Second Major-US Open 2009

Looks like Phil Mickelson will pull a miracle and win the 2009 US Open. This is really an amazing story following the announcement that his wife Amy has breast cancer. Given her health concerns, how could he concentrate on golf with all this going on? It is clear that Phil is a fan favorite at Bethpage Golf Links (Black Course). They must be going wild today. As I write this, he just bogeyed 15th and now is one shot back. I still think he will win it.

As for Tiger Woods, he can point to a four hole stretch on Friday morning where he went from even par to +4. The remainder of the tournament seemed he just couldn't get anything going. He would get to minus territory and then bogey the next hole. His iron play was good but the putting was off line by inches. Tiger finished at even par after the start-stop-start-stop rain delayed tournament. Somehow he was just never in sync.

Lastly, it is nice to see David Duval come back from the "dead". His last tour victory was in 1999. Before this Open, he was the 882nd ranked player. But over the past five days, he has hung in there and now is -2 and will finish in the top 5. A remarkable tournaround for this player. He seems to play better when he has more weight.

State of California-Needs to go on a Budget Diet

Recently, I have taken a closer look at how the State of California spends money. If you ran your household this way, you would be filing for bankruptcy. Take a look at the chart above which shows spending vs. revenues for the State budget years 2000-2001 to 2008-2009:

Notice how spending has increased over 43% since the 2000-2001 budget year? The budget was balanced through the 2005-2006 budget year but spending continued to escalate while revenue growth slowed down. Unfortunately, the State Legislature never considers that the tax payers will go through a tough economic time or those revenues will slow let alone decline. Welcome to the recession of 2008-?

Since tax payers revenues are decling, where can the State of California make real cuts (not phony one like cutting the “rate of spending”)? My source document is the 968 page State of California budget document for budget year 2008-2009. Let’s take a look at programs that can be cut or reduced immediately. It will require hard choices just like any taxpayer would be required to make when their income levels off or is reduced.

1. Heath and Human Services Agency $5,335,000

(We spend this kind of money on an agency that advises the State on health issues?)

2. California Conservation Corps Workforce Development $37,638,000

(Why is the State spending money doing workforce development-scrap the entire program)

3. Department of Conservation-Mineral Resource Development $5,117,000

(The State doesn't need to map mineral resources-Private Industry can do that)

4. Housing &Community Development Block Grants $4,276,000

5. Migrant Services $6,866,000

6. Wildlife Conservation Board $204,000

7. Health Planning & Development (Work Training) $5,059,000

8. California Department of Aging $216,442,000

(What does this department do??)

9. Small Business Loan Guarantee Program $4,886,000

(Would need to see a report on how this department is doing. If this is the Cedley Program, it might make sense)

10. California Science Center $17,934,000

(Users should pay for this in terms of fees)

Total Savings $303,757,000

These are relatively small programs when you are dealing with a $111.8 Billion budget. But there are tons of other programs and worthless commissions that need to be cut. How about the Solid
Waste Advisory Board? These commissions are where they park old politicians who are termed out and pay them $135,000 per year to do nothing.

Now, let’s look at two of the bigger sinkholes in the budget:

1. Aid to illegal aliens Approximate cost of $10-15 Billion per year. This includes teaching illegal alien children in school, funding emergency room visits for the uninsured where the bills are sent to the State and every hospital is straining to get paid for their services.

2. Growth in Government Workers Cost estimates run from $10-30 Billion per year depending on what budget year you want to use.

The number of California State employees has increased from 170,000 to nearly 350,000 over the past 10 budget years! With increases in employees also come increased salaries, health insurance benefits and higher pension obligations that will further bloat spending in the future.

It is well past time for the State bureaucrats to make serious cuts in State employment rolls. An immediate hiring freeze should be instituted and 35,000 to 50,000 workers should be eliminated. We are talking about 10-15% work force reduction. Workers in the private sector are losing their jobs at a record pace and the State of California should be no different. California managers need to review and cut spending and personnel across the board. The benefits:

• Restore the State’s bond rating so the State can borrow at lower rates

• Balance the budget so that recently passed taxes can be eliminated or rolled back

• Cut future budget problems now rather than let them mount up leading to additional tax increases

Since the State of California has no leadership in either house of the Legislature or in the Governor’s office, I doubt it will happen anytime soon. So, we taxpayers need to starve the beast. The first place to start is rejecting Proposition 1-A on May 19, 2009, a ballot initiative that would extend recently passed tax increases for two more years under the guise of putting spending caps on the State budget.

Tiger Woods-The Masters

Watching Tiger Woods in the Masters was amazing and frustrating! You watch him make amazing shots year after year so expectations were very high going into this years Masters golf tournament. It seems as if he starts off slowly each year. Why? I think he isn't playing enough tournaments to stay sharp under tournament conditions. Certainly the 9 month layoff from knee surgery impacted his sharpness but if you go back to the last few Masters tournaments since he won it in 2005 you will see a similar pattern. Slow out of the gates the first two days and then he will catch fire at some point but it is almost too late to matter. Last year, he finished second to Trevor Immelman but three shots off the lead.

Well, 2009 was no different. The first two days, Tiger shot birdies followed by bogies. He missed a lot of putts by an inch or two. He made unforced error after unforced error with his irons and missed a lot of shots he normally makes. He could easily have been minus -5 or -7 heading into the final round. Instead, he was -4. Still a good score but 7 shots off the leaders.

He was pared with Phil Mickelson and they had an amazing battle. This was the tournament within the tournament as the leaders were stumbling while Phil and Tiger were hot. Phil shot 6 birdies in the first nine and at one point was 1 shot off the lead. Tiger was -3 on the front nine and picked up another three shots to get to 10 under by the 16th hole. Could he pull this off?! Alas, he and Phil ran out of gas and Tiger bogeyed the last two holes to finish at -8 (Tied for 6th place). Phil Mickelson plunked a shot into the water on the beautifual 12th hole but did fight back to get back to -10 before surrendering a bogey on #18 to finish at -9.

Tiger Woods is a grinder. He never lets up nor will he go away once he starts a tournament. He just needs to play more tournaments to get out of the gates faster. I look forward to following his progress in the US Open (June), the British Open (July) and the PGA Championship (September). Can he add another Major Title to the 13 he already has? We shall see.

Hollis-Eden Pharmaceuticals-Ego and Mismanagement-Part II

Throughout its many years of corporate existence, there have always been power struggles within management. Richard Hollis co-founded the company with Patrick Prendergast. Soon after the company went public, Prendergast was forced out by Richard Hollis. Prendergast sued the company and eventually the suit was settled with Hollis-Eden getting the rights to early molecules (HE2000 was assigned to Hollis-Eden as part of the settlement) and Prendergast getting stock plus options based on his delivery of other compounds. Terren Peizer, an ex Drexel Burnham Lambert bond broker who some say helped bring down Michael Milken, was President of Hollis-Eden for a brief two year period before being forced out by Richard Hollis in February 1999. Peizer was and is a master at stock promotion and had the Hollis-Eden stock price trading in the $15-19 range as significant money was raised from Robert Peterson (founder of a Car Magazine Empire) to fund early R&D efforts. No one is quite sure what caused the blow up between Richard Hollis and Terren Peizer or what functions Peizer was there to perform while there (other than fund raising and stock promotion) but Peizer, in order to go quietly, did get cheap warrants at attractive pricing with a 10 year holding period.

Daniel Burgess was brought on as Chief Financial Officer in August 1999 after leaving Nanotech Technologies. He eventually became Chief Operating Officer in December 2004. He made a lot of Hollis-Eden’s presentations to the financial community during biotech conferences and was instrumental when the company was out raising funds for future research and development or intellectual property buyouts. Hollis and Burgess led the company on the acquisition of Congressional Pharmaceuticals in February 2004. This acquisition brought in numerous patents filed by Dr. David Gordina and included Phosphonol, a compound that was advertised as Hollis-Eden’s lead candidate to prevent DNA mutation. With Neumune and Phosphonol, the Company seemed to have the right compounds to offer the government to treat people who were exposed to radiation and needed treatment to ward off the effects of neutropenia and cell mutations.

Hollis-Eden raised $62.5 million in September 26, 2003 at a time there was a lot of hope and hype about BioShield and Neumune. In fact, the stock kept reaching new highs during the summer of 2003 as the Hollis and Burgess went out on a road show and reached an all time high of $36.00 on September 23, 2003 only to have the Company’s secondary offering quickly deflate the stock value as the underwriters and their cronies knew about the secondary offering and shorted stock knowing full well that the offering price would be far below what the company’s stock was trading at. The deflation of the stock price was swift and the stock was back trading below $15.00 by November 2003.

The funding was used to fund expensive trials with Neumune leading up to the Company’s application to the Department of Health and Human Services under a Request For Proposal. Hollis-Eden announced on December 21, 2004 that it had filed a formal request with DHHS to have Neumune considered for this award. The Company submitted data on both mice and monkey trails. Since the Company had partnered with a government agency (AFRRI) and was backed in its efforts by the Department of Defense and one of the architects of BioShield Legislation passed in July 2004, things were looking good right? Not so fast my friend. Dealing with the government can lead to a lot of disappointments, especially when money is involved.

In May 2005, Hollis-Eden filed an IND application with the FDA to begin Phase I clinical trials in healthy human volunteers. The company also hired John Clerici of law and lobbying firm, McKenna Long & Aldridge, LLC help secure the DHHS award. In September 2005, DHHS issued a Draft RFP for a therapeutic to treat neutropenia associated with Acute Radiation Syndrome. The company was lobbying to have up to 24 million doses of Neumune stockpiled around the country so that the drug could be delivered and administered within a 6 hour window needed for survival. So what do the geniuses at DHHS do? In December 2005, they say they will stockpile only 100,000 doses of ARS treatments, substantially lower than HEPH management anticipated. The stock price plummeted to around $5.00.

On January 29, 2006, CBS correspondent Ed Bradley took on the topic of Nuclear Terrorism with a 15 minute segment dealing with the potential effects of a nuke going off in a major city and how the government procurement efforts were coming along. He spoke to Richard Hollis and Robert Marsella of Hollis-Eden, a representative from DHHS (Stewart Simonson who headed up this procurement effort declined to be interviewed but Dr. William Raub agreed to be thrown under the bus), US Representative Tom Davis and Vice Chairman of the 9/11 Commision and former congressman Lee Hamilton. Davis and Hamilton were roundly critical of Stew Simonson and his department’s decision making. Raub said that 100,000 doses was the beginning not the full procurement. Even Bradley admits that Hollis-Eden took the unusual step of criticizing the agency that would be handing out the award. At this point, the game was probably over but the Company continued on.

In June 2006, DHHS says that HEPH is in the “competitive range” for further discussion. Two other contenders for the award were thrown out at that time. On September 27, 2006, DHHS announced a delay on the ARS procurement. HEPH stock traded at $5.57. Company management expected the award to come by the end of November 2006 but that date came and went with no announcement. Finally, on February 1, 2007, DHHS set a new revised date of March 7, 2007 (HEPH-$5.46). On March 7, 2007, DHHS abruptly announces that Neumune is “technically unacceptable” with no other explanation. The stock closes at $2.90.

At that point, management was in shock and, in May 2007, Daniel Burgess COO left the company with some other non essential employees. At that time, the stock traded at around $2.50 to $2.90. Richard Hollis and the science team regrouped and decided to never again deal with a government procurement effort and would begin to push its next generation small molecule compounds’ HE3235 (Apoptone-treatment for prostate cancer) and HE 3285 (Triolex-treatment for Type II Diabetes, Rheumatoid Arthritis and Ulcerative Colitis). The company finally started preparing for trials and entered into four Phase I/II trials with these two compounds beginning in February 2008-July 2008 with expected trial conclusions in the March to April 2009 time frames.

The key area where management has gotten in trouble is never having entered into a partnership with a large pharma company. Partnering would do two important things for the Company-validate the science and share financial risk without diluting the shareholders. Richard Hollis’ stubborn determination to “go it alone” has done a disservice to his shareholders. Hollis could have partnered HE2000 for malaria, hepatitis B and AIDS with a larger Pharma. He chose not to in hopes that funding would come from the Government of South Africa, the World Health Organization or the Gates Foundation. He could also have partnered Neumune with a larger better established Pharma partner that was better connected to the process of navigating the FDA. He did not and the Company and the stock price got clobbered. Finally during the Q2 and Q3 2009 conference calls with investors, he admitted that the Company would look to get Phase I/II data on Triolex and Apoptone so they could partner with Big Pharma.

So, let’s fast forward to February 10, 2009, Richard Hollis was scheduled to present at the BIO-CEO Conference in New York City. About the time the presentation was to begin, a conference employee came in and said the conference has been cancelled. No explanation from the Company. Numerous investors call the company’s investor relations staff to find out what is going on. They are told that no information is available. This same explanation goes on for five weeks with no explanation. What could cause the Company CEO to abruptly cancel the meeting? Are they about to announce a partnership with a Pharma who wants the inside track on Triolex? Or is the trial data bad but the shareholders aren’t being told. Finally, in late March, the Board of Directors filed with the SEC indicating that Richard Hollis has been fired for “cause” on March 18, 2009 with no explanation. It isn’t until the 10-K filing on March 31, 2009, that the Company announces the first Triolex trial data doesn’t show an acceptable endpoint although the Board of Directors acknowledge that all that data hasn’t been analyzed yet. No additional data was provided for the Ulcerative Colitis, Rheumatoid Arthritis or Apoptone trials. The stock gets crushed again. So much promise and so many disappointments.

Somehow I doubt that all the drama is over. Who knows, the company has approximately $20 million in the bank as of March 31, 2009 and some key trials ongoing. Will it rise again like the Phoenix or will it continue to fall victim to boardroom power struggles and infighting. The book rights might be more valuable than the stock.

Please note that the writer continues to hold stock in HollisEden Pharmaceuticals.

Hollis Eden Pharmaceuticals-Ego and Mismanagement-Part I

HollisEden Pharmaceuticals, Inc. (Symbol:HEPH) is a sad tale of a once promising biotech company that has been mismanaged and severely weakened by a lack of adherence to fundamental management principles. The company was founded in March 26, 1997 when Hollis-Eden, Inc. was merged into Initial Acquisition Corporation (Reverse Merger into a Public Shell) and changed its name to Hollis-Eden Pharmaceuticals, Inc. The Co-Founders, Richard B. Hollis and Dr. Patrick T. Prendergast, formed the company to commercialize Prendergast’s work on small molecule metabolites branching off from DHEA(Dehydropiadivesterone), a multi functional steroid produced by adrenal glands. Later, it was found that Prendergast didn't even have a doctorate.

Their early work focused primarily on a drug compound named HE2000 subsequently called Immunitin. This compound showed tremendous promise in eliminating malaria parasites from malaria sufferers. In early Phase I/II testing, HE 2000 cleared malaria parasites from 17 out of 21 patients. Testing was done in South Africa and Thailand where patients were plentiful and where malaria was becoming resistant to current therapies. The Company’s scientific team lead by James Frincke found that the drug worked by boosting the patient’s immune system such that it could naturally fight off the parasites. In addition, Immunitin was also tested in rhesus monkeys that were given the Shiv Virus (a close substitute to the AIDS virus) to see if Immunitin could boost the monkeys immune system so they could fight off the advanced AIDS virus. The monkeys did well and survived for up to and past the trial end point of six months. Because the trials were conducted in South Africa, Richard Hollis made many trips down to South Africa and became friendly with Prime Ministers Nelson Mandela and Thabo Mbeki to see if he could get the South African government to sponsor HE 2000 in large scale Phase II/III human trials. The Company also courted the World Health Organization and The Gates Foundation to get funding. After years of working in that country, it became apparent that funding would be difficult due to the fact that the South African government would not guarantee that Hollis-Eden’s patent rights would be protected. HE 2000 was also tested in Singapore for patients fighting Hepatitis B.

Meanwhile, Hollis-Eden scientists were also testing and building up a huge patent library of other metabolites that showed promise for curing other autoimmune diseases. They learned a lot about how the immune system worked in regulating inflammation, which is the leading cause of many common immune diseases such as Diabetes, Rheumatoid Arthritis, Ulcerative Colitis and Crohn’s Disease.

In Mid 2001, the Company was approached by an research agency of the Department of Defense that was seeking to test compounds that might be effective as radioprotectants. When the terrorists attacked the World Trade Towers and the Pentagon on 9/11, this defense agency came to HollisEden within two weeks of the attack to speed things along. HEPH worked with thm on HE2100 (subsequently called Neumune) to see if they would be a suitable compound. In February 2002, the company received research funds from AFRRI (Armed Forces Radiology Research Institute) under a Cooperative Research and Development Agreement (CRADA). AFRRI team members indicated that they had been looking for a suitable radioprotectant for over 40 years and were encouraged by testing with Neumune. From 2001-2005, the Company tested Neumune on over 30 rhesus macaques using AFRRI research dollars and raised more money to continue testing monkeys. Richard Hollis and his management team pushed hard for the government to set up new procurement procedures. Project BioShield was conceived and passed by Congress in July 2004 to streamline government procurement of various drugs that would protect Americans against anthrax, dirty bombs and other terror agents. Hollis-Eden was viewed by many to be the "poster child" for BioShield. Little did any investors know what would ultimately happen.

Disclaimer: It should be noted that the author has held postions in Hollis-Eden since 1997 and currently holds stock in the Company today.

Another Time Bomb-Pension Shortfalls

The stock market's steep decline is a ticking time bomb for state and local governments and universities that have their employees enrolled in defined benefit plans. Think the Federal Government is the only entity with bailout problems? Think Again.

The National Bureau of Economics Research published an article in September 2008 by University of Chicago professors Robert Novy-Marx and Joshua Rauch entitled “The Intergenerational Transfer of Public Pension Promises”. In the article, the authors pointed out that the value of Public Promises is $7.9 Trillion in the next 15 years. Their belief is that there is a 50% chance of underfunding these pensions by $750 Billion and a 25% chance of underfunding these pensions by $1.75 Trillion during this time period. One writer recently commented that this underfunding has grown to over $2.5 Trillion. Where is this money supposed to come from to pay these obligations?

So, let’s look at the State of California as one example of the looming problems. The State Legislature just came through a bruising battle to solve a $40 billion hole in the State budget. Taxes were raised on sales taxes (up 1%), car license fees (100% increases) and gasoline ($.12 per gallon). The cost to taxpayers is estimated to be over $1,200 per family per year. What we didn’t see in this debate was any discussion of projected shortfalls in pension obligations. The State of California has some of the most powerful employee unions in the United States and pension shortfalls will be huge given the recent drop in the market. How many billions will be required to “top off” these pension funds?? It remains a mystery but bears watching to see how it will impact the State’s deficit.

Now there is a second potential impact to each state. Taking a quick look at public universities and potential pension shortfalls in this sector, we expect to see pension shortfalls of several billion dollars for some of the largest university systems which, in turn, are creating funding stresses for Regents and State Legislators. For instance, the University of California system saw its investments drop by about $6 billion as of June 30, 2008. Facing a funding problem, the California Regents agreed to fund an additional $877 million against an estimated $2 Billion short fall. Since the stock market has only gotten worse since June 2008, we can only expect that the University of California pension shortfall will grow larger and will contribute to California’s budget deficit problems. It is safe to say that most other states have the same growing pension funding problem for public employee retirement systems and universities.

Are there any reasonable solutions for this ticking time bombs? It seems as if public pensions will have to be restructured and quickly or face looming bankruptcies in the near future. There are only so many tax dollars that can keep being transferred to unions at the expense of taxpayers that are struggling in a bad economy. Will any of the politicians recognize the problem and begin to make the hard choices needed? I doubt it but we must face it before the citizenry comes unglued.

Health Insurance Part2-Saving $5,000 per year

As a consumer of health care services, it is time to get smarter on what makes up insurance premiums and how you can reduce them. A knowledgeable broker recently told me that 15-20% of our premiums go to cover those who go to emergency rooms either as uninsured patients or just trying to not incur charges on their insurance. We are talking about illegal aliens who go to the emergency rooms for "colds" or other ailments because they are uninsured. Think about this. If your monthly insurance premium is $700, up to $140 goes to the insurance company and the state to cover costs of those who shouldn't be here. This is an outrage.



I have heard recent stories where emergency room doctors are treating people with and without insurance for colds and various ailments because they don't want to see or can't afford to see a regular doctor. Some patients are even taking ambulances as it represents a "free way" to get to the ER. We are paying for this in much higher premiums.



Another area that causes premiums to continue to increase is maternity coverage. My broker told me that premiums run $350-400 per month to cover maternity alone. Make sure that you review your coverage with a knowledgeable broker, especially if you aren't having anymore children. This could save you nearly $5,000 per year.

Health Care Costs are Out of Control

You see it. I see it. Health care costs have spiraled out of control. I just received a new insurance bill for next month, up 33%! Why are our health insurance bills continuing to go up at astronomical rates year after year with no end in sight?

Here are some of the causes:

1) Longer approval times and higher costs to get drugs approved by the Food & Drug Administration. A recent study indicates that the cost to get one drug approved is over 10 years and costs over $ 1 Billion for testing. Drug Companies pass along the costs in terms of higher drug pricing.
2) Health care providers submit inflated bills for routine procedures hoping that the insurance companies won’t knock off most of their billing. I recently saw an imaging center submit a bill for $2,400 to the insurance company for a cat scan that took 5 minutes to perform and was told it would cost $600.00 if I paid cash. The insurance company knocked the bill down to $733.00, 22% higher than the cash price.
3) Administrative costs were up 23% at the top 5 Health Insurance Companies according to some health care industry watchdogs. What are they doing to control their costs?
4) Increasing use of emergency rooms by illegal aliens and the uninsured. These costs are passed along to the State who ultimately approves health insurance premium increases for you and me.

What can be done about this mess?

-California employers can pass along the higher premiums to their employees for only so long before they must leave the state. Either that or they can band together to bring pressure on the insurance companies.

-Self employed individuals and small companies don't have many choices. They can look for health insurance policies that have higher deductibles to keep insurance premiums lower, change to HMO’s such as Kaiser Permanente or set up Health Savings Accounts or Health Reimbursement Accounts.

-We can also support legislation aimed at controlling insurance premiums just like what occurred with auto insurance rates in 2003. A defeated California Assembly Bill 1554 proposed having all health insurance premiums and deductible changes approved by the State Insurance Commission. The bill was defeated in 2007 and 2008 after campaign money was funneled to key assemblymen and senators who blocked its passage. Election pressure is needed to break the insurance-politician connection that continues to hurt consumers.

Has Midas Lost His Touch?

Fitch Ratings announced on March 12, 2009 that they were cutting its top-level AAA credit rating for Berkshire Hathaway, Inc. to AA+ on the so called issuer default rating and cutting its senior unsecured debt to AA. Fitch left the insurance and reinsurance units with AAA ratings but changed its view to a negative outlook. Fitch went on to say"Fitch views this risk as unrelated to Mr. Buffett's age(78), but rather Fitch's belief that Berkshire's record of outstanding long-term investment results and the company's ability to identify and purchase attractive operating companies is tied to Mr. Buffett". Berkshire Hathaway has $37.1 Billion in equity puts tied to four of the world's stock markets. Buffett recently told investors that they have lost $9.5 Billion in value since the markets turned down.

I wonder if Moody's will cut Berkshire Hathaway's rating like they have all the other insurance companies that Berkshire competes with? Given Berkshire's significant holdings of Moodys common stock, I doubt it. They will wait to do that until way down the road or until Midas dies.

SEC Chairman Mary Schapiro Where art Thou?

March 11, 2009-SEC Chairman Mary Schapiro said today that the "uptick rule" may be reinstated. She said that the SEC will "hopefully" propose for public comment next month for the reinstatement of the so-called "uptick rule". Investors have been requesting the reinstatement since the rule was eliminated on June 6, 2007. The uptick rule requires short sellers to sell at a price above a stock's most recent trading price. It would keep short sellers from piling on a stock that is a decline. Schapiro said that "a multitude of investors, both large financial institutions and individuals, have been pushing for the rule to be restored".

Ms. Schapiro appeared before a Congressional panel to request an increase in the SEC budget. She was also asked about "Mark to Market" accounting rule that forces banks to value assets at current prices, as relief for those institutions in the financial crisis. She said "I have a lot of sympathy for" that view adding that "it is not our intention that these assets be written down to zero or to fire-sale prices." The SEC doesn't advocated suspending the rule but is pushing the Financial Accounting Standards Board to come up with new guidance.

Hello Mary...you have the power to suspend Mark to Market Accounting today as you were given that power in September 2008 by Congress. What are you waiting for?? With stocks down over 50% since the uptick rule was eliminated and "Mark to Market" accounting rules were implemented in mid to late 2007, haven't we seen enough evidence that both need to be scrapped for the public good?

If the Obama Administration wants a turnaround on the way Americans are feeling, getting the stock market moving upwards will be a way to restore confidence. With confidence, personal spending will resume.

Moodys Blues

Rating Agencies continue to be at the center of the storm for why the financial markets, especially financial institutions are in their own mini depression. Moodys Corporation has been the chief culprit hitting banks, life insurance companies and monoline insurers with quarterly investment downgrades primarily due to "Mark to Market" problems. When they aren't actually marking down companies, they are "warning" they will be marking down companies after they complete their review of the most recent quarterly numbers. Most banks, life and monoline insurers depend on their ratings to bid on new business. When they are downgraded, they have to increase their reserves for their investment holdings and their ability to write new business declines. Each new quarter brings lower earnings and thus another chance for the Rating Agencies to mark them down once again. This has been going on for about six or seven quarters. These stocks are down 85-95% in value.

Since sophisticated investors can't figure out what these complex derivatives are worth and how long these assets will be held, how can Moodys provide accurate ratings on the company's they are rating? Mark to Market valuation problems continue to overhang this process.

There is another issue that adds an element of uneasiness to ratings process. Warren Buffett's Bershire Hathaway owns a large investment in Moodys (around 48,000,000 shares or 20% of Moodys common stock). There seems to be an inherent conflict of interest here since Berkshire Hathaway has been building up insurance business in the very lines (monoline insurers and life insurers) while Moodys is downgrading Berkshire's competitors to junk status. Berkshire Hathaway can write all the business it wants with a AAA rating while its competitors are being downgraded repeatedly. Could one hand be helping out the other hand? Since master investor Buffett was pushing hard for "Mark to Market" accounting rules back in 2003-2005, was his goal to clean up balance sheets or to drive down competition so he could pick up more assets on the cheap? I think financial reporters should ask Warren Buffett some tough questions about the inherent conflicts of interest he has between his investment in Moodys and his ever expanding insurance business.

Mark to Market Accounting and your investments

The Financial Accounting Standards Board put forth FAS 157 ("Mark to Market Accounting") effective for public entities filing financial statements due on or after November 15, 2007. What did this seemingly innocuous rule do? It changed the way that companies (banks, insurance companies, brokerage companies and other public companies account for assets on their books). FAS 157 created a new definition of Fair Value as follows: "The price that would be received to sell an asset or paid to Transfer a liability in an orderly transaction between market participants at the measurement date". In times of illiquid markets, the price of these assets fall away and are valued at $.10 on the Dollar.

The Dow Jones Industrial Average was 13,110.05 on the day this went into effect. Since that time, investors have seen trillions of dollars of net market value evaporate with capital being raised and institutions such as Lehman Brothers, Merrill Lynch, Wachovia Bank being swept under into either bankruptcy or hastily arranged mergers. The DJIA closed today at 6,624 (March 6, 2009) and it is clear the Obama Administration is struggling to figure out what to do to stem the economic disaster that a declining stock market brings.

Here is something that can be done to stem the capital drain. Congress, in passing the Emergency Economic Stabilization Act of 2008, included a Section 132 which gave the SEC the authority to suspend Mark to Market accounting if they determined that it is in the public interest to do so. After losing 50% of stock market valuation since November 2007, isn't it well past time for the SEC to suspend FAS 157??

The answer is clear enough to me. Suspend FAS 157 and its Mark to Market consequences.

Welcome

I have a lot to say about the current economy and stock market. How did we get to this point in the economy and what solutions are there to get the stock market out of a bear market?

How did we get here??

1) Abusive loan underwriting which was bundled and sold off around the world
2) Hedge funds using short sales to weaken once strong financial institutions
3) The Securities and Exchange Commission was asleep at the wheel in not regulating the Hedge Funds and Naked Short Selling abuses
4) A certain mega billionaire pushing for "Mark to Market" on all assets whether understood or not. Well, he got his wish and billions of asset value have disappeared. And the market value of many of his companies have gone down as well.
5) Ratings agencies like Moody's and Fitch have been marking down banks, insurance companies of all stripes constributing to the market decline. At some point, it becomes self fulfilling.
6) Politicians from both parties throwing money at the problems with no accountability. Does anybody really understand the mess that is AIG? What is happening to those billions in investments and loans?

How do we get out of this mess? It isn't easy and will take some hard "medicine":
1) Like the Brits, eliminate short selling.
2) Suspend "Mark to Market" accounting rules. Nobody really knows how to value the various instruments on the financial statements of banks and insurance companies now anyway.
3) Set up a bad bank to purchase the toxic assets from the banks and insurance companies. It was done before with the Resolution Trust Company in the late 1980's. It wasn't perfect but it did help clean things up.
4) Politicians need to present a positive message about where we are heading. Right now, they are ineffective and clearly don't have a plan. Spending money at record amounts isn't a good plan. It just increases debt at a time when foreign governments don't want to buy US paper.
5) Banks and credit card companies need to be restrained from cutting credit card lines of credit at the worst possible moment.

It takes leadership-someone who has a vision to lay it out-and the backing of the American people to make it happen.