Saturday, March 28, 2009

What to do when DOW re-tests the Bottom?

The current rally will soon loose out on the steam. The rally was mainly procured due to the short covering on the financial stocks and soon this will wear off as earning will be announced by each stocks. Even though financials have started making profits, there are lots of issues yet to be taken care of:

Immediate issues related to financials are

1. Commercial Mortgage Market.
2. Credit Card Defaults.

Now looking at these issues I was wondering what I should buy when there is a re-test. My safest bet is OIL.

US has only one and final solution to all these problems. Just keep printing money. Surely, they will use electronic methods rather than an old-fashioned printing press. But the effect will be the same.

The catch is that money creation on the scale required will amount to debasing the currency. That means the value of the U.S. dollar will decline versus harder currencies. This means OIL will go higher.

From its low of $35, oil has risen over 50%. If we hadn't gone through last year's spike in oil prices, $50 would seem outrageously high to most people. Considering the world economy is poised to shrink this year, oil's recent rally shows how very tight supplies really are.

Of course the same is true for many other commodities. So when economic growth returns, the next commodity bull market will be awesome.

DOW will retest the Bottom.

There is an interesting article about the DOW's Future. And I would go with the first scenario:

courtesy:
http://www.kiplinger.com/columns/picks/archive/2009/pick0323.htm


We've seen the bottom, 6440 (intraday) on March 9, with the Dow 55% off its October 2007 record.

Probability: About 60%

One way to assess the Dow is to consider the collective earnings of its members-in effect, treating the 30 stocks as one mega-security. Unlike the S&P 500, which is weighted by each stock's market capitalization, the Dow is a price-weighted benchmark. The higher a member's price, the more impact it has on the Dow's movements. (The Dow's free public Web site explains this and more about the average's mechanics and its background).

The highest-priced Dow stocks happen to represent the average's best-performing businesses, among them IBM, Johnson & Johnson and Wal-Mart. Those three account for 21% of the average. Add Chevron and Exxon Mobil, which stand to benefit from what looks like a new uptrend in oil prices, and you have 35% of the Dow.

By contrast, the Dow members with the most-uncertain futures -- Citigroup and Bank of America, which are pure financial stocks, and General Electric, which has a strong financial-services component -- trade, as mentioned earlier, at or near single-digit prices. Their disappearance would have little impact on the Dow (although, admittedly, their demise would probably lead to panic selling and could exacerbate already weak economic conditions).

At any rate, Dow Jones itself figures that the average should trade at about 13.6 times its members' combined earnings during 2009. But what might those earnings be? This is a complex calculation that requires you to add the estimates for the 30 companies and then apply the Dow's "divisor," a factor that accounts for stock splits, additions and deletions over the years. Skipping the details, let's assume 2009 earnings for the Dow of $80, which would be roughly the same as last year's figure, and adjust it by the divisor, which is 0.1255etc.... That gives you $637. Multiply that by 13.6 and you get the Dow at 8666, 11% higher than the March 23 level.

A bull could say that is eminently reasonable, but remember that analysts tend to be overly optimistic, so today's earnings estimates are probably too high. Plus, if inflation heats up sometime down the road, that 13.6 price-earnings ratio may be too high. So, to be conservative, let's assume a P/E multiple of 11 on the $637 figure. That gives you a Dow of 7007. That's lower than the latest close but well above the March 9 low.

Thursday, March 26, 2009

Rich Dad's Real Estate Era is Back!!

Long time back I had read the book called "Rich Dad, Poor Dad" by Robert Kiyosaki. Its a very interesting book with great conceptualization about:
  • Personal Finance: How one should manage his own money.
  • Real Estate Investment.
  • Clear definition about what Asset & whats a Liability.
  • Why one needs to own a Business or become an Investor.
Even though I liked his ideas I could never find the kind of Real Estate deals he talked about, in real life. But it seems the time has come that such deals will soon be available.

Check out this article: http://www.thestreet.com/story/10477259/1/buy-rental-properties-with-uncle-sams-cash.html

Our government is unleashing an ocean of cheap financing in the hope of stimulating the economy and preventing further deflation of assets, especially real estate. Although most of this government largesse is going to directly benefit large financial institutions, private-equity shops and hedge funds, there are a couple of ways that smaller investors can directly benefit from it and get their fair share.

Fannie Mae(FNM Quote - Cramer on FNM - Stock Picks), Freddie Mac(FRE Quote - Cramer on FRE - Stock Picks) and the U.S. Department of Housing and Urban Development are offering generous financing terms for the purchase of apartment buildings priced at or above $1.5 million.

In addition, the agencies will now buy the mortgage paper of investor-owned individual rental properties such as condos or single-family homes being used as rental properties, up to 10 properties per individual owner.

The irony of all of this cheap and easy financing for investors in rental properties is that the government is basically trying to replicate exactly the cheap and easy financing that caused the real estate bubble of a few years ago and the current crash.

What is different today is that the spread between the rate of financing and multiple of earnings on rental properties (or capitalization rate) has never been more favorable to investors. (A cap rate for an apartment property is calculated by dividing the current net operating income of the property by the purchase price.)

This is probably a once-in-a-lifetime opportunity for investors to generate current cash flow of 15% to 25% per year by locking in extremely favorable financing from the government to buy rental properties at a time when there are not enough investors willing to step up and buy these properties because of concerns about the economy and falling real estate values.

To understand why rental properties are such a good buy today, let's start by looking at how they traded historically. In supply-constrained markets such as Los Angeles, apartments have generally sold at cap rates -- the inverse of a price-to-earnings multiple -- of between 3% and 8% of the purchase price in good neighborhoods during the past several decades.

A couple of years ago, cap rates were mostly around 3% to 4% of the purchase price, which is the equivalent of a 25 to 33 multiple of earnings, even though interest rates were higher than today. People were very optimistic about rents and real estate values a couple of years ago.

Today, people are very pessimistic about both rents and values. Cap rates are generally closer to 8% today in good neighborhoods, which is the equivalent of a 12.5 multiple of earnings. These numbers not only include operating expenses but also capital replacement reserves for these properties.

Also, because Los Angeles has some form of rent control in most areas, the current rents at these rental properties are substantially below market rents on average. Many properties have average in-place rents that are 30% to 40% below current market rents. What this means is that even if market rents decline somewhat because of a weak economy, average rents at these properties and income should continue to rise because the spread between current and market is larger than the potential decline in market rents.

At today's interest rates, an investor who is an experienced real estate operator meeting certain net worth and liquidity tests can borrow about 75% of the purchase price of these apartments from Fannie or Freddie or HUD at around 5% fixed for seven years.

Ten years is typically the maximum loan term, but the seven-year loan is better because of the current slope of the yield curve and programs offered by Fannie. If you're not an experienced real estate operator or don't have sufficient net worth or liquidity to meet the requirements, you can still take advantage of this attractive financing by investing as a limited partner with an experienced real estate operator.

Experienced real estate operators can be identified in your local market or other markets in which you want to invest through licensed real estate brokers at any of the major national firms such as CB Richard Ellis(FNM Quote - Cramer on FNM - Stock Picks), Cushman or Grubb and Ellis.

At those loan terms, the initial cash flow to the investor would be 17%, and for the reasons explained above, that cash flow is very likely to increase over time. Further, the loans from Fannie, Freddie and HUD are typically non-recourse, meaning that the investor is not personally liable to repay the loans. The lender will look only to the property as collateral for repayment unless there are so called "bad acts" such as fraud or a bankruptcy filing by the owner.

It gets even better. As a direct owner of rental properties, the cash flow you receive is partially sheltered from income taxes by depreciation. Depending on your personal tax bracket, the 17% pre-tax cash flow yield from the example above could be substantially higher on an after-tax basis.

Lastly, these properties can often be purchased at a large discount to replacement cost, which is the cost to build new apartments or other multifamily housing such as condos. This discount to replacement cost further increases the chance of an increase in the value of the property in the future.

For investors with a higher risk tolerance, there are even better cash flow opportunities in rental properties located in markets like Phoenix. Historically, cap rates in Phoenix have ranged from about 5% to 10%. Cap rates are higher, which means that income multiples are lower, in Phoenix vs. someplace like Los Angeles because the supply of housing is not as constrained, and there is no rent control, so rents are always close to market. At the peak of the real estate market a couple of years ago, cap rates in Phoenix were mostly in the 5%-6% range because of investor optimism.

Today, cap rates are sometimes 11% for similar rental properties. Although there is still some potential that the income at these properties could decline because of economic weakness, a significant amount of that decline has already happened during the past two years.

If you buy at an 11% cap rate, borrow 70% of the purchase price from Fannie, Freddie or HUD at 5.25%, which is available for Phoenix properties, your initial cash flow to the equity is nearly 25%. Even if the cash flow declined by 10% after you buy the property, your cash flow to the equity would still be 21%.

As previously mentioned, these pre-tax cash flow yields will be even higher after adjusting for the tax benefits of direct real estate ownership, and there is also likely to be future appreciation because of lower cap rates in the future and the large discount to replacement cost at which these properties can be purchased today.

If you compare these two opportunities for direct ownership of a multifamily property to owning a public apartment REIT such as Equity Residential(EQR Quote - Cramer on EQR - Stock Picks), owning the REIT shares doesn't look very attractive.

Even at these depressed share prices, EQR's common stock pre-tax yield is only about 10% vs the 17% to 25% yields in these examples. Also, the investor does not receive any additional tax benefit from sheltering income by owning REIT shares.

As a public company, EQR's stock is also subject to many other issues for an investor such as Sarbanes-Oxley, more expensive overhead and management costs, short-sellers driving down the shares via various trading strategies, negative impact from inclusion in the REIT index, and potential misalignment of interests between the managers and the shareholders.

EQR also has a much more complicated and risky capital structure as far as its corporate debt and preferred stock vs. an individual apartment building.

Many investors will not be able to understand all of these risks, as recently happened with General Growth Properties(GGP Quote - Cramer on GGP - Stock Picks), which has seen its share price collapse nearly to zero primarily because of issues relating to its capital structure and unrelated to its properties.

Further, this more complicated capital structure means that the investor is not getting a similar direct benefit from government financing that you can get from buying apartments directly. Yet another risk with REITs that will be difficult for investors to evaluate is the quality of earnings and the assets in the portfolio of a public company. The additional liquidity that you get from having a public security does not compensate you for the much lower yield and other costs and risks involved.

There are obviously other risks of direct ownership, including asset selection, market selection, due diligence and other property-specific issues such as evictions of tenants and bad debts. Finding good-quality apartments buildings for sale and evaluating those investments can be challenging for individuals with no real estate experience.

However, this process is actually easier than trying to understand the balance sheet and portfolio of a national REIT. Investors who want to pursue these investments should start by contacting apartment sales brokers and mortgage finance brokers in their local area.

Alternatively, all of the issues relating to asset selection, underwriting and due diligence can be handled by professional real estate operating and management companies that will typically invest their own capital alongside the limited partner investors so that there is no potential for a misalignment of interests.

If investors want to own rental properties for cash flow and appreciation, this is potentially a great time to do it through direct ownership that takes advantage of attractive government financing.

The spread between apartment cap rates and fixed-rate financing to buy them has never been wider. It is very likely that this spread will narrow either because of higher interest rates or lower cap rates in the future. In either case, this should be a relatively good time to buy if investors want to achieve solid current cash flow returns and upside potential.

Sunday, March 22, 2009

Assam Company Promoter Stake up to 46.19 percent.

Assam Co promoters up stake

Calcutta, March 3: The promoters of Assam Company Ltd have raised their holdings by 5 per cent during the October-December quarter.

During the same quarter, Mavi Investment Fund, the sub-account of Switzerland-based MM Warburg Bank, has reduced its holding in the company by 5 per cent.

Assam Oil Company has increased its holding in Assam Company to 38.45 per cent during the quarter ended December 31, 2008 from 33.45 per cent in September 2008.

This raised promoters’ holding to 46.19 per cent from 41.19 per cent till December 31.

Mavi Invest Fund — which had an 8.72 per cent stake in Assam Company at the end of September 2008 — brought down its holding to 3.72 per cent at the end of December 2008.

The total public holding (entities holding more than 1 per cent) came down to 29.70 per cent from 34.80 per cent as on September 2008.

Assam Company managing director Aditya K. Jajodia refused to comment on the issue when contacted by The Telegraph.

On October 27, 2008, Sebi allowed the promoters to up stake, through creeping acquisition and share buyback from open market, by up to 5 per cent in a year.

A firm or a person whose holding in a group company is 55 per cent and above but below 75 per cent is eligible to take this share acquisition route up to a limit of 5 per cent in a year.

In another development, Assam Company had informed the Bombay Stock Exchange on February 17 that the promoters had pledged 1.47 per cent (45,56,000 units) shares.

During the quarter ended December 31, Assam Company suffered a net loss of Rs 11.47 crore.

The company is engaged in cultivating, manufacturing and selling tea, and in oil and gas exploration.

Courtesy: http://www.telegraphindia.com/1090304/jsp/business/story_10622441.jsp

Saturday, March 21, 2009

Credit Cards Crisis On The Horizon!!

Date: March 21, 2009.

There has been lot of commotion regarding the Meredith Whitney’s, new crisis that US will soon face. It’s the rising defaults in Credit Card payment.

California jobless rate has just climbed to 10.5 percent. The state unemployment rate jumped to 10.5 percent in February, a level not seen since 1983. All told, the recent economic slide has left 1.95 million Californians scrambling for work.

Bernanke recently stated that unemployment problems would continue till 2011 and unemployment rate would be contained around 9%. American Economy will bounce back in 2010 if they are able to stabilize the banking crisis.

Now looking at the California numbers, I am wondering if Bernanke would be able to manage the unemployment numbers. Obama’s Infrastructure plan will bring in lots of blue collar jobs. But will it be sufficient to cater the growing unemployment numbers.

According to Jim Cramer, the whole credit market will fail if the unemployment touches 10%. Looking at these unemployment numbers and the current shabby economy, credit cards crisis seems quite plausible.

Wednesday, March 18, 2009

Rising New Housing Permits: Bad for Economy.

“U.S. housing starts in February unexpectedly snapped the longest streak of declines in 18 years, raising optimism the market may be finally finding a floor.

Work began on 583,000 homes at an annual rate, a 22 percent increase from January that was propelled by a surge in condominiums, apartments and townhouses, Commerce Department figures in Washington showed today. A separate report showed gains in producer prices slowed, underscoring a lack of inflationary pressures with the economy in a recession.

Wall Street stocks took heart from the data and rallied throughout the session, with the Dow Jones industrial average closing nearly 2.5 percent higher at 7,395 points.”


This news does not bring in optimism for me. For me the leading indicator of the Housing bottom would be “Existing Home Sales” rather than “New Housing Permits”. With Existing Home sales in the declining trend, the increasing number on New Home Permits brings in a more gloomy economic picture.

Soon there may be more homes in the market with no buyers and the housing prices would drop further. It’s certainly not in the best interest of the US economy to provide Housing Permits in today’s scenario.

I suppose these new homes would hit the market a year or so. So the existing glut of existing homes needs to be cleaned up way ahead, to see some price stabilization.

We are certainly very close to the housing bottom but things can get worse with increasing New Housing Permits and rising defaults on credit cards payments.

Thursday, March 12, 2009

Citi Never Sleeps!!

Yesterday, comments from the company’s CEO, Vikram Pandit, in an internal letter that was also filed with the Securities and Exchange Commission, set off the biggest rally in stocks since November. But there’s a lot less to the story than investors took away from the news.
Pandit boasted that the bank has conducted its own stress test ahead of regulators and, low and behold, it was confident in the bank’s capital strength even using more pessimistic assumptions than the Fed would employ. Pandit also touted that the company was profitable during the first two months of 2009 and it was having its best quarter-to-date performance since the third quarter of 2007.

It all sounded great on paper; and the media not surprisingly focused on the profit part of the picture while largely ignoring the fact that Citi’s sour assets still have to be addressed. Delving a bit deeper we were far from impressed.
In terms of its capital strength, thanks to the conversion of the government’s preferred shares into common stock (assuming 100 percent preferred conversion), Citi’s pro forma tangible common equity is $81 billion (including $29.7 billion in capital as of 12/31/08). The conversion raises the company’s tangible common equity to risk-weighted assets 8.1 percent.
If it really did have $81 billion in tangible equity, why not just buy back all of the outstanding stock? The company’s market capitalization after all is only $8 billion.
And then there were the “oh, by the way…” comments buried in the letter. For instance, Citigroup has $44 billion in deferred tax assets most of which it expects to be able to realize, even if near-term conditions deteriorate significantly. But later on in the letter Pandit says that some observers say Citi’s deferred tax assets may be at risk and may have to be deducted from its tangible equity. If true, that alone would halve the company’s tangible equity.
And here’s the real kicker: Citi has $301 billion of assets that have been “ring-fenced” under an agreement with the U.S. government. That’s a nice way of saying guaranteed by Uncle Sam. Pandit is claiming that after three government bailouts Citi is in great shape. And it is—assuming the government comes through on its guarantee of more them $300 billion of the company’s toxic assets! It’s hard for us to keep a civil tongue when we read Pandit pushing such unmitigated crap.
He takes investors to task for the “broad-based misperceptions about the company and its financial position.” Perhaps investors are misinformed, but we think the $1.45 share price (down from $20 six months ago and $55 when the financial sector started to unravel) tells the real story. Another sign the company is still in quite a lot of hot water can be seen in the sky-high cost of its credit default swaps. The cost of insuring against its bonds defaulting in the next five years is more than 5.7 percent of the face value of those bonds.
We don’t know about you but we’ll take our cue from the market over the company’s chief cheerleader any day. Nevertheless, plenty of investors bought the story as a sign that the banking sector is on the mend. To be fair, stocks were deeply oversold and looking for an excuse to rally, and they found it (a weak one at that) in Citigroup. The early buying also brought about short covering which added fuel to the rally.
Equities could rise a bit further in the coming days and weeks, but don’t get your hopes too high. The market has not displayed the classic signs of a bottom—and the financial crisis is far from resolved. Chances are the rally will falter at some point and we’ll trade back down to the recent lows and possibly go lower before an ultimate bottom is reached.

Courtesy:Stephen Leeb, Ph.D.

Total Banking Armageddon.

Cramer said if you wanted to destroy all the banks and create a total banking Armageddon, there are three things you would do.
First, you'd keep the ban on the uptick rule, which would eliminate the fear in the markets and keep short sellers at bay.
Second, you'd keep the strict mark-to-market rules so the banks would be forced to liquidate assets rather than loan more money.
And third, you'd demonize all bankers, treating them all as crooks, driving the wedge of mistrust in even deeper.
These three things, Cramer said, are what you'd need to do to create a total collapse in banking. Ironically, he said, these are precisely the current rules of the day. and that needs to change. "If we don't change," said Cramer, "all of the major national and regional banks are going to fail."

Courtesy:http://www.thestreet.com/story/10470674/4/cramers-mad-money-recap-march-11.html

Wednesday, March 11, 2009

Time to Say Goodbye to the Bear?

Courtesy: http://www.kiplinger.com/columns/value/archive/2009/va0310.htm

Don't call Jim Stack a bull -- yet. The veteran market strategist was one of the most bearish analysts at the start of 2008, and he has remained cautious. But Stack sees classic signs that investors are capitulating to the downward slide in share prices, signaling that the bear market will likely end soon. "We're reaching the point where we really question whether there's much more downside risk," he says.

For Stack, the glass is currently both half full and half empty. "Until we see solid evidence that a market bottom is in place, it's difficult to take a strongly bullish outlook," says Stack, who publishes the newsletter InvesTech Research from his perch in Whitefish, Mont. "On the positive side, we have all the extremes in pessimism that typically accompany a bear-market bottom -- a once-in-a-lifetime buying opportunity."

Another big plus: Stocks are dirt-cheap, whether you consider price-to-cash flow, price-to-book value, price-to-sales ratio or dividend yield. "This is a 1929-style bear market for lots of big companies, such as Dow Chemical, General Electric and International Paper, which have each fallen more than 80%," Stack says. The yield on Standard & Poor's 500-stock index is 3.6%, and stocks of many solid companies are yielding 5% or more. That's especially significant given how low interest rates are.

So, although Stack isn't ready to declare the bear dead, he currently recommends that clients keep 58% of their assets in stocks. That's a lot more than he's been suggesting the past couple of years.

Stack uses a bushel of technical indicators and fundamental economic measures to assess the market's direction. Many signals have flipped to the bullish side.

Investor capitulation is one of the final signs he looks for at a bear-market bottom. Says Stack: "By definition, capitulation occurs when investors ultimately decide to abandon the stock market in lieu of safer alternatives. It's often accompanied by panic selling and steep declines on high volume."

In other words, bear markets often end amid just the kind of sound and fury we've been witnessing of late.

How will Stack know the new bull market has begun? "One of the most important signposts is downside selling pressure drying up," he says. Stack wants to see a dramatic drop in the number of stocks hitting new 52-week lows. "Once everyone who wants to sell has sold, then pressure dries up."

Not long after the market bottoms, the number of stocks making new lows falls to fewer than 100 -- and that number remains fairly constant for a time. "If you see two or three weeks of that, it's meaningful," Stack says. After bear-market bottoms in 1990 and 2003, the number of new lows dropped to less than 20-and stayed there for months. (October 9, 2002, marked the low point of the bear market that began in 2000, but some analysts think the downturn actually ended the following March.) On March 5, a day on which the S&P 500 fell 4.3%, 728 stocks trading on the New York Stock Exchange hit new lows.

You'll make the most money on the upside if you hop aboard the market shortly after it signals that it has hit bottom. Stack says most investors will miss a big chunk of the rebound, so he's recommending a healthy allocation in stocks. "By the time you feel comfortable that the bottom is in place, you'll be uncomfortable going in because the Dow Jones industrial average will be up 1,000 or 1,500 points."

Don't expect the economic news to turn rosy anytime soon. The economy generally hits bottom about five months after a bull market begins. "As the market goes up, it's going to move higher on bad news," says Stack. "The bad news isn't going to go away."

Here's the sweet part: Stack thinks we're in for a doozy of a bull market. After the market bottoms, he anticipates back-to-back years of 20%-plus returns.

Why? Because stocks are so cheap and because this bear market has been so deep and protracted. Plus, the current bear arrived just five years after the 2000-02 bear market, which was also severe. The past decade has been miserable -- the S&P 500 lost an annualized 4% through March 6, according to Morningstar. From the market's peak in October 2007 through March 6, the S&P plunged 56%, making this easily the worst bear market since the Great Depression.

The odds of the current recession turning into Great Depression II are slim, says Stack: "The U.S. economy is very diverse and amazingly adaptive. And even if we're undergoing some of the same pressures of 1929, you have to bet that all these Nobel Prize-winning economists know something because the Federal Reserve and the Treasury are applying a textbook bailout. While the headlines are filled with everything that's going wrong, maybe it's time to ask what the market will do if some things start to go right."

Credit Cards Are the Next Credit Crunch.

March 10 2009. By MEREDITH WHITNEY

http://online.wsj.com/article/SB123664459331878113.html

Few doubt the importance of consumer spending to the U.S. economy and its multiplier effect on the global economy, but what is underappreciated is the role of credit-card availability in that spending. Currently, there is roughly $5 trillion in credit-card lines outstanding in the U.S., and a little more than $800 billion is currently drawn upon. While those numbers look small relative to total mortgage debt of over $10.5 trillion, credit-card debt is revolving and accordingly being paid off and drawn down over and over, creating a critical role in commerce in America.

Just six months ago, I estimated that at least $2 trillion of available credit-card lines would be expunged from the system by the end of 2010. However, today, that estimate now looks optimistic, as available lines were reduced by nearly $500 billion in the fourth quarter of 2008 alone. My revised estimates are that over $2 trillion of credit-card lines will be cut inside of 2009, and $2.7 trillion by the end of 2010.

Inevitably, credit lines will continue to be reduced across the system, but the velocity at which it is already occurring and will continue to occur will result in unintended consequences for consumer confidence, spending and the overall economy. Lenders, regulators and politicians need to show thoughtful leadership now on this issue in order to derail what I believe will be at least a 57% contraction in credit-card lines.

There are several factors that are playing into this swift contraction in credit well beyond the scope of the current credit market disruption. First, the very foundation of credit-card lending over the past 15 years has been misguided. In order to facilitate national expansion and vast pools of consumer loans, lenders became overly reliant on FICO scores that have borne out to be simply unreliable. Further, the bulk of credit lines were extended during a time when unemployment averaged well below 6%. Overly optimistic underwriting standards made more borrowers appear creditworthy. As we return to more realistic underwriting standards, certain borrowers will no longer appear worth the risk, and therefore lines will continue to be pulled from those borrowers.

Second, home price depreciation has been a more reliable determinant of consumer behavior than FICO scores. Hence, lenders have reduced credit lines based upon "zip codes," or where home price depreciation has been most acute. Such a strategy carries the obvious hazard of putting good customers in more vulnerable liquidity positions simply because they live in a higher risk zip code. With this, frequency of default is increased. In other words, as lines are pulled and borrowing capacity is reduced, paying borrowers are pushed into vulnerable financial positions along with nonpaying borrowers, and therefore a greater number of defaults in fact occur.

Third, credit-card lenders are currently playing a game of "hot potato," in which no one wants to be the last one holding an open credit-card line to an individual or business. While a mortgage loan is largely a "monogamous" relationship between borrower and lender, an individual has multiple relationships with credit-card providers. Thus, as lines are cut, risk exposure increases to the remaining lender with the biggest line outstanding.

Here, such a negative spiral strategy necessitates immediate action. Currently five lenders dominate two thirds of the market. These lenders need to work together to protect one another and preserve credit lines to able paying borrowers by setting consortium guidelines on credit. We, as Americans, are all in the same soup here, and desperate times are requiring of radical and cooperative measures.

And fourth, along with many important and necessary mandates regarding fairness to consumers, impending changes to Unfair and Deceptive Acts or Practices (UDAP) regulations risk the very real unintended consequence of cutting off vast amounts of credit to consumers. Specifically, the new UDAP provisions would restrict repricing of risk, which could in turn restrict the availability of credit. If a lender cannot reprice for changing risk on an unsecured loan, the lender simply will not make the loan. This proposal is set to be effective by mid-2010, but talk now is of accelerating its adoption date. Politicians and regulators need to seriously consider what unintended consequences could occur from the implementation of this proposal in current form. Short of the U.S. government becoming a direct credit-card lender, invariably credit will come out of the system.

Over the past 20 years, Americans have also grown to use their credit card as a cash-flow management tool. For example, 90% of credit-card users revolve a balance (i.e., don't pay it off in full) at least once a year, and over 45% of credit-card users revolve every month. Undeniably, consumers look at their unused credit balances as a "what if" reserve. "What if" my kid needs braces? "What if" my dog gets sick? "What if" I lose one of my jobs? This unused credit portion has grown to be relied on as a source of liquidity and a liquidity management tool for many U.S. consumers. In fact, a relatively small portion of U.S. consumers have actually maxed out their credit cards, and most currently have ample room to spare on their unused credit lines. For example, the industry credit line utilization rate (or percentage of total credit lines outstanding drawn upon) was just 17% at the end of 2008. However, this is in the process of changing dramatically.

Without doubt, credit was extended too freely over the past 15 years, and a rationalization of lending is unavoidable. What is avoidable, however, is taking credit away from people who have the ability to pay their bills. If credit is taken away from what otherwise is an able borrower, that borrower's financial position weakens considerably. With two-thirds of the U.S. economy dependent upon consumer spending, we should tread carefully and act collectively.

S&P 500 Going below 600.

Courtesy: http://www.bloomberg.com/apps/news?pid=20601103&sid=a0oeKmwfkr9k&refer=us

March 9 (Bloomberg) -- The Standard & Poor’s 500 Index is likely to drop to 600 or lower this year as the global recession intensifies, said Nouriel Roubini, the New York University professor who predicted the financial crisis.

The benchmark index for U.S. stocks would have to slump 12 percent from last week’s closing level to meet his forecast. Roubini is assuming that companies in the S&P 500 will report profit of $50 a share this year and investors will pay 12 times that for equities.

“My main scenario is that it’s highly likely it goes to 600 or below,” Roubini said today in an interview at the Chicago Board Options Exchange Risk Management Conference in Dana Point, California. A level of “500 is less likely, but there is some possibility you get there.”

The S&P 500 has dropped 25 percent to 676.53 in 2009, its worst start to a year, following a 38 percent decline in 2008 that was the steepest annual retreat since 1937. In response to the U.S. recession that began in December 2007, the Federal Reserve cut its benchmark lending rate to as low as zero and President Barack Obama got congressional approval for a $787 billion economic stimulus plan.

“Even if you do everything right with fiscal and monetary policy, we’re still going to be in a recession through the end of this year and into next year,” Roubini said earlier during his speech at the options-industry conference. “The recession train left the station over a year ago, and it’s going to continue.”

‘Severe’ Risks

Stocks still face “severe” risks and may extend declines amid plunging corporate earnings, an accelerating contraction of the global economy and a dimming outlook for banks, he said. The global economy is likely to shrink for the first time since World War II and trade will decline by the most in 80 years, the World Bank said yesterday.

“This onslaught of worse-than-expected macro news is going to have a negative effect on stock markets,” he said in his speech. “In the next few months many people are going to realize that many financial institutions are insolvent.”

Merrill Lynch & Co.’s chief North American Economist David Rosenberg said today the S&P 500 may bottom out at 600 in October, lowering his estimate after the benchmark’s decline last week. That level is about 20 percent below November’s level of 752.44, which was then widely viewed as the “fundamental low,” Rosenberg said.

Roubini, known as “Dr. Doom” because of his predictions of global financial collapse, also said there was “some positive news” because the Group of Seven industrialized nations has pledged not to let major banks fail.

“Last fall, we were one accident from a financial meltdown,” he said. “That risk of a total sudden meltdown has been reduced by the actions of the G7. They said we’re not going to let any major institute collapse.”

Keep an eye on Baltic Dry.

Tuesday, March 10, 2009
Courtesy: http://marketplace.publicradio.org/display/web/2009/03/10/pm_baltic_dry_index/

In a recession, the world is divided into two types. The worry-warts who obsessively check the value of their 401(k)'s and the optimists who start looking for the bottom. So, let's say you want to be the second type -- a forward-looking person. What do you do?

Well, a lot of people watch the leading indicators. These are 10 indices, put out by the Conference Board, which track variables like the S&P, consumer confidence and new building permits.

Fine. Except the leading indicators don't have a perfect track record. In the past, they've given off lots of false signals. For example, leading indicators often predict a recession when none happens. They falsely predicted five recessions since 1959. Even more problematic, the leading indicators track U.S. performance. Important? Yes, but not totally on the point for a global recession.

So I have something better. I suggest you watch an index that will tell you when the world economies are starting to perk up and when trade conditions are really starting to ease. It's called the Baltic Dry Index.

Essentially the Baltic Dry tracks the average daily price for shipping dry bulk like coal, iron ore, wheat and soybeans. There are three things that make it such a good leading indicator. One, the index looks at raw materials, so it captures activity at the very beginning of the production process. Two, it looks at ocean shipping, so it reveals what's happening to international trade -- the critical driver of global growth. And, three, the shipping business depends heavily on credit, so the Baltic Dry indicates whether credit is tight or loose.

Back in 2005, when the world's economies were just fine and credit was abundant, the Baltic Dry looked like a powerhouse. But it peaked in May of 2008. And it's been heading almost straight down ever since -- losing about 90 percent of its value.

So forget about your 401(k) and start paying attention to the Baltic Dry. And here's the really nice thing about starting now: You missed the six-month, worry-wart part when it tanked in such a nauseating fashion. In fact, one could almost say, the Baltic Dry has nowhere to go but up.

Kai Ryssdal: Susan Lee is an economist living in New York City.

The Baltic Dry Index can be found at
http://www.bloomberg.com/apps/quote?ticker=bdiy&exch=IND&x=15&y=11