December 2008 Developments and Scandals
During the past few weeks, Toomre Capital Markets LLC ("TCM") has been busy working on client engagements and hence has had limited time to comment upon important sentiment and capital market developments. Since the start of December 2008, there have been a number of significant developments. Several of these deserve further detailed commentary that hopeful will be forthcoming before the end of the year.
First, the United States Department Labor reported a very sharp decline of some 533,000 jobs for the November period as well as significant adjustments to the prior reports for the September and October periods. In total, some 830,000 more jobs were reported lost over the most recent three-month period for a total of 1,156,000. Ouch! On a percentage basis of the workforce, this is the worst report since the recession period at the start of the Reagan presidency in the 1980s. Other economic reports have subsequently confirmed that economic activity sharply dropped around the time of the Lehman Brothers bankruptcy on September 15th and continued through November.
The sharp drop-off in both business investment and consumer demand since the Lehman Brothers bankruptcy has led many businesses to reevaluate their staffing needs. On Wall Street, there have been a considerable number of "redundancy" decisions leading to layoffs of more than ten percent of staffs. Many speculate that there will be further layoffs after the start of the 2009 if underwriting volumes continue at such non-existent levels. After all, what good is an investment banker if there are no deals to complete or capital to raise? Equally as well, what good are large staffs of salesmen and traders if there is no capital to commit or investors/hedge funds with whom to buy and/or sell?
On Main Street, the relatively sudden and very steep contraction in demand is leading to mass layoffs and even questions about whether the American automobile industry might survive. Clearly, the job losses witnessed in the last few months will continue and the fourth-quarter GDP will be sharply negative. Many macabre discussion wonders whether the 4th quarter GDP decline will be five, six or even eight percent on an annualized basis. Not many are willing to definitively speculate about what the first quarter of 2009 might be.
The Federal Reserve has responded in a very proactive manner to the down-turn in economic activity. The Federal Reserve lowered the effective Fed Funds target to a range of zero to 0.25 percent and announced further expansions in its alphabet soup of various special lending programs. Its decision to start to purchase GNMA, FNMA and FHLM mortgage pass-through securities, Agency debentures and highly-rated ABS backed by consumer debt has started a contraction in credit spreads relative to Treasuries. With many portions of the Treasury yield curve now yielding around two percent or less, the Federal Reserve clearly is encouraging investors to take on more risk premium than simply buying Treasuries and hunkering down in a bunker-like mentality seeking safety and no worries.
In the past month, three significant scandals have become public. In late November, Democratic Illinois Governor Rod Blagojevich was arrested by federal authorities who alleged that he was engaged in a "political corruption crime spree" that included recorded conversations about he might personally profit from the "sale of US Senate seat" to replace President-elect Barack Obama. While many not from Illinois might dismiss such charges as part and parcel of Chicago-area machine politics, the crassness of the conversations disclosed in the criminal complaint suggests that "pay to play" was very much a part of that Governor's mode of operation. No doubt with the Governor's subsequent pledge to "fight, fight, fight" the public will be exposed to more details about this repugnant public official.
The second scandal that recently emerged concerned the fraudulent activities of one Marc S. Dreier, the sole equity partner of a major law firm called Dreier LLP. He was first arrested in Toronto where he apparently was impersonating a lawyer at a Canadian pension fund in an effort to sell fake promissory notes to a unit of Fortress Investment Group. After spending several days in Canadian jail, he was released and then arrested again by American authorities upon his return to the United States where he was charged with defrauding several other hedge funds by selling or attempting to sell fake promissory notes based upon commercial real estate. Subsequently, the scope of his fraud was alleged to have totaled approximately $380 million. Surely more details about this fraud too will emerge in the coming days as this Harvard-educated lawyer languishes in the "comfort" of federal government custody.
The third scandal concerns the fraudulent activities of one Bernie Madoff. This former chairman of NASDAQ apparently ran an "investment" division within his well-known market-making firm. Some investors had invested with him for more than thirty years and were rewarded with steady returns in the range of ten to twelve percent each year. On December 11th, he was arrested after he confessed to his two sons who held senior executive positions in the market-making side of the family firm that the whole investment side of the business was one large Ponzi scheme. By his own admission, Bernie Madoff apparently defrauded investors world-wide of approximately $50 billion. He since has been released to supervised home confinement as various investigators search through his firm and the various fund of hedge funds firms that fed monies to his fraudulent operations. This Madoff scandal is going to continue to be in the news for many weeks to come and Toomre Capital Markets LLC will expand its posts on this scandal shortly.
Combined the dismal economic statistics, the large number of layoffs (that also apparently have continued in December) and the three above scandals have led many investors to pull back even further from making significant investment decisions. Liquidity continues to be quite poor in the capital markets and is likely to remains so through the early months of 2009. There is considerable speculation that the hedge fund redemptions will continue at a high rate as a result of the Madoff scandal as many investors flee the opaqueness of these investment pools and their relatively poor absolute performance during 2008.
There also is considerable uncertainty about what the earnings potential of large companies might be during 2009. The net result is that at least through the first quarter of 2009, Toomre Capital Markets LLC expects business activity to continue to decline and returns from investment activity to be relatively flat if not negative. It appears that few seem willing to make significant investment decisions until the depth and breadth of the economic downturn that accelerated in September 2008 becomes more fully known. Hence, it probably remains a prudent decision to keep one's powder relatively dry and to continue to deleverage wherever possible. In the meantime, the above scandals (and others that are likely to emerge with proverbial receding of the economic tide) will dominate many of the coming news cycles. Reader comments and thoughts are welcome.