A Melman Minute
By: Leonard Melman
July 14, 2008
American patriot Thomas Paine once wrote, "These are
the times that try men's souls." He was referring to the time of the American
Revolution, but his words might be most applicable to the present era,
particularly as matters relate to the entire concepts of banking, sound finance
and government intervention in the marketplace.
What brings this to mind are two stories relating to the devastation - and that
is the correct term - which has been wrought of late on the American financial
structure. As we have documented many times on this site, one major financial
corporation after another has seen their stock suffer through horrendous losses
while the entire home mortgage industry buckles beneath one onslaught of losses
after another.
The first story relates to the largest single bank seizure by regulators in
American history, that of Indy Mac Bank which took place this past Friday. As
can be seen from the two-year chart, the stock has fallen to virtual
worthlessness this morning, with a current price listing of 14 cents! (all
prices US$) This was a stock that sold for fifty dollars just two years ago so,
with one hundred million shares outstanding, it can be readily seen that
shareholders in that once-proud bank have lost five billion dollars in equity
from the shares' recent peak.
One of the most troubling aspects of the seizure is that regulators found many
accounts held by the bank exceeded the government guaranty limit of $100,000 per
depository account, leaving many depositors vulnerable to serious losses on what
were thought to be the most secure of all financial assets, bank depository
accounts.
The problems which brought IndyMac to its knees include loss of capital value on
bank mortgage holdings, rising delinquencies in all manner of loans, reduced
levels of income from business activities and rising cost pressures. All of
these problems continue to afflict many other banks and, as Donald G. Ogilvie,
longtime President of the American Bankers Association told the Wall Street
Journal, "This is a very serious banking crisis. There's just no question about
that."
The other story, which has had a truly dramatic impact around the world, was the
'rescue' by the Federal Reserve Board of the two giant mortgage agencies,
Freddie Mac and Fannie Mae. Both government-originated but privately held
corporations, who together underwrite or guarantee about half the enormous U.S.
mortgage market and are, therefore, considered to be 'too large to fail', have
seen their share prices plunge dramatically.
The rescue plan involves two specific actions. First, the government would
provide direct loans to FNM and FRE to bolster their financial capital
positions. Second, the Fed is even considering entering the securities markets
and directly purchasing shares of the two companies for their own account, a
move that we believe is unprecedented in American history, given the scope of
the assets controlled by the two corporations..
TMR recently ran the chart on Fannie Mae and this morning we include the chart
on Freddie Mac to once again demonstrate the enormous damage done to shareholder
wealth.
As can be seen, the stock of Freddie Mac has dropped from a high near $67 to
under four dollars before recovering slightly on the news of the Fed's plan.
However, we would point out that there have been several bounces in the stock
during the past year, but they have been short-lived and have not altered the
clear downward trend.
There is a troubling aspect of all of this which your editor believes will have
important long-term consequences. For the most part of America's two hundred
twenty year existence, there has been a clear separation between the ownership
of businesses and the world of government. Our concern is that by taking these
two enormous steps, the entire historic balance between (supposedly) free
enterprise and government will be altered dramatically and to the negative. We
also hold to the opinion that as government obligations adopted as part and
parcel of rescue operations dramatically increase, which they are bound to as
other failing corporations seek government help, the basic structure of the
American government's financial strength will deteriorate - and that
deterioration will have its effect on the US currency.
For the moment, some observers and investors believe corporate bailouts
strengthen the American Greenback, but we believe that the opposite is true,
that as government obligations mount, the dollar will weaken and the historic
correlation between a weaker dollar and a rising price for gold is a matter of
record.
Therefore, we continue to hold to our position of maintaining and even adding to
insurance positions in gold and the other precious metals.
Markets in Europe and North America this morning reflected the publicity
surrounding the Fed's actions and were sharply higher with the Dow and TSX both
up over 100 points within the first few minutes of trading. However, optimism
has been tempered somewhat and by 8:00 AM PDT, the Dow had returned to virtually
unchanged. However, in Toronto, the TSX has held onto its early gains, buoyed up
by rising precious metals and petroleum prices as gold has just passed through
$970 spot, silver is above $19.00 per ounce and base metals are close to
unchanged. Crude is slightly higher while the U.S. Dollar is a bit lower.
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