March 12, 2008

Market Comments for March 12, 2008

1) The Fed action yesterday is like a cortisone shot for a sick patient. It gives immediate relief, but doesn't cure the disease. Financial problems won't end until house prices stop going down and eroding bank capital. But the Fed has injected $1 trillion in liquidity since December and by next week will have lowered interest rates 3%. They are pouring a lot of gasoline around hoping that someone will eventually strike a match.

2) Call buying in Sallie Mae increased ten times yesterday. The stock has fallen from $60 to $16 and is now a screaming buy. Unlike Fannie Mae and Freddie Mac you cannot discharge student loan obligations through bankruptcy. They carry a call on your future earnings for your entire life until they are paid off.

3) The CEO of Freddie Mac said that we are in the worst housing crisis in 100 years. He said that we are only 1/3 of the way through the down move in house prices.

4) Commercial real estate transactions declined by 68% in January YOY. But this represents just a backing off of the record $470 billion in total transactions in 2007. The industry is in far better position to enter this recession than in past recessions. Occupancy rates are higher, the quality of properties is better, and lease terms are longer. There is less unused capacity, less overbuilding, far greater institutional participation, and plenty of vulture money from outside the industry waiting on the sidelines to swoop in and buy distressed properties (Warren Buffet, sovereign funds, hedge funds, etc.). One new and worrying problem is the record level of spreads of commercial mortgage backed securities over Treasuries, which will inevitably raise the cost of capital for investors, despite the Fed rate cuts.

5) The media is having a feeding frenzy over Spitzer. The tabloids are offering $1 million to 'Kristen' to come forward for an interview. Papers are scouring East coast model agencies looking for the 5'5' petite brunette.  Who were 'Clients 1-8'? Were they republicans? It wasn't me! Watching the coverage of  Spitzer's motorcade to the resignation speech on TV was reminiscent of the OJ arrest. That's what happens when you live in a glass house and throw rocks. Couldn't happen to a nicer guy.


My suggestion to short the 2-10 year Treasury spread at 260 points last week came in big time today. The spread collapsed to 220 basis points. The profit on the trade would have been 4% in 5 days, or $120,000 on $3 million in capital, which is huge for an almost riskless trade. Normally you have to wait six months to make this kind of profit on a spread trade.

SPX0312.png picture by sbronte