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L. Neil Smith's
Number 510, March 15, 2009

"The Missouri government wants you dead."

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What Changed?
by Jim Davidson
planetaryjim -+at+-

Special to The Libertarian Enterprise

Earlier today, one of my clients phoned me up to let me know exactly what he thinks of my doom and gloom scenario. I guess he misunderstood my recent article "Lessons of 1722" published kindly by The Libertarian Enterprise. You see, the failure of 95% of listed stocks and the 60 year depression which helped to incite the American Revolution, were not gloomy thoughts, to me.

In addition to berating me for "wanting to see people suffer," he also gave a childish reaction to today's bear market rally. Yes, it is Tuesday and the Dow has been up 4%, the NASDAQ by 6%. So, he says, I was wrong. Everything is fine.

When I could get a word in edge wise, I said, "I'm surprised to learn from you that all is well. What changed?"

Since my client didn't have an answer, I expanded on the question.

Has the banking system worked out its toxic assets problem? No. Citigroup announced that it thinks it can play accounting tricks or something to show a profit for the first two months of 2009. Which is a curious announcement, because most companies report quarterly, and a few monthly, but I have not heard of a two-month report before. This report occasioned a rise in their share price by 36% or so, today.

Now, that's impressive for a company that was trading toward the penny stock range last week. What happened, really? CEO Vikram Pandit said, "We are profitable through the first two months of 2009 and are having our best quarter-to-date performance since the third quarter of 2007."

Of course, we cannot verify how profitable. His comments were accompanied by word that in the first two months, the company had revenues of $19 billion, compared to average 2008 quarterly revenues of $21 billion. However, keep in mind that 2008 was not a banner year for the company. Citigroup has had five quarters of losses totaling more than $37.5 billion since it posted a $2.1 billion profit in the third quarter of 2007. So, if this quarter is anything like those other five quarters, Citigroup would lose $7.5 billion on about $21 billion in revenues. If you do the math, you find that two months at $19 billion would be three months at $28.5 billion ($9.5B each). And what is $21 billion plus $7.5 billion? Exactly.

The quarter isn't over, and we don't have a chance to look for accounting gimmicks. In the finance industry, this tactic is called "talking up the stock." It is shrewd, and it seems to have worked in this case. "Profitable" he said, but not "very profitable." If they make two cents profit this quarter, that's profitable. Judging by recent experience, that would be the way to bet.

We also have no idea if Citigroup is charging fees to customers that they know they'll have to repay (customers should always check their bank and credit card statements for errors that favor a bank, the more so when it is a failing bank). Nor has anything been said about how the capital infusion from the government is being accounted for— revenues on $30 billion they got handed from the government probably are helping this picture.

If that's to be expected, how should one play the resulting bad news at the end of the quarter? Take a short position.

What else has changed? Someone in the government argued for going back to the "uptick" rule, which refers to the execution of short positions. In the bad old days, you could only short a stock on an uptick. That sort of capital control generated some enthusiasm from firms that don't want to see anyone benefit from the losses in the market.

Has Fiscal Policy Changed?
Fiscal policy has not changed. The government plans to spend more and more. As well, they plan to raise taxes from those people who still have any wealth to invest. Oddly, this plan has not inspired a lot of confidence.

Regulatory policy has also run in step with fiscal policy. For example, the Securities and Exchange Commission (SEC) is planning to increase dramatically its fee on stock trades. The FDIC is planning to punish banks which have been responsible by raising, across the board, its fees to insure deposits. (Expanding coverage to $250,000 simply expands the extent to which FDIC is unable to meet the obligations of major bank failures, let alone a widespread banking crisis.)

Bill Butler comments, "What is really going is that the Bailout Banks are using the government and its insurance monopoly to help them gain market share by drastically increasing the operating costs of their smaller, better-run and scrappy competitors. You see, in the fall of 2008 as the Wachovias and Washington Mutuals of the banking world were going down and being served, on a federal silver platter, to the Bailout Banks, the free market—individual depositors—were silently and electronically withdrawing their deposits from poorly run and insolvent banks and depositing those funds with smaller, well-run banks."

Has Monetary Policy Changed?
It has not. Raising interest rates is still unattractive. Instead, the policy is to print money or just call it into virtual existence by typing on computer keyboards. The rate at which the government is creating new money out of nothing is illustrated by this chart.

Look closely at 2009, because it is greyed over. But you can clearly see the blue line going vertical. That, my friends, is the start of hyperinflation.

Has TARP Worked?
In other words, has throwing money at AIG made an insolvent insurance company solvent? Has throwing money at GM and making GMAC financing into a bank (now advertising for certificates of deposit, if you really want to throw your money away) made an insolvent auto company solvent? No, and no.

"Eli Broad, a former director and shareholder of AIG who joined other investors last year to hatch a plan to reclaim the insurer from federal ownership, said he has thrown in the towel."

AIG already has $180 billion of taxpayer money. If I were running one of the other insurance industry giants, I'd sue to get rid of AIG which is clearly being give favored treatment in restraint of trade.

Meanwhile, it develops that one of the big foreign banks which received benefits from the AIG bailout may be Bank of Montreal, which now claims to have ended its transactions with AIG.

What's that about? AIG was helping foreign banks subvert banking regulations in their countries, according to a New York Times analysis, by providing "credit default swaps" and other "assets" which proved to be worthless. Part of that scheme was enhanced by favorable ratings that AIG paid ratings agencies to provide.

Their stock price is up 20% today to 42 cents a share. What's changed? Well, last week their stock was 99.66% gone, and today it is 99.59% gone, from the peak trading value in November 2000.

One analyst has said about AIG, "It looks like the situation only has one solution—giving the company more money and forgetting about them till the time comes to give even more."

Needless to say, I don't find that to be any sort of "solution." The correct solution is to encourage AIG to fail, and to take down the big banks that relied on it to create virtual assets on their balance sheets that were provably fraudulent. I would also argue for having the banking gangsters put in prison on charges of fraud until they fully pay their victims compensatory and punitive damages.

General Motors stock is up 12.5% today. I think that's also market whimsy on a bear market rally. GM sold fewer cars in Brazil by about 7% last month, while other major auto makers were selling more. The tax break, which has been motivating sales there, ends in March. Buyers are obviously worried about solvency of the company selling them a new car—will it be around for the warranty work?

Company insiders are not buying GM stock, which is a sure sign things aren't going well. The last minimal purchase by a GM insider shows in September of 2008, and is minuscule compared to buying and selling in March 2008.

What about Dow component General Electric, one of those big defense contractor companies that, like Westinghouse, also owns a lot of mainstream media companies. GE owns MSNBC, CNBC, and the other NBC networks. Well, their stock price peaked on 11 September 2000 at $60.06 and today trades at $8.87—up about 20% on the session. Their stock is off about 85% from its peak.

Now, the government had the FDIC back a bunch of GE bonds recently issued. And they are clearly a very well connected company, politically. But, so are GM, AIG, and Citigroup.

I really don't see anything has changed. There's a lot of reason to expect a bear market rally. Prices get low. People buy in for poor reasons. Market enthusiasm changes a bit.

But the fundamental reasons why I am not invested in American stocks, and not invested in dollars, remain. The market is reacting to its own reactions, and to talking statements about how things aren't as crappy as they once looked to be about now.

That's no reason to buy into this rally. If the market has turned around, and I'm completely mistaken, there's going to be plenty of upside to a long term bull market. So, wait a few weeks. I think you'll see more bad news arrives, more of the unsound practices that have failed so far continue to fail. I think you'll see this rally is very short lived, and, if anything, presents an opportunity to get out of positions you regret holding to this point.

And, yes, when I see banking gangsters like Citigroup and JP Morgan Chase and defense contractors like GM and GE closing down shop and failing and turning into blots on the market, I feel that there is a just God who prevails in the universe. Sic semper tyrannis.

Jim Davidson is an author and entrepreneur. He recently started a new company with author J. Neil Schulman, Alongside Night Publications, to promote Neil's book and screenplay.


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