Another Wild Week

It has taken me a while to get back into the swing of things this week after vacation. What seems pretty clear is that the government is hell bent on inflating the economy out of the current mess.

The Fed announced yesterday that rates would remain flat but that it was going to buy up a few hundred billion more of treasury bonds. It also announced that it was going to expand the type of collateral that could be used under the TALF program.

What does all the gubalty goop mean? Well here's an article in plain English explaining the former:
http://online.wsj.com/article/SB123749350368087807.html
Essentially the Fed wants to lower interest rates on mortgages, which is working because anecdotely a coworker just refied over the phone at 4.6%. The Fed accomplishes this by going into the market and buying the bonds, whose price and interest rate has an inverse relation. So, as prices rise (because the government is demand/buying so many), interest rates end up dropping.

The latter is somewhat explained here:
http://online.wsj.com/article/SB123748950250187103.html?mod=rss_topics_obama
TALF is what the government has decided to use to get lending going again. Previously, someone like a Carmax had sold a bunch of cars on credit and then sold those loans to an entity that would in turn create a security out of a bunch of pooled loans making an Asset Backed Security (ABS). This was done with all kinds of loans from car to school to home. The creator of the ABS would then sell them on as investments to other people. Part of the reason that most of our fine financial institutions are currently near insolvency is that although they moved a bunch of the ABS on to other people, a lot of the worst/lowest rated (and I use that term loosely) was left on their books - and now its gone bad or looks like it will not be paid down.

So where does this leave us? It is hard to argue that some sort of stimulation to the economy would not be welcome. As you probably know by now, I'm just not in favor of trying to do that by having a Part II of the last six years. (I think there is a lot of really creative stuff that could be done with sustainable energy sources to create jobs and reestablish America's strength in the world economy, but that's another topic.) Inflation is an obvious concern too. At some point rates will have to go up in order to control what is almost unavoidable inflation. This is the primary reason I advise not to lock yourself into any kind of interest rate on an investment product for more than 12 months at a time today. In 18 months rates could be 8% and I wouldn't want you in a 60 month 5% product.

One vehicle to play a rise in rates is the ETF, ticker TBT. It is the inverse of the Lehman Brothers 20+ Year Treasury Index. So, its price goes up when the Lehman Brothers 20+ Year Treasury Index goes down (or interest rates go up b/c remember bond prices move inversely to interest rates). That's a lot of inverses! This is one of the few stock tips I would go on record with friends and family. At some point I guarantee that it is going to go up - a lot! I just don't know when. I bought a little in my IRA in mid December and sold on the above news this week. I will get back into it at some point. Please note, this is one of those leveraged ETF's so it trades at two times the inverse of teh Lehman Brothers 20+ Year Treasury Index.

As for the TALF, I suppose I understand the need to get high grade debt paper circulating in order to lend more money, etc., but I also want to stick to the fact that I think America just needs to deleverage and that the process will be painful. This kind of program to me delays that deleveraging as much as anything. For example, the numbers for a company like Carmax were explained to me like this earlier in the week:
Carmax used to make a loan with a 10% interest rate, their loss rate would be 2%, they would sell the loan off at a 4 percentage point cut to the buyer of the loan and Carmax would end up with 4 percentage points of the interest on the loan, and supposedly this interest income accounted for a large percentage of earnings. (All numbers used are examples only.) This explains why Carmax's stock was crushed last Fall when the ABS markets, or ability to sell on ones' loans completely seized up. The problem is that the above numbers today look more like this:
Carmax makes a loan with 10% interest rate, their loss rate is now 6%, they sell the loan off at a 4 percentage point cut to the buyer and Carmax ends up with no profit on the loan business. Therefore, it kind of makes Carmax (ticker: KMX) of interest on the short side because a huge portion of its earnings will likely not repeat in this environment.

The point is that the TALF is being implemented and will likely be used to securitize loans from places like Carmax, but ultimately these loans are not profitable to the Company, and could be a negative to earnings in an inflationary environment where they have to offer the buyer a higher rate because rates in general are higher. In a sense, in this example, TALF just allows the consumer to buy that car at an artificially low rate and allows the car sellers to move volume. Does anyone see the need for the government to prop up volumes in that and similar markets?

It doesn't really get us on any stronger financial ground as a country in the long run. It just perpetuates business as usual, which I thought we just voted to change.

-2outof4