Growth Report : short

Paulson Asset Management, LLC

Ian Wyatt — Wed, 24 Sep 2008 19:43:00 GMT

Paulson Asset Management, LLC

So now the Treasury has a massive $700 billion bailout plan on the table. The idea is to create a government agency to deal with bad mortgage related debt, sort of like how the Resolution Trust Corp. (RTC) dealt with $394 billion in assets of failed banks during the S&L Crisis in the 80s.

You probably recall how regulators would swoop in on troubled banks, close them down and turn their assets over to the RTC, who would then dispose of them, sometimes for pennies on the dollar.

It was like free money for some savvy investors as they were able to buy assets on the cheap from the RTC. Still, many shareholders in failed banks like Silverado and Lincoln never recovered their money.

That’s got me curious as to how Paulson Asset Management, LLC (PAM) will deal with the mortgage-related assets it takes on. Clearly, some of those assets, like the credit default swap derivatives, are essentially worthless and will remain so.

However, there’s certainly a fair amount of mortgage-backed securities that have been written down to near-zero out of necessity, because no one will buy them now, but will probably regain some value in the future.

After all, why else would PIMCO’s Bill Gross say that he’s expecting to be called by PAM (Paulson Asset Management), to help manage the mortgage-backed assets it buys?

Economic Socialism: Puttin It Mildly

My point here is that we’re seeing much more than economic socialism, or the economic communism that Jim Rogers alluded to recently. This is more akin to Valdimir Putin’s hostile takeover of Yukos Oil.

Politics aside, there’s a profit-motive here. Think about it. The Fed and Treasury lent AIG $85 billion. AIG can either pay up (with 11% interest) or the Fed and Treasury get an 80% stake in the company. And from what I understand, AIG has a matter of days to come up with the loot.

At $5 a share, AIG is worth around $13 billion right now. At the start of the year, it was worth around $130 billion. As of June 30, 2008, AIG had $67 billion in tangible assets, down from $95 billion a year earlier.

Obviously, those tangible assets are worth less than $67 billion now. Nobody will buy them.

But what will they be worth a year from now, after most of the bad debt out there has been exposed and investors can make informed decisions about what’s got value and what doesn’t?

That’s OUR $85 Billion

I suspect that PAM’s stake in AIG could be worth a decent sum in a few years. Same goes with whatever assets PAM’s $700 billion buyout fund targets.

It seems to me, since PAM is using taxpayer money to fund its investments, the American people should be considered shareholders. We should share in the spoils.

Now before you think this suggestion is like investing social security in the stock market, there’s a very important distinction here. For instance, PAM can change the rules anytime it wants to. Stock price going down? No problem. Just make it illegal to short.

The more I think about it this idea, the more I like it. And for the record, I have no problem with Bill Gross as the Chief Investment Officer.

What Will Congress Do?

Now I want to be clear about something. I might sound a little flippant with my suggestions here. But this financial mess is very serious. It’s a massive fraud, and the government’s bailout plan doesn’t mention even the slightest slap on the wrist for the offenders or deal with homeowners problems.

Of course, there will be new regulations. There always are. But they never seem to do what they’re intended to do.

As the panic from last week’s market rout eases a little, and Bernanke and Paulson testify before Congress, Congress seems to be taking a harder line on the bailout plan, which is good.

Because, again, I want to know how PAM intends to dispose of billions in impaired assets.

And what’s more, Bernanke apparently wants to buy impaired assets from banks at a premium to current value, and hasn’t really talked about what he’ll do with them. That’s a problem.

If you remember the S&L Crisis, you’ll recall that there was a lot of criticism as to how the RTC disposed of its assets. Much of it was real estate, and in less than desirable markets, as well. Still, many felt that the RTC sold at prices that were way too low to compensate investors for their risk. (The New York Times reported about a resort with an $8 million book value selling for 695K.)

If Bernanke and PAM buy impaired assets at a premium with no realistic plan of how to monetize them, then they’re simply seeking to recapitalize failing banks at taxpayers expense. If so, this PAM shareholder has to vote no.

So what Should We Do?

I’d tell you to call your Congressmen, but they’re busy. Plus, judging by the tone of yesterday’s Q&A following Bernanke and Paulson’s testimony, I’d say they’ve got the message. Taxpayers are not wild about bailing out banks.

Why not expand the powers of the FHA and let Americans with mortgage problems refinance to a lower rate? At least that would address the “real” problem, which is default and foreclosure.

As far as investing goes, my advice hasn’t changed from last week:

“There’s one asset class I like a lot right now. It’s something of a defensive play, mainly due to the high dividend yield. But there’s also a case to be made for some capital appreciation.

It’s MLPs. Master Limited Partnerships. These companies own and operate pipelines for oil and natural gas, mostly in the Southwestern U.S. These companies have pretty stable revenue streams because they sell capacity in advance. MLPs are required to pay 95%+ of their income in dividends to maintain their tax exempt status. And they rely on credit to expand their operations, and hence, revenue.

Many MLPs are currently trading at 52-week lows. I believe this is because their ability to expand has been impaired by the banking liquidity problems. But these companies have stable revenue and they pay dividends of 6-11%. That alone makes them a good place to park your cash until the markets get better.

Plus, as the lending situation improves over the next few months, you could see as much as 30% gains for the stocks as investors anticipate revenue expansion.”

Here’s the link I posted last week to get my favorite MLPs. Most of these stocks have jumped 10+% since lows last Thursday.

Best Regards

Ian Wyatt

Editor

Big Idea Investor

The Hero's Dilemma: Kill the Dragon or Rescue the Princess?

Ian Wyatt — Tue, 05 Aug 2008 20:47:00 GMT

The Hero's Dilemma: Kill the Dragon or Rescue the Princess?

Our previous experiences with "stagflation," as the double economic whammy of slowing growth and rising inflation is known, occurred in the '70s and early '80s.

Market veterans still recount the Legend of Former Fed Chief Paul Volcker as if it were a cautionary tale for children -

"...and then, Volcker held interest rates aloft (to a now unthinkable 20%) and vanquished the foul worm (inflation rates of 13%)."

Volcker made his heroic choice. He fought the dragon first. Once that threat is no more, living happily ever after with the princess is no problem.

But if we understand the true nature of this Hero's Dilemma, we see that stagflation isn't really a double whammy. In the modern era (the only era that matters), stagflation is caused by one thing: high oil prices.

Sure, one could argue that the condition of stagflation is exacerbated by several factors, like a bombed out housing market, a weak U.S. dollar or a financial crisis. But ultimately, it's rising oil prices that both slows economic growth and causes prices to rise.

Volcker really had no choice at all.

Any attempt to invigorate the economy with lower interest rates would only push oil prices higher. In other words, if you rescue the princess first, then the dragon eats you both.

Memo to Bernanke: The Dragon's Breathing Down Your Neck

So another FOMC meeting has come and gone. And as expected, the Fed did nothing to surprise the financial markets. Most of the time, it's good monetary policy to give the market what it wants.

But we're quickly getting to the point where Fed Chief Ben Bernanke has to make a heroic choice. At least, that's how it seemed a week ago, before oil prices dropped 20%.

It would appear that Bernanke is keeping his sword in its sheath, hoping that falling oil prices will render the necessity of choosing between the princess and the dragon moot.

Stocks rallied strongly today in reaction to Bernanke's non-decision. The average investor can usually be counted on for hope. But ultimately, I don't think many investors are comfortable with a Fed relying on luck to take care of the problem.

The meteoric rise of oil prices could have been a bubble. And we could be seeing that bubble deflating right now. But there's one way Bernanke can be sure: raise interest rates, strengthen the dollar and actively force oil prices lower.

That might put the princess through the ringer for another few quarters, but princesses have a way of coming out of tough situations looking pretty good.

For my money, I'd rather see Bernanke deal the dragon a mortal blow.

Time to Live Happily Ever After?

I'd like to think that the oil "bubble" is popping. I'd like to think that the effects from that main driver of inflation will soon be reversed. But I just don't see the current economic problems having a fairy tale ending without a fight.

That's probably why interest rates rose on T-bills after the Fed's statement. Investors might like the news. But the bond market seems to think that higher rates are coming. And that's probably not good news for stocks.

So what's an investor to do? Well, my stock picking machine (which, by the way, is called TRIGR) is still turning up some great stocks to short. In fact, on July 29, one of its Top Shorts was WCI Communities. Yes, that WCI Communities, the one that filed for bankruptcy on August 4.

Actually, TRIGR's been pulling up WCI Communities regularly since May 8. Of course, it also targeted IndyMac on May 12, 2008, and we all know how that turned out.

We also closed two other short positions yesterday - Western Refining (NYSE:WNR) for 17% since July 31 and Accuride (NYSE:ACW) for 16% since July 30.

Today, TRIGR turned up Hansen Medical (Nasdaq:HNSN) as a Top Short. In light of the decent gains TRIGRs pulled up with its Top Long Biotech stocks, the sight of a medical devices company on the Top Short was worth another look.

I'm not sure how Hansen Medical ever commanded a $1 billion market cap on $16 million in revenues. And I suspect it'll have difficulty holding on to its current $300 million market cap without a massive jump in revenue. Judging by the ever-widening loss estimates from the covering analysts, such a jump in revenue isn't forthcoming.

You might want to give this stock a look as a potential short opportunity while Bernanke tries to figure out what to do about that pesky dragon.

Ian Wyatt

Chief Investment Strategist

Growth Report

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