We had a great meeting and ended up discussing topics from all over the place!
It is always refreshing to talk and listen to Tommy Schultz and Andrew Whatley as they throw much insight into the topics being discussed. We had 3 attendees: (from left to right) Andrew Whatley, Tommy Schultz, and VJ Arjan (funny how we all have glasses on).
Andrew’s Citigroup Play
Andrew Whatley has done some research on the very imminent government takeover of Citigroup common shares. The current target price for government entry will occur around $3. The preferred shares are convertible at the price of $2.50, so that it could be feasible to buy up preferred shares just before the government entry, convert, and cash out at a quick 20% profit.
The ramp up of the dreaded Pay Option ARM
We spent a good deal of time discussing the wonder mortgage product that brought down the financial world: the pay option ARM (adjustable rate mortgage). The product was initially designed for self-employed individual who may typically receive large chunks of cash every quarter or so, so that the payment amounts to only a small one that doesn’t even cover the interest for that period. For example, the interest during a month may total $2,000, while the payment is only $1,200. It will be well to remember that this set-up worked well for those who may receive $50,000 quarterly cash sums, not for the average salaried employee. The esteemed collegues at World Savings then thought why not offer this product to the rest of the potential prospects. Many borrowers honestly did not know what kind of loan they were getting into, not being intelligent enough to decipher that they would never be able to pay off such a loan with minimum payments. Below is a comparison of a regular mortgage, and the amortization schedule of the pay option ARM, which amortizes negatively (i.e. Considering the initial example, with only the minimum payment, the $1,200 payment still leaves an $800 balance in interest to be paid. This then is tacked onto the loan, and the loan balance increases.)
Understand also that these types of loans have been written in large bulk by subprime lenders like Countrywide and New Century Financial. The lawsuit against Countrywide was for nearly $8 billion! (Bank of America bought Countrywide for around $4 billion).
The Level Playing-Field
Being myself in the mortgage industry now with Bank of America, and knowing that the average borrower keeps a loan for between 3 to 5 years, I have to ask myself of the ethics of selling loans that do not help the borrower to build any substantial equity at all. This concern really goes back to the question of whether the marketplace is a level playing field or not. Tommy Schultz explained that although the playing-field is level, the players’ abilities are different. Some are smart and understand the system and the rules of the game, and, therefore, win. Others act like eager and distracted dogs who get overwhelmed when a strong emotional desire comes into them. The smart players cannot take responsibility for the weak ones, and, therefore, in the game of life, should win, as it is their right to do so.
The playing-field, itself, is not a natural creation, but instead created by man. The game is that of money and the rules were created by men. The creators of the game knew that by making the rules convoluted and difficult to understand, only the smart and persisting types would win. These individuals are few, indeed, but, therefore, are far more wealthy than the bulk of the other players.
Cut the losses already
President Obama’s attachment to saving the auto companies can be equated to keeping a losing stock play and watching one’s losses run. Instead, the Obama administration must recognize that the manufacturing industries must be outsourced to the manufacturing countries, i.e. China, Korea, Eastern Europe, etc. Those who become unemployed as a result of bankruptcy should be given grants to attend school again and learn a new skill.
There should be decisive support given to future industries that America can specialize in, i.e. stem cell, nanotechnology, and robotics. The greatest asset that America has is its people and the wealth of the knowledge resource in them. By doing so, the Obama administration can focus on letting their profits run.
Never catch a bottom
VJ Arjan was explaining how difficult it is to catch a bottom in a market. He recently invested in GE in his LT portfolio at $14.10 and watched it plummet further to $6. The same occurred with Bank of America which he picked up at $9.69 and subsequently watched plummet to under $3.
Bubble bath
We discussed the inevitability of a bubble in asset classes. In 1926, we had the Florida real estate bubble followed by the stock market bubble crash in 1929. The same occurred recently, a stock market bubble in the late 1990s followed by a real estate bubble in the past decade. In both instances, officials in office deliberately prevented contractionary measures as they themselves had vested interests in the market.
The next bubble seems to be occurring in U.S. Government Treasuries. Baby-boomer investors who have become fearful of the current financial meltdown have taken their assets from the equity markets and fled to the safety of fixed-income government bonds. However, with the Obama administration spending like there is no tomorrow, hyperinflation seems imminent with a subsequent collapse in the U.S. dollar. The biggest losers will be Treasuries as investors rush out of dollar-denominated assets.
The housing crisis
Andrew Whatley believes that the Schiller index indicates a bottoming and stabilizing of home values in the next 6 months. However, there are scores of foreclosures waiting to be processed in the next 5 months or so and there may be more bleeding to go. The result should be, however, a short-term rally while the market indices might well go lower toward the end of the year.
Energy
Of the alternative energy plays, wind and nuclear seem promising. Solar involves a great investment in land and may have great potential in desert regions of the world. Oil inventories may be cut further as OPEC meets on May 18th, raising oil prices.
Commodities
We should expect the price of lean hogs to decline with the scare of the swine flu. Corn should rise as increasing ethanol production takes away feeder corn for livestock and consumer staples.
The next meeting will be on Sunday, June 7th, 2009. For those who have not attended a meeting, but would like to attend, please email your wish to VJ Arjan at vj_arjan@yahoo.com
