analyst Christopher Flanagan. "We would characterize this situation as a systemic margin call."

This past week, JPM sent a default notice to Thornburg Mortgage after the lender missed a $28 million margin call – sending a ripple through the market. The Thornburg notice is just the start of the cycle according to JPM. There were others this past week missing margin calls, the Carlyle Group's mortgage fund also failed to cough up $37 million it owed. Is there any wonder, why sovereign wealth funds are now taking the position that they can not save Citi.

The worst news is that this is just the start of the cycle, despite the Fed planning to add an unprecedented $50B in liquidity at each of two auctions in March. The current margin calls are only for sub-prime debt; the deteriorating auto loan, credit card, and commercial real estate loan situations have not been addressed yet.

The jumps in unemployment, faltering consumer confidence, and other headwinds make it more likely that the first quarter of 2008 will officially be recorded as a recession for the U.S. economy.

Come Take the New Poll

How will agricultural commodities as represented by the DBA ETF perform in 2008?
Is this market in a bubble or does it have more upside? Let your voice be heard.

The previous survey asked "Now that the 4th quarter earnings are out of the way, is it time to buy banks?" It appears that 45% of the respondents believe that the financial sector will sink by another 20%... and so far they are right on track. With Citi primed to write-down another $18B, the Fed announcing that it is injecting another $50B into the system at both auctions in March, the credit crisis spreading to more forms of debt, and liquidity drying up... the picture appears bleak. Another 30% of the survey respondents believe the banks will at best remain flat. Not much optimism in the banking sector, it is probably not time to bottom fish yet.

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Is Citi doomed?

Citigroup Inc (C) shares sank to their lowest level in more than nine years on Tuesday after analysts projected that the bank would be taking another $15B to $18B write-down for bad mortgage debt this coming quarter. This places the bank in the perilous position of needing further capital infusions.

Unfortunately, it appears that the sovereign wealth fund spigot is shutting off. Samir al-Ansari, the head of Dubai International Capital, said that it will take more than the combined efforts of the Gulf's wealthiest to save the U.S.-based bank. These statements, made at a private equity conference, are a signal that Citi must find another source for capital.

Sovereign Funds May Not Save Citigroup
Citigroup Shares Drop After Dubai Fund Says Mideast Sovereign Wealth Funds May Fail to Save It
http://biz.yahoo.com/ap/080304/dubai_funds_citigroup.html

SunCom customers can breathe a sigh of relief

SunCom customers can stop living in fear that their cell service would be cut off any day. T-Mobile acquired the train-wreck known as SunCom; salvaging the wireless firm from its certain demise.

Prior the purchase, SunCom had huge debt, regulatory problems, a very dissatisfied customer base racking up record complaints to state authorities, and was primarily recognized for their abusive treatment of customers. The list of hurdles facing the company was almost endless, and self-inflicted. Unable to find refinancing, the only alternative was to sell the company… for pennies on the dollar.

The benefits of this acquisition for T-Mobile are very strong. “Through this acquisition, T-Mobile USA expects to significantly expand its national network to cover 259 million Americans, an increase from 244 million. T-Mobile USA also expects to realize synergies with a net present value (NPV) of approximately $1 billion through reduced roaming and operating expenses. Plus, the company anticipates further upside growth opportunities through the addition of the new markets.”

Inversely, it is not really possible to find any benefits for SunCom in the press release. “These factors also include risks that the acquisition disrupts current plans and operations; the potential difficulties in employee retention as a result of the acquisition; and the ability to recognize the benefits of the acquisition.”

Well at minimum, the good news is that SunCom customers don’t have to worry about their phones going dead.

The local bank downgrades: Commercial loans cited as culprit

The crisis that is about to overwhelm many local banks was discussed recently (see Just how bad is the situation with local banks?). Community and regional banks are facing significant exposure with their commercial real estate portfolios. Many of the loans to real estate developers and commercial builders are starting to turn sour reflecting the problems with overall market. This is turn has started a rush by the rating agencies to downgrade many of these banks as their financial strength weakens.

Moody’s downgraded a number of regional and community banks over the past week. The ratings agency has cut the outlooks of Associated Banc-Corp (ASBC), Associated Bank NA, Bank of Nevada, Susquehanna Bancshares Inc (SUSQ), Western Alliance Bancorporation (WAL) to negative from stable.

Additionally, the ratings agency cut the financial strength rating of Amegy Bank National Association, First Commercial Bank (FCHI.PK), and Nevada State Bank to 'C+' from 'B-'. While placing Fulton Financial Corp (FULT) rating under review for possible downgrade.

This cycle of downgrades, reflecting the likelihood that commercial real estate loans will not be repaid, is expected to increase over the upcoming months. A good number of these banks will be forced to merge or be bailed out by the FDIC.

Once again, it is very important at this time to pay attention to the financial rating of the institution where you perform your banking. Nothing is more painful than having your money locked up and unavailable for eight months while they FDIC “bails out” your bank or to having all your money above the FDIC insurance limit magically disappear forever.

The Subprime Mess Explained

A very funny skit that gets to the heart of the subprime crisis....

http://it.youtube.com/watch?v=SJ_qK4g6ntM

Is your Town or County next?

The Muni debt crisis continues to unfold. The failure of the Muni Auction Rate market is forcing many local governments to pay the default rate on their bonds. These higher payments, many times more than double the standard interest rate, are putting municipalities under stress.

The most recent casualty is the $3.2 billion of sewer bonds in Jefferson County (Al) that were cut to junk status after the county said it will be unlikely be unable to pay banks holding its floating-rate debt. S&P slashed the county’s sewer bonds by six levels to B, five steps below investment grade. The county, which includes Birmingham, is struggling to find alternatives to survive the predicament.

Previous posts touched on the impending muni crisis (see Bankrupt Cities, Muni failures, and CDS stress, Auction Rate Stress Continues: Muni Bond Funds Impacted, More Credit Turmoil: The Muni Auction Rate market freezes) discussed the issues facing this market.

The obvious next question should be how this situation will impact your local government. Munis are being downgraded every day; governments are finding no buyers for new issues to refinance existing debt. Will your local services come to a grinding halt as municipalities scale back and scramble to overcome debt problems?