Blogs Update - 1

Linda Stern, a freelance writer laments about the confusing world of financial blogs in her Reuters article, “Financial blogs multiply” and then goes on to provide a list of her OWN financial blogs.

http://seekingalpha.com/.
The mother of all investment blogs with links to everything stock market, venture capital and economics.

http://pfblog.com/.
A big, busy blog by a 29-year-old seeking to retire at age 40 with at least $1 million. It's full of personal finance and investing tips, well organized, with links to many, many other money blogs.

http://www.soundmoneytips.com/2005/04/the_personal_fi.html.
This is a list of most financial blogs. It's also a money tips blog of its own, that appears to have a writer AND an editor. Consequently, it's shorter, snappier, and smarter than a lot of the competition.

http://www.fivecentnickel.com/. Short and sweet and focused on family finances. Newish, so there's not too much there yet.

http://allthingsfinancial.blogspot.com/. A fee-only financial planner's musings on stocks, savings, inspirational books and more.

http://frugalforlife.blogspot.com/. Where the self-proclaimed cheapskates chill. Lots of links and content for folks who are convinced they can save as much through smart household management as they can make in the stock market -- especially these days.

Commentary - The Beginning of the End of General Motor (GM)?

This chart (click here) shows that the 5-year credit default swap (CDS) spread of GM has jumped from 280 basis points over treasuries on March 15 to over 700 basis points today. A CDS is essentially a bond insurance and spread is the premium. The usual buyers of CDS are hedge funds because that's what they do for living. When hedge funds buy GM's CDS from GM's bondholders (banks, mutual funds, insurance companies etc.), they are paid premium. In return, hedge funds bear the credit risks embedded in those bonds. This week's blowup in GM's CDS shows that hedge funds are demanding higher premium to offset higher risks of bond default. Is such high premium really warranted? Is GM really going broke? That depends on whom you ask.

GM is NOT going broke if you ask Wall Street equity analysts. Their recommendations have improved since last month. In fact, GM's rating is higher than the average rating for the industry or even the average rating for the broader market. GM is also good investment according to the octogerian, Armenian-American, owner of MGM Grand in Las Vegas, swashbuckling investor named Kirk Kerkorian. He dropped a bomshell on May 4 when he made a tender offer for 4%-5% of GM's share at $31 per share. GM's share promptly rose from $25 to $30.

GM is going broke if you ask the S&P. Why else would they downgrade GM’s bond to junk on May 5. On that fateful day, S&P lowered its long- and short-term corporate credit ratings on GM and its finance affiliate, General Motors Acceptance Corp (GMAC) to BB/B-1 from BBB-/A-3; a rating below BBB is considered junk. In addition to the two-notch downgrade, S&P maintained a negative outlook on GM and GMAC.

Does S&P know something Wall Street analysts and Kerkorian don't? May be, may be not. GM's problems are all very well known. The only debate between the optimists and the pessimists is whether GM will be successful in working around those problems. GM's problems are (1) its huge legacy obligations. GM provides healthcare to 1.1 million people, second only to the U.S. government. It spends $5.5 billion a year on medical costs and has an additional $57 billion unfunded obligations [FASB does not require healthcare obligation to be funded]. GM's pension obligation stands at a whopping $87 billion. The company has had to pump money into its pension fund to shore it up - in 2003 it dumped $18.5 billion to close a $19.6 billion deficit. (2) GM is losing customers to the Japanese and the Korean competitors. GM's North American marketshare has gone down from +45% in the early 1980s to +35% in the early 1990s to <25% most recently (see the chart). (3) A huge amount of its debt are coming to maturity soon (see the chart). (4) High oil price is hurting its most lucrative segment, the SUVs. (5) GMAC, the only business making money for GM is going to be hurt by the flattening yield curve.

I am not an expert on GM but my intuition says that GM is more likely to declare bankruptcy than not. My reasons (1) GM is not a car company but a finance company. Its $31 stock price is entirely made up of GMAC. GMAC is valued around $30-$35, which means the market has assigned a negative value to its automotive division. A finance company's life-blood is its ability to cheaply refinance its debt. GMAC won't be able to do so with junk ranting. Moreover, no finance company has survived with a junk rating. (2) GM will find it lucrative to take the UAL's route, which is to declare bankruptcy, dump its pension obligations to Pension Benefit Guaranty Corp (PBGC), exit the bankruptcy with a clean slate and compete like crazy. (3) Unlike the Reagan administration in the early 1980s, which bailed out Chrysler, the current Bush administration is unlikely to come to GM’s rescue.

Given GM’s owes, it is probably the time for Michael Moore to make a sequel to his 1989 documentary on the GM-town and also his hometown, Flint Michigan, “Roger and Me” and name it “Toyota, Kia & the End of GM”.

Commentary - Stagflation

Stagflation is becoming a vogue in business journalism. Just try googling the term and see for yourself. I wonder why, and why at this particular juncture? Perhaps business journalists are just plain tired of reporting sensational, soap-operatic business scandals like Enron, Arthur Anderson, Worldcom, Nigerian barge, SPEs, off-balance sheet items, Jack Grubman, Henry Bloget, mutual fund timing, after-hours trading, AIG, finite-insurance product etc. etc. etc. Perhaps they want to be taken seriously by the public. What is a better way for journalists to elevated themselves than to jibe about the economy and duel with Chairman Greenspan at his own game? No less authority than the Economists has delved into that debate. For serious followers of the economy, the Economist's conclusions were not very surprising. It argued that a return to classic stagflation is unlikely because productivity growth is going to continue and wage growth is going to remain mute which will produce robust growth with no inflation.

The Economists is right in that there are two components to stagflation, a prolonged period of "below potential economic growth and above trend inflation". Duh! That is the definition! The classic example obviously is the U.S. experience during the 1970s. There is a whole literature on that subject but the basic conclusions (I think) for the stagflation in the 1970s were a combination of bad economic policies and demand shock. Economic policy in the early 1970s had to deal with the immense imbalances created in the 1960s by the Vietnam War and the Great Society Program vis-à-vis rising inflation, declining economic growth, and foreigners holding tons of gold which they could repatriate to the U.S. at $35 an ounce exasperating inflationary pressure. President Nixon decided to deal with them all - inflation, economic slowdown, and foreign imbalances -
at once in the summer of 1971 by ordering wage and price freeze and closing the "gold window" effectively taking the U.S. out of the gold standard. Meanwhile, the Fed under Arthur Burns kept the monetary policy loose. Some conspiracy theorists suggest that Nixon and Burns had a deal prior to the 1972 election but there is no veracity to that. Such drastic fiscal and monetary policies achieved the economic goals but did not solve the underlying problem; rather they only postponed them until the oil price shock couple of years later. Oil prices jumped from $4.3/barrel in December 1973 to $10.1/barrel in January 1974 because the OPEC countries placed embargo on the U.S. and other western countries that supported Israel during the Yom Kippur War (6 October 1973 -23 October 1973). The oil price shock pushed up inflation and lowered economic growth. The Fed's tightened monetary policy to curtail inflation but inflation only budged a little but the economy went into a tail-spin. The Fed made a U-turn in policy within a year to reverse the economic decline. Economy did pickup but inflation picked up even more. The Fed fell "behind the curve" and spent the entire late 1970s trying reverse the policy mistake that created the inflationary pressure.

The Economist article argues that the current situation does not warrant a comparison to the 1970s. I beg to differ somewhat because I see many ominous similarities. The fiscal policy today is a mess. Irresponsible tax cuts and uncontrolled spending has worsened the structural imbalance in the federal budget when the administration should have been doing the opposite given the demographic onslaught that is certain to occur starting 2011. Monetary policy is not that great either despite legions of Greenspan’s fans in the financial markets because it is excessively loose for this time in the cycle. The Fed is pumping so money so fast into the system that the U.S. real estate speculators, emerging market investors, and junk bonds purveyors don' t know what to do with all the money other than to pump up the prices. Normally, too much dollar in the market should have caused it to depreciate. Well it has but not as much as it should because Asian countries are hoarding them in the form of U.S. securities. China alone bought $16 billion worth of U.S. stock and bonds in February 2005.

The only dissimilarity with the 1970s is that inflation remains contained. Fed is taking comfort in the fact that inflation expectation is anchored around 3.0%. But the Fed better not be complacent because inflation is already creeping up. The core inflation is exhibiting momentum not seen in several years. Moreover consumers could readjust their inflation expectation fairly quickly. Of course the Fed has said it is vigilant about inflation in its most recent FOMC statement. But the Fed’s view on inflation is influenced by, like the Economist magazine, its strong belief in continuing growth in productivity. That explains the Fed’s slowness in normalizing the rates. The Fed knows that productivity growth is decelerating but it thinks that it is a cyclical phenomenon and not the beginning of a sustained decline. We hope the Fed is right.