March 2008 Newsletter
Issue Three, Volume Nine

WHERE IS MY FREAKING BAILOUT?

By Mike Gasior

There will most certainly be moments during this newsletter where I am going to come across as angry and somewhat bitter. The simple explanation for that is because I am angry and bitter. For the past eight months or so I have disagreed with nearly every knee-jerk decision made by the Federal Reserve and U.S. politicians in response to the housing "crisis", the credit "crisis" and now the ever-looming oil "crisis". Those of you that have been readers of this publication for any extended period of time already know that I've predicted this situation with oil for many years now and wrote extensively of the lunacy of housing prices and lending practices three years before anything hit the fan. None of what is occurring right now surprises me in the least since all of it was inevitable. What is upsetting is that the Federal Reserve also knew it was inevitable also and I struggle to comprehend why the politicians didn't see it coming either. Rather than be preemptive in trying to help avoid these assorted "crisises" they instead chose to wait and react with policy decisions that will only make things worse. Examining these situations will be the thrust of my newsletter this month.

NEW YORK AND GRAND CAYMAN TRAINING SESSIONS

I will be presenting two extremely timely seminars in New York in July and a particularly relevant slate of "a la carte" one-day sessions in Grand Cayman in November. Here is brief list of those programs and you can see the details of all New York and Grand Cayman classes at the following links:

NEW YORK

Swaps & Swap Derivatives - July 14, 2008
http://www.afs-seminars.com/swap.html

Mutual Funds & Variable Products - July 15 & 16, 2008
http://www.afs-seminars.com/mutual-funds.html

GRAND CAYMAN

The Hedge Fund Industry 2008 - November 17, 2008
http://www.afs-seminars.com/services-hedge-fund.html

Securities Operations, Processing & Accounting - November 18, 2008
http://www.afs-seminars.com/securities-operations_offshore.html

Mortgage & Asset Backed Securities - November 19, 2008
http://www.afs-seminars.com/mortgage_offshore.html

CMO, ABS & CMBS Securities - November 20, 2008
http://www.afs-seminars.com/cmo_offshore.html

Swaps & Swap Derivatives - November 21, 2008
http://www.afs-seminars.com/swap_offshore.html

I look forward to seeing you or your colleagues at one of these seminars.

THE FED FIGHTING ITSELF

There is a long held belief in the financial markets that is summarized in a simple rule of thumb:

"Don't fight the Fed."

All this means is that no matter how much you might disagree with the actions and viewpoint of the Federal Reserve, it is folly to bet against them since they will ultimately prevail with their policies if they're determined to do so.

But what is one to do if the Fed can't decide what they should be doing, or are trying to fight multiple wars on multiple fronts? This is the dilemma yhat Chairman Bernanke and his counterparts find themselves in now and while they may win certain battles, it is less clear whether they can ever win the wars they are currently engaged in. I've been pretty harsh in my criticism of many of their actions during my seminars, while giving speeches and in print, but I don't envy the position the Fed finds themselves in and I can only imagine a growing bitterness on the part of FOMC members toward Alan Greenspan for this mess he left them in.

Please understand that the Fed is between a rock and a very hard place at the moment and winning one battle almost entirely assures losing another one. To understand what I mean, please humor me in reviewing some very elementary economics.

When an economy is doing well, with consumers feeling confident and businesses booming, this often will lead to inflation. Inflation is the enemy of any currency since it erodes its value and to slow this inflation, a central bank (The Federal Reserve, European Central Bank, Bank of England, etc.) will usually begin to raise interest rates in order to slow the economy. Hopefully the higher interest rates will discourage consumers and businesses from borrowing and spending and the economy will slowdown, which, in turn, will hopefully slow inflation down too.

Of course, when consumers are feeling pessimistic and sales begin to slow for businesses, the economy will start to stall. A central bank will then try to stimulate the economy by lowering interest rates; trying to encourage consumers and businesses to borrow and spend. Hopefully this spending helps the economy to rebound and life is once again wonderful in "Capitalism Land" (my term) and things begin growing once more.

Here is where the Fed is in a real pickle; which caused me to remember and begin telling a joke to almost every audience I've been in front of for six months, which I previously hadn't told in 20 year. It goes like this:

Two guys are sitting around a campfire at night when Guy One decides to ask his buddy a question.

Guy One: "Hey! What would you do if a HUGE Grizzly Bear came crashing through the bushes right now and let out a roar? What would you do?"

Buddy: "Well, I guess I would take off and run like hell."

Guy One (finding the answer funny): "Oh yeah? Don't you know that Grizzly Bears can run 35 miles an hour in short bursts? You think you're going to outrun a Grizzly Bear?"

Buddy: "No. I just have to outrun you."

The joke has merit since this is precisely the dilemma the Fed finds itself in now because things aren't "normal" in the economy. We have very serious inflation creeping in on multiple fronts and we're clearly saddled with a pretty crappy economy.

So now the Fed had to make a decision on which guy to chase. Do they chase the economy guy? Or do they chase the inflation guy?

It's obvious they've elected to chase the economy guy with the aggressive, and in my opinion enormously stupid, rate cutting of the past six months. They were clearly hoping to stimulate the economy, mitigate the housing "crisis", and hopefully ease the credit "crisis".

Well ask yourself something; is it working? I'd personally vote no. Housing prices are going down like a stone, the economy is a mess and Lehman Brothers announced a $3 billion second-quarter loss yesterday due to the credit crisis and asset write-downs. Sounds like a train wreck to me, actually, and I doubt it gets any better anytime soon. The Fed could cut rates to zero and it wouldn't save the broke-ass American consumer who has been on a drunken spending spree for the past 10 years, who hasn't saved a dime and who wouldn't be able to repay borrowed money with NO interest being charged anyway.

While the Fed's been chasing the economy guy the inflation guy is running in the other direction like an S.O.B. History has shown that with enough of a head start the inflation guy can be a tough mother to catch. Just look back at the 1970's into the early 1980's. It took a tough S.O.B. in Paul Volker to put that inflation genie back in its bottle with massive and aggressive increases in interest rates starting in 1981. I worry that the public of today doesn't appreciate the tough actions taken by the Volker Fed in the early 1980's or that Alan Greenspan inherited a very nice situation from his predecessor when he took over. Nothing like the quagmire that Greenspan left to Bernanke, which is almost assuredly a lose-lose situation. I see little chance that this whole situation ends well since all the evidence and economics point in the other direction.

I couldn't help but be amused a few weeks ago when on the same day Henry Paulson, Treasury Secretary and John Thain, formally of Goldman Sachs and the New York Stock Exchange and now currently CEO of Merrill Lynch announced that the credit "crisis" was effectively over. I nearly peed myself laughing at this coincidence. I would have definitely peed myself if someone had flown the two of them off to some aircraft carrier with a huge banner reading "Mission Accomplished". That would have been brilliant since in my opinion the credit "crisis" still has plenty of legs left.

The chasing of the economy guy by the Fed with all the rate cutting (which was not mirrored WHATSOEVER by the Bank of England or European Central Bank who are in hot pursuit of the inflation guy) has caused the American consumer massive and difficult-to-cure pain.

If you want to have some fun, do yourself a favor and remind yourself first that the Fed began aggressively cutting rates last August. Then go to some financial website and look at a chart for the U.S. Dollar starting at that same period (plummeting) and a chart for the price of oil (skyrocketing). This writer suggests you may spot at least some correlation there and I will offer that it's not a coincidence either. The next time you're filling up your car with $4.00+ gasoline, please think about your friend Benjamin Bernanke at the Fed and perhaps send him a thank you card. We don't need any Congressional investigations to figure this oil "crisis" out. Mikey has given you the solution for free and without investigation. I'll have more about the pontificating stooges who populate Congress and the White House shortly.

Finally, I know many of you are wondering about my opinion on the Fed "bailing out" Bear Stearns. To give the concise, two-part answer, here are my thoughts:

--Bear Stearns should have been allowed to fail, which in this Darwinistic, capitalistic economy is the natural fate of running your business badly and taking risks that could break you.

--That said, the Federal Reserve had no choice but get involved and they did what they could and had to do.

I do not like what the Federal Reserve did here.

But they absolutely had to do what they did in that precise moment of history, so I will not and cannot beat them up for that.

And don't start with the usual crap about the "government bailing out Bear Stearns and letting poor, subprime homeowners fail."

First of all, educate yourself (unlike the media, most of whom couldn't find their ass with both hands, much less the facts) and learn that the Federal Reserve is NOT the government at all and operates as a privately owned corporation and a Government Sponsored Enterprise (GSE).

Second of all, the Fed truthfully didn't "bail out" Bear Stearns. The Fed very possibly prevented the potential collapse of the U.S. financial system and if they bailed out anyone it was most likely Bear's customers and counterparties. You see, as the fifth largest broker in the United States, had Bear Stearns become bankrupt they would not have paid on the countless derivatives they had outstanding nor made good on all their securities trades that were unsettled. This is the situation that might have truly caused the markets and financial system to seize up. I'll speak specifically about the subprime homeowners in the next segment of this newsletter.

Finally, please also understand that the Fed is at the absolute outer edges of what their charter allows them to do with this $29 billion "loan" they made so that JPMorgan could acquire Bear Stearns.

For the sake of full disclosure I should say that I have many, many friends at JPMorgan and I think Jamie Dimon is the best manager on Wall Street right now, and this was a genius acquisition for them. Bear Stearns was probably the best mortgage backed and structured products broker on the street (all evidence the contrary obviously) and JPMorgan picked them up for an excellent price. It struck me funny that people were lamenting the original buyout price of $2.00 per share being an "outrage" (later raised to $10) since probably any price over zero was too much to pay.

But this supposed "loan" from the Fed is a joke and also a lie. It isn't a loan at all, but an equity investment for the Fed. You see, I studied such things in school and was taught to understand the difference. Let me explain the terms of this "loan":

--The Fed took as collateral for this "loan", $29 billion of Bear Stearns assets, which are currently being held at the Wilmington Trust Company and is being managed and sold off by the money management firm, Blackrock.

--If the collateral for the loan should sell for less than $29 billion, the Fed will suffer the losses.

--If the collateral sells for more than $29 billion, the Fed gets to keep the profits.

Now here's another example where you should be asking yourself questions. If GMAC lends you $10,000 to buy a car and you should sell that car for $8,000. Does GMAC forgive you for the $2,000 shortfall? Or, if you were able to sell the car for $12,000 instead, does GMAC get the $2,000 additional amount on top of the balance of their "loan". The answers are no and no and even people with almost no financial training or background would know those answers. Anything that had the characteristics of the Fed "loan" is an equity investment. So why does the media continue to refer to this situation as a loan? I feel somewhat like "The Church Lady" asking this question; But could the media be......mmmmmmm......idiots? Perhaps they are.

In summary, I don't like what the Fed did here, nor do I like the package they offered being referred to as a "loan" since it wasn't, but Americans and the world might never know how close we came to a financial cataclysm. My worry, however, is while they successfully stuck a finger into this leak in the dike, it will take us some time to find out how many other leaks are still yet to happen and how many fingers the Fed has left to stick in them.

SUBPRIME HOME BUYERS BAILOUTS

Let me start this segment of the newsletter with a little of my own personal history. I bought my first home in 1986 with a 20% down payment and a 9.75% mortgage (and if it makes it funnier for you, I paid three points to get that rate since the zero point mortgage rate was 10.5%). My bank had offered me what they called a "step ahead" mortgage, so instead of paying $1,800 per month, I paid $900 every two weeks. By making my payments bi-weekly I shortened the lifespan of my 30-year mortgage to 21.7 years. On top of that, I always made extra payments and paid that mortgage off is just over nine years. I always paid on time and after the real estate crash of the late 1980's and early 1990's, I was able to finally sell that house in 1999 and get out just a little better than even.

My current house I bought in 1999 and had a jumbo mortgage with an 8.375% interest rate, which I refinanced once and currently have a rate of 6.125%. It is a standard 30-year loan and I have always made extra principle payments since inception. Once again, I have always made my payments on time and since the house is on a 60 acre parcel (for which mortgage lenders don't consider any land beyond a "typical" building lot and would not consider 59 of the acres toward the value of the home for the mortgage) the lender ended up requiring me to put up nearly a 50% down payment. I hope to have this mortgage paid off no later than 10 years from now.

Regarding to these people who took out these subprime mortgages with little or no money down, and in some cases, took out loans in EXCESS of the purchase price. Whose mortgages had ridiculously low "teaser" interest rates that would quickly jump to 10% to 12%. Whose credit scores showed their questionable credit history and possibility/probability they may never be able to pay these loans back. To the politicians of all ilk who are currently suggesting that the government bail them out of the situation they find themselves in. To Benjamin Bernanke who recently suggested to an audience of Federal Reserve Bank members that they "forgive" some of the principal of these loans that the banks made to these sketchy borrowers. To the investment bankers who packaged these loans and the investors who bought them and should have known better. To ALL of these people, I only have one thing to say.

Screw you.

I made a new friend named Susan during a visit to a client in Washington D.C. last week and she suggested what I thought was a wonderful idea. Her idea is that lenders should forgive 15% of the principle on loans for terrific and timely paying borrowers like her and me. Not these lowlife, deadbeats who are currently sending the U.S. foreclosure rate to all-time record levels and creating a hairball in the windpipe of the American financial system.

Lots of you are currently reeling at my seeming lack of compassion for these "poor" homeowners who are going to lose their dream. Or wondering why I'm not picking on whatever lender you'd like to martyr for employing predatory lending practices (you pick whatever company you'd like here). To you I say that it is indeed a human tragedy that these people and their children perhaps are losing their homes and the media will have a field day in covering this story. Yes, there were most certainly some VERY aggressive lending practices that took place during the past seven years or so.

However, it is simply a fact that turning 18 years of age in the United States carries a lot of importance and responsibility. You become of "legal age" and are able to make decisions about your own life. "Land of the free, home of the brave." Now you can vote, join the military, fly to Vegas and marry Brittany Spears if you so desire and while people can gauge your judgment, nobody can stop you. I love my country and I love the freedom that I've enjoyed damn near every moment of the past 30+ years where I've been in charge of my own life. Not every decision I've made has been genius, but I've taken my lumps, learned my lessons and hopefully grown into being a better and smarter person. It's been a wonderful thing being a legal adult, with all the opportunities, freedoms and decisions that come with it.

Well, one of the freedoms that come with turning 18 years old is the freedom to sign the paperwork for a REALLY stupid mortgage. Perhaps without even spending the couple of hundred bucks for a lawyer to represent you prior to borrowing hundreds of thousands of dollars. You know what? You made a mistake. Oops.

But I'll tell you one thing, I don't want to be the one paying for your mistake. If anything, guys like me should be getting 15% of MY principle balance forgiven and you should get 15% added to your balance. AND to pay back EVERY dime you owe you should have to come mow the grass at the houses of guys like me until your balance is paid. Now there's a bailout plan I could get on board with.

I'm frankly sick of all these ludicrous bailout plans being thrown around. These homeowners (and many subprime corporate borrowers) simply have to go. They have to lose their homes or companies, and the market needs to adjust to reflect this new reality. It's called capitalism. It's called Darwinism. The law of the jungle. Otherwise, what's next? Credit card bill bailouts? Gas price bailouts? Mutual fund loss bailouts? Politicians on both sides of the aisle need an immediate lesson in basic economics and the sooner the better.

This country is in the trouble it's in due to overspending and undersaving. No one needs an economics degree to figure that one out. But what do the politicians have in mind to solve the real crisis in our economy? A comprehensive energy plan to wean us off fossil fuels? Cutting back on the spending habits of the Federal government? Encouraging investment, saving and business?

Nope.

Congress is investigating speculators and hedge funds looking for the bogeyman of the oil markets (even though I could have told them that it was Bernanke). Obama wants another $50 billion of economic stimulus on top of the moronic $150+ billion package they already approved as well as windfall profit taxes for oil companies (more on this shortly). McCain wants a gas tax holiday. There are proposals to raise the margin requirements for speculators in the futures and derivatives markets. I could go on and on, but I'll spare you that misery. Suffice it to say that all the ideas are just idiocy and will not solve a damn thing. The government does nobody any favors with the example the set of overspending, undersaving and overpromising.

Frankly, there is not a single proposal currently being offered by George Bush or the U.S. Congress that is worth a bucket of spit with regard to solving the "crisis" trifeca of facing America and the world (housing, credit and oil). In fact, they will probably serve to make the situation even worse. It's typical, really, and something we should remember come November.

So let's please drop this conversation about bailouts of all order. Let the market take its course and see where the chips fall. Sure, there will be pain and suffering on the way down, but we need to find our where the bottom is and begin building the economy back from there. This is the nature of the universe and there is no amount of Band-Aids the government and Federal Reserve can apply to this sucking wound that will ever make it appear to be a skinned knee.

OIL COMPANIES AND OPEC WILL SOON CUT PRODUCTION

The heading of this section sounds ludicrous and counterintuitive, but please hear me out before you commit to that opinion.

With oil prices now north of $130 per barrel, conventional wisdom would dictate that oil companies and oil producing countries would want to pump as many barrels as humanly possible and then head to the bank to cash huge checks.

And while that's the conventional wisdom, there is an extremely provocative argument for why they will quietly and slowly tighten their production during this very volatile time.

Imagine the following scenario:

--You are the owner of an asset (oil), which is only gets more and more valuable every single day lately.

--You are wealthy beyond your wildest expectations and your income and profit margins make it seem like you're printing money in your basement.

--The media is hounding you day and night about how the amount of money you make is obscene and argue how you should perhaps be ashamed of yourself.

--The U.S. Congress is calling you to testify in front of committees to explain why you're making so much money and are proposing the creation of special taxes to take away some of the income you're making because they view it as obscene also.

--And all of this is occurring when just a few years ago you were broke on your ass with a cup of pencils on the street when oil was $20 a barrel and gasoline was moving toward $1.00. None of these people were taking up collections for you back then.

Perhaps you'd be angry.

Perhaps you'd even be bitter.

Perhaps your name is ExxonMobil, Chevron, Occidental, Sunoco or Shell.

Would you pump MORE oil and make MORE profits so you could attend MORE investigative hearings about whether you should pay MORE taxes than "normal" corporations? I think not.

I would expect pipeline problems. Offshore drilling issues. Refinery outages. All sorts of itty, bitty problems that will at least reduce their output in some minor way that will get the government out of their face and off of their backs. OPEC will behave the same way. George Bush was just in Saudi Arabia begging them to increase production and they told him to go pound sand. (Cute, huh?)

Every entity I mentioned in this section has PLENTY of money and there isn't really any good place to invest any extra amounts right now anyway. Their best investment is probably stuff they already own, which is black, slippery and thousands of feet underground. I would personally keep this valuable asset tucked away for as long as possible.

What do you think they'll do?

ONE FINAL THING ABOUT THE ECONOMY

Do yourself a favor and immediately stop listening to the wooden, talking head stooges you see on CNBC and elsewhere (including Chairman Bernanke) who claim the economy shouldn't get very bad.

Instead do some very basic research of your own.

Here is a wonderful link you should immediately save to your "Favorites", which is a page on The Department of Energy's website. It gives you the consumption statistics of all the basic petroleum products used in the United States weekly. It will also allow you to research consumption back to 1990 if you wish:

http://tonto.eia.doe.gov/dnav/pet/pet_cons_wpsup_k_w.htm

One more educational item before I explain my logic about where economy has got to be heading. The page I just gave you lists how many thousands of barrels of product are consumed per day and there are 42 U.S. gallons in a barrel.

With that said, Americans consume about 156,424,000 gallons of gasoline, diesel fuel, kerosene and whatnot on a daily basis.

Multiplied by 365 days per year will get us to 57,094,760,000 gallons of consumption annually.

Another page for you to be knowledgeable about is this Department of Energy page that gives you average prices:

http://tonto.eia.doe.gov/dnav/pet/pet_pri_gnd_dcus_nus_w.htm

Once more, simple research will show you that the average price of gasoline in January 2007 was $2.21 per gallon and the current average price is $4.03.

This is an increase in price of $1.82 per gallon in the past 18 months.

Multiply that price increase times annual consumption gives you a total of $103,912,463,200 of additional cost for fuel every year.

Over a hundred billion extra dollars being spent on fuel annually in just over a little over a years time.

That doesn't include the higher cost of food and other essential items that must be bought by consumers.

It also doesn't include the loss of nearly $3 trillion that U.S. homeowners have suffered with the decline in real estate values. This was one of the largest reductions ever in American net worth.

And finally, the stock market hasn't been treating investors very well either, so 401K and retirement plan statements might be somewhat depressing to people also.

Now ask yourself a couple of questions:

--Do you think Americans are really going to be in a position to spend the United States into some sort of economic nirvana and that "the worst is over" for the economy as suggested by Chairman Bernanke last night (June 9, 2008)?

--Do you think this $168 billion tax rebate currently being sent out to American taxpayers is going to do a damn thing to save the economy?

I know most of you probably don't fancy yourselves economists, but I would suppose what your forecast for the economy might be.

Enough said.

YOUR MARCH BRAINTEASER

This is yet another newsletter that didn't really offer any "light hearted" sort of moments, so I will try not making this month's brainteaser any sort of horrific nightmare. I truthfully found this one fairly perplexing (which means I didn't get it myself) and a bit of departure from what I tend to offer you guys. It is also one you can share with your kids and they might enjoy spreading it around.

Here it is:

"An old man wanted to leave all of his money to one of his three children, but he didn't know which one he should give it to. He gave each of them a dollar and told them to buy something that would be able to fill their living room. The first child bought straw, but there was not enough to fill the room. The second bought some sticks, but they still did not fill the room. The third child bought two things that filled the room, so he obtained his father's fortune. What were the two things that the man bought?"

Good luck, and when you can't take it anymore you will find the answer at the following link:

http://www.afs-seminars.com/brainteaser_Apr2008.html

Copyright 2008, Michael Gasior. All Rights Reserved

AFS Seminars LLC
500 Chamberlain Hill Road
Middletown, CT 06457-5564

http://www.afs-seminars.com

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