February 2004 Newsletter
Issue Two, Volume Five

THE ALAN GREENSPAN SHOW

By Mike Gasior

THE FEBRUARY VIDEO COMMENTARY IS UP

I thank all of you who wrote with nice comments about my initial video commentary for January, and would like to especially thank those of you who DIDN'T write to take any easy, cheap shots at me. All the emails I got were actually positive and I really appreciated them.

This month I chose to talk a little about hedge funds. Although the clip is about seven minutes long, I barely have time to crack the surface of an amazing and interesting topic. You let me know what you think.

Just visit the homepage of my website and you will see the link for viewing the February 2004 video right in front of you. There are two versions of the clip depending upon whether you have a high-speed connection to the Internet or are on a dial-up connection.

Go here to view the video:

http://www.afs-seminars.com

ON TO CHAIRMAN GREENSPAN

I will immediately admit that the title of this month's edition was adapted from Ermine's album "The Eminem Show". Considering that people usually try to determine what Alan Greenspan is thinking by analyzing the slightest change in the wording or punctuation of cryptic messages released by the Federal Reserve, our friend Alan suddenly seems to have an opinion on darn near everything. The only thing I haven't heard him chime in about is the status of the J-Lo/Ben breakup, but maybe he's just saving those thoughts for next week. Consider that he has made public his viewpoints on at least the following topics in the past couple weeks:

• Social Security
• Fannie Mae's and Freddie Mac's businesses
• Adjustable versus Fixed Rate Mortgages
• U.S. Competitiveness
• The U.S. Federal Budget Deficit
• Bankruptcy Rates
• Consumer Debt Levels

And there is likely more to come, given that the Chairman is scheduled to be speaking somewhere everyday during the last week of February.

I'm not certain what has caused the sudden rise in his profile lately, but it is somewhat troubling that this all seems to coincide with the release of Mel Gibson's new film "The Passion of the Christ". Perhaps Mr. Greenspan has been a little upset over all the publicity that Jesus has been receiving in recent weeks, and doesn't want anyone to forget that there is only one God on earth at this moment, and his name is Alan Greenspan. Of course, that's just my theory, and it's always possible that I might be somewhat off.

Some of the things Chairman Greenspan has brought up for discussion are deserving of a deeper look; I would like to address a few of them in this issue.

IS GREENSPAN READING THIS NEWSLETTER?

Two months ago I wrote extensively on how I was concerned that U.S. companies were cutting back on the training and educating of their people. Here is a quick paragraph from that issue:

"If you ask the management of the U.S. companies shifting jobs overseas they will likely tell you that it is strictly a short-term strategy, and that longer-term they are committed to their people. Clearly this seems counterintuitive and it ought to seem that way. The only way to succeed in the longer term is through constant innovation and improvement, and the only way that results is if you have bright, motivated people working for you. How long before an Indian or Chinese company emerges offering better quality products than IBM at lower prices? What will IBM do then? No doubt they will scramble to innovate with new designs and improved efficiencies and hope they can achieve this before it is too late. But will they have the talent necessary to stop this runaway truck before they end up over the cliff? Only time will tell."

I sent that edition out on December 30, 2003.

Speaking in Omaha on Friday, February 20th, Alan Greenspan made the following comments:

"There is a palpable unease that businesses and jobs are being drained from the United States, with potentially adverse consequences for unemployment and the standard of living of the average American."

"Protectionism will do little to create jobs; and if foreigners retaliate, we will surely lose jobs. We need instead to enhance the skills of our workforce with rigorous training and ongoing education."

Hmmmmm...very interesting indeed. But rather than me leveling any particular accusations, we'll move onto some of the issues now making news thanks to Chairman Greenspan.

GREENSPAN ON SOCIAL SECURITY

On this particular topic I am likely to agree with literally everything Mr. Greenspan has to say.

Social Security is in very serious condition, and this is a secret to no one. As the life expectancy of Americans has increased, the ratio of workers paying into the system for each retiree has been steadily decreasing. If my memory serves me correctly (although it often doesn't) there was something in the order of 20ish people paying in for every retiree when Social Security began. Chairman Greenspan quoted a statistic that this ratio will drop to 3 to 1 in 2008 and 2.25 to 1 in 2025. This will be about the time that the system will begin to deplete the Social Security Trust Fund, which is currently around $1.4 trillion. When you hear mention of Social Security being "bankrupt" it is when there is more money going out than coming in, and the trust fund is emptied out. The best estimates figure that will happen around 2040, give or take a few years on either side of that date.

For all the buzz regarding Mr. Greenspan's comments, in all honesty, his suggestions were all fairly tame. He simply said that the retirement age should be increased slightly, changing the way the CPI number is computed, and reducing the benefits for future retirees. This is not much different than what he pointed out to Congress exactly four years earlier, when he told the politicians that they must either raise the Social Security tax rate, or raise the retirement age. Or perhaps both. At best, these are rather subtle changes, and many of the Social Security programs in Europe and Asia are facing even larger scale problems.

This should serve to remind everyone what cowards politicians are. Anyone with an IQ of a grapefruit understands that this system is broken and that if steps are not taken, then disaster is certain. Yet, knowing this, watch and see if any current politician will be willing to step up to the plate and make the changes necessary to secure the future of younger Americans.

If you need vivid statistics, let me give you these:

• If you are 35 years old, your scheduled benefits will be reduced by 27 percent from what today's retirees are receiving when you reach 74 years old, and your monthly benefit will continue to be reduced each year until you die.
• If you are 25 years old, your retirement year is currently 2046 and your initial monthly benefit will be 27 percent lower than what your grandparents are getting now. Your monthly benefit will keep getting cut each year you live, and if you are lucky enough to reach 100 years old (which is more possible each year) you will be unlucky enough to have your benefit be 35 percent lower than your grandparents are receiving right now in 2004.

So with that gruesome outlook in place, please observe as politicians do nothing to fix this, instead passing on this time bomb to a future generation of politicians who will inherit an even worse situation.

Every day that nothing is done to correct this inevitable situation makes the ultimate fix more difficult. Greenspan's suggestions were subtle and minor and might actually work if adopted sometime soon; and I agree with him completely.

GREENSPAN ON TAXES

Chairman Greenspan said very clearly that raising taxes anytime soon would be harmful to the economic recovery, saying that fixing the current deficit should be taken care of "primarily, if not wholly, from the outlay side."

I agree completely with this viewpoint as well. It remains my feeling that this current recovery is tepid and tenuous, and any minor event might tumble the economy very quickly toward recession. I cannot imagine much more in the way of stimulus coming from either the Federal Reserve with more rate cuts, and any increase in money out of the pockets of Americans will be very detrimental. This is what makes literally any tax increase extremely risky.

President Bush wants his tax cuts made permanent, and the odds of that actually happening are somewhat dicey. The Democrats are against it, and the fiscally conservative Republicans are not at all happy with the current deficit. So there is a decent chance of those cuts ending, and tax rates rising.

Both John Kerry and John Edwards openly admit that they will raise taxes if they become President. While it makes for a good sound bite on television to say you will "take away tax cuts for the wealthiest Americans", this means quite simply that you will be raising these taxes. John Kerry also made statements after Greenspan's testimony that Social Security benefits will never be cut if he is President, so you do the math yourself.

Chairman Greenspan and I are in agreement that this would be a terrible time to raise taxes. Unfortunately, no matter who ends up President, we might end up in that situation anyway.

GREENSPAN ON CONSUMER DEBT LEVELS

First and foremost, here is what Chairman Greenspan had to say:

"Overall, the household sector seems to be in good shape and much of the apparent increase in the household sector's debt ratios over the past decade reflects factors that do not suggest increasing household financial stress", Greenspan said. "And, in fact, during the past two years, debt-service ratios have been stable", he added.

While I may immediately acquiesce that the Chairman has more access and knowledge of intricate statistics regarding these matters, I still cannot agree that U.S. households are in any sort of "good shape".

During the Mr. Greenspan's speech from which I quoted his remarks, he did mention two statistics that continue to trouble me.

• Just in December the Federal Reserve released data that consumer debt reached a record level of over $2 trillion. This number does not include mortgages, but items like car loans and credit cards.
• The number of individuals who filed bankruptcy in 2003 reached a record level of 1,600,000 people.

Chairman Greenspan is correct that these statistics are often not good predictors of future economic results, but I cannot discount them as possible symptoms of deeper, underlying issues facing American consumers. Consider the three following facts:

• American incomes are not increasing in any substantial way.
• The level of consumer debt is at record levels.
• Tax increases are already occurring at local levels and are likely to increase at the Federal level.
  

Add those three things together, and I am hard pressed to understand where any earnest economic expansion is going to occur that is driven by consumer spending.

On this issue, I do not share Mr. Greenspan's viewpoint.

GREENSPAN ON FLOATING VERSUS FIXED MORTGAGES

Well this isn't much of an issue, but I suppose I agree with Chairman Greenspan that the rate for adjustable rate mortgages is sufficiently low and that consumers might be better off switching to ARMs right now to save themselves perhaps thousands of dollars a year in interest.

But let me expose my cynical side for a moment with a somewhat Oliver Stone type of conspiracy theory.

Maybe Chairman Greenspan is more worried about this economic recovery than he is letting on, and HOPES that people will refinance to floating rates so they have new money that can be used to continue their consumer spending? If they don't refinance, where will any extra monies come from?

Also, maybe Mr. Greenspan is unafraid to suggest moving to adjustable rates and give up the comfort of fixed rates because he cannot imagine anytime in the near future rates rising. Perhaps he cannot imagine the economy growing in any meaningful way, and there would be no specter of inflation creeping in to cause any rise in short term rates.

So I suppose what the question really is, is whether Mr. Greenspan actually thinks adjustable rate mortgages would be good for homeowners. Or would adjustable rate mortgages be just another form of short-term stimulus to the economy, which he can no longer provide since it is unimaginable that he would cut rates anytime soon? You make your own decision.

A DEFINATIVE EXPLANATION ON LAST MONTH'S WORDING CHANGE BY THE FEDERAL RESERVE

On January 28th, the Federal Reserve Open Market Committee changed its choice of words regarding their position on the direction of interest rates.

For several previous months, the Fed has commented that they were willing to leave rates low for "a considerable period of time".

On January 28th they said that the Fed could "be patient" regarding leaving rates low.

Too many observers immediately thought that the Fed was laying groundwork for an eventual increase in interest rates, and this was the consensus viewpoint.

I never thought that was the message being sent.

Remind yourself how much investing on Wall Street involves leverage, and if you don't know how much, I'll round it off for you. Lots.

With short rates so unbelievably low, and the Ten-Year Treasury still paying over 4.00%, why not borrow money short-term and invest the borrowed money long-term? You don't even have to be very bright and this seems like an easy way to make a very handsome spread. This is known in the business as a "carry trade".

But what if I told you that the level of leverage in the bond market is now higher than it was when the hedge fund, Long Term Capital Management blew up in the summer of 1998? By some measures, the leverage is as much as 50% to 75% higher than back then.

Given that level of speculation in the current market, I believe Chairman Greenspan was sending a signal directly to those investors warning them that bad things do sometimes happen to good people like bond market speculators.

Everyone is free to form their own opinion about what the FOMC meant, and now you have my two cents on the change in their language.

GREENSPAN ON FANNIE MAE AND FREDDIE MAC

I won't spend much time on this matter, since I have written at length on it in the past.

Chairman Greenspan thinks that the growth of the two companies has been excessive and that they pose a "systemic risk" to the American taxpayer.

I don't feel like re-hashing my remarks about Freddie Mac, but I want to remind you that the scandal of last November involved them having too MUCH earnings (they were accused of understating their earnings by $5 billion) and that they had used questionable (illegal?) accounting methods to move those earnings into future accounting periods. In accounting parlance, you'd refer to this as "income smoothing". Simply stated, they did some dirty things, but they are making buckets of legit money.

And Fannie Mae is one of the finest run companies you will find anywhere and are a benefit to homeowners, investors and their own employees.

Now I am always first to admit that anything is possible in this day and age, and no company is immune from scandal or failure. So is it POSSIBLE that Fannie Mae or Freddie Mac could fail someday? Sure. I guess. But it is impossible to imagine how. Even while Mr. Greenspan was making his critical statements, he had to admit that both companies had done a good job managing their risk thus far and that "nothing on the immediate horizon" is cause for concern.

I was somewhat troubled by his comment that the savings enjoyed by homeowners from the fact that both companies have implied guarantees from the Federal Government is somehow "modest". It is estimated that Fannie Mae and Freddie Mac's GSE (Government Sponsored Enterprise) status saves mortgage borrowers about .50% in interest on their loans. Given that Fannie Mae and Freddie Mac currently have approximately $4 trillion of mortgages packaged into mortgage-backed securities with their guarantee on them.

Let's do some math here:

$4,000,000,000,000 x .005 = $20,000,000,000 in annual interest savings

I would suspect if you suddenly increased American's mortgage payments $20 billion annually, that the effect on the economy would be something more than "modest", thus, my confusion about his comment.

Not to be cynical again so soon, but if you study the proposals being tossed about regarding increased regulation, one might find it ironic that some of the new oversight of Fannie Mae and Freddie Mac would come from Chairman Greenspan himself over there at the Federal Reserve. With that in mind, it is difficult not to take his commentary without at least a few grains of salt.

GREENSPAN ON THE SUPER BOWL HALFTIME SHOW

Of course I was kidding! Or at least, I haven't been personally told what the Chairman's views on the halftime show were, if he even has any. But what I really have to address is another rare failed prediction on my part, regarding Jennifer Lopez showing up unexpectedly because she didn't show up after all, and I was wrong. Although I don't know how much she might have helped.

So here are just a couple of quick thoughts on the Super Bowl halftime show.

• It was God-awful horrible.

And my thoughts on the pre-game show.

• It was God-awful horrible too.

Also, my thoughts on the post-game programming.

• Even worse.

Finally, my thoughts on the commercials.

• Better than the first three, but I've seen enough advertisements for men's health pharmaceuticals, horse flatulence and dopey beer commercials to last me a long time.

It is really a sad day when MTV can't put together a decent, musical halftime show. Even Kid Rock, who I frankly like a lot, aggravated me with the poncho made out of a U.S. flag. Wearing some red, white and blue always goes over well, but cutting a hole in the middle of a flag and shoving your somewhat greasy head through it sorta ruined the moment for me.

And I'm not skipping our friend Janet Jackson. It was an inappropriate thing to do, and not even particularly shocking frankly. As far as stunts go, it was a fairly stupid one. I thought CBS cut away quickly, and I wasn't even certain what I'd seen.

What is amazing to me in all this was the furor over the Janet Jackson boob exposure. I actually heard some stooge on a television talk show refer to it as maybe "the most controversial event ever". Come on now. Janet Jackson is not even the most controversial member of her immediate family. If anything, you have to give her some credit for generating probably $20 million of free publicity for her upcoming album release in March.

Thank goodness all can be forgiven because of an excellent game. I'm not even much of a football fan, and had planned to take a shower sometime during the game so I wouldn't miss any of the halftime show. But the game was so good, I couldn't stand to tear myself away from it and had no idea that the halftime could have easily been skipped.

TWO SEMINARS IN THE COMING WEEKS

I will be presenting our brand-new Securities Operations, Processing & Accounting Seminar in Manhattan on March 15 and 16, and our two-day Derivatives Seminar in Hartford on March 18 and 19.

You can view the two courses at the following links, and I would love to see you or your colleagues there:

http://www.afs-seminars.com/securities-operations.html

http://www.afs-seminars.com/derivatives.html

You will also find all the other programs I will be presenting during 2004 listed on the website.

THE FEBRUARY BRAIN TEASER

I continue to avoid mathematical based questions for another month, and will try another logic-based problem. I took a little grief that last month was too simple, and I truly believe that this one is a little more challenging. I don't need to ask you to let me know what you think since I know I will hear those opinions whether I want to, or not.

Here is this month's brainteaser:

There are the names of at least five animals hidden in the following sentence. You have to find the letters necessary in consecutive order within the sentence. Good luck.

"He is rich or seems to be, since he buys from expensive catalogs and ogles million-dollar homes for sale."

You can view the solution at this URL:

http://www.afs-seminars.com/brainteaser_Feb2004.html

And the answer to LAST month's brainteaser is:

The three cards placed on the table are the king of spades, the queen of spades, and the queen of hearts.

http://www.afs-seminars.com

Copyright 2004, Michael Gasior. All Rights Reserved.

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