Cisco Systems [CSCO: 23.46, -0.22 (-0.93%)] Recent Price $17.04 Value Range 21.86 – $38.41
Cisco Systems, Inc. designs, manufactures and sells Internet protocol (IP)-based networking and other products related to the communications and information technology (IT) industry, and provides services associated with these products and their use. The Company provides a line of products for transporting data, voice, and video within buildings, across campuses, and around the world. Its products are designed to transform how people connect, communicate and collaborate. Cisco Systems, Inc.’s products, which include primarily routers, switches, and products that the Company refers to as its technologies, are installed at enterprises, public institutions, telecommunications companies, commercial businesses and personal residences. In November 2008, the Company acquired Jabber Inc. In January 2009, the Company acquired Richards-Zeta Building Intelligence, Inc

CSG Systems International [CSGS: 16.83, 0.00 (0.00%)] Recent Price $15.47 Value Range $21.39 – $28

CSG Systems International, Inc. (CSG) is a provider of outsourced solutions that facilitate customer interaction management on the behalf of its clients, generating approximately 95% of its revenues during the year ended December 31, 2007, from the North American cable and Direct Broadcast satellite (DBS) communications markets. The Company’s solutions also support a number of other industries, such as financial services, utilities, telecommunications, and home security. CSG’s solutions manage customer interactions, such as set-up and activation of customer accounts, sales support and marketing, order processing, invoice calculation (customer billing), production and mailing of monthly customer invoices, management reporting, electronic presentment and payment of invoices, automated and interactive messaging, and deployment and management of the client’s field technicians to the customer’s home. In May 2008, CSG completed the acquisition of DataProse, Inc.

Forest Laboratories [FRX: 29.57, +0.46 (+1.58%)] Recent Price$26.21 Value Range$51.57 – $64.09

Forest Laboratories, Inc. and its subsidiaries develop, manufacture and sell both branded and generic forms of ethical drug products, which require a physician’s prescription, as well as non-prescription pharmaceutical products sold over the counter. The Company’s products in the United States consist of branded ethical drug specialties marketed directly or detailed to physicians by its sales forces, Forest Pharmaceuticals, Forest Therapeutics, Forest Healthcare, Forest Ethicare and Forest Specialty Sales. Forest Laboratories, Inc.’s products include Lexapro, the Company’s selective serotonin reuptake inhibitor (SSRI) for the treatment of major depression and generalized anxiety disorder (GAD); Namenda, its N-methyl-D-aspartate (NMDA) antagonist for the treatment of moderate to severe Alzheimer’s disease; Bystolic, its novel beta-blocker for the treatment of hypertension, and Campral, for the maintenance of alcohol abstinence.

Robert Half International [RHI: 23.23, -0.11 (-0.47%)] Recent Price $18.22 Value Range $26.27 – $30.14

Robert Half International Inc. provides specialized staffing and risk consulting services through such divisions as Accountemps, Robert Half Finance & Accounting, OfficeTeam, Robert Half Technology, Robert Half Management Resources, Robert Half Legal, The Creative Group and Protiviti. The Company, through its Accountemps, Robert Half Finance & Accounting, and Robert Half Management Resources divisions, is a specialized provider of temporary, full-time project professionals in the fields of accounting and finance. OfficeTeam specializes in skilled temporary administrative support personnel. Robert Half Technology provides information technology professionals. Robert Half Legal provides temporary, project and full-time staffing of attorneys and specialized support personnel within law firms and corporate legal departments. The Creative Group provides project staffing in the advertising, marketing, and Web design fields

Advance Auto Parts [AAP: 39.74, -0.38 (-0.95%)] Recent Price 33.63 Value Range 10.02 – 12.07

Advance Auto Parts, Inc. (Advance) operates within the United States automotive aftermarket industry, which includes replacement parts (excluding tires), accessories, maintenance items, batteries and automotive chemicals for cars and light trucks (pickup trucks, vans, minivans and sport utility vehicles). The Company is a specialty retailer of automotive parts, accessories and maintenance items to do-it-yourself (DIY) and do-it-for-me (DIFM) customers in the United States, based on store count and sales. Advance operates in two business segments: Advance Auto Parts (AAP) and Autopart International (AI). The AAP segment consists of its store operations within the United States, Puerto Rico and the Virgin Islands, which operates under the trade names Advance Auto Parts, Advance Discount Auto Parts and Western Auto. The AI segment consists solely of the operations of Autopart International, which operates as an independent, wholly owned subsidiary.

American Eagle Outfitters [AEO: 14.62, -0.22 (-1.48%)] Recent Price 9.64 Value Range 0.63 – $0.75

American Eagle Outfitters, Inc. is a retailer that operates under the American Eagle Outfitters, aerie by American Eagle and MARTIN + OSA brands. The Company designs, markets and sells its own brand of clothing targeting 15 to 25 year-olds. American Eagle also operates ae.com, which offers additional sizes, colors and styles of AE merchandise and ships to 41 countries worldwide. AE’s original collection includes standards, such as jeans and graphic Ts, as well as essentials like accessories, outerwear, footwear, basics and swimwear under its American Eagle Outfitters, American Eagle and AE brand names. The aerie collection is available in aerie stores, predominantly all American Eagle stores and at aerie.com. The collection includes bras, undies, camis, hoodies, robes, boxers, sweats, leggings, fitness apparel and personal care for the AE girl. MARTIN + OSA is a concept targeting 28 to 40 year-old women and men, which offers refined casual clothing and accessories.

Bed Bath & Beyond [BBBY: 37.24, +0.13 (+0.35%)] Recent Price$24.00 Value Range $ 8.03 – $9.73

Bed Bath & Beyond Inc. and subsidiaries is a chain of retail stores, operating under the names Bed Bath & Beyond (BBB), Christmas Tree Shops (CTS), Harmon and Harmon Face Values (Harmon) and buybuy BABY. The Company sells a range of merchandise principally, including domestics merchandise and home furnishings as well as food, giftware, health and beauty care items and infant and toddler merchandise. In March 2007, the Company acquired buybuy BABY. In May 2008, the Company announced the formation of a joint venture with Home & More, S.A. de C.V., a privately held home products retailer operating in Mexico

Brown-Forman Corporations [[BF-B]] Recent Price $48.18 Value Range $8.17 – $10.28

Brown-Forman Corporation manufactures, bottles, imports, exports and markets a variety of alcoholic beverage brands. Its principal beverage brands are Jack Daniel’s Tennessee Whiskey, Southern Comfort, Finlandia Vodka, Herradura Tequila, Gentleman Jack, Jekel Vineyards Wines, Jack Daniel’s Single Barrel, Jack Daniel’s Ready-to-Drinks, Bel Arbor Wines, Bolla Wines, Bonterra Vineyards Wines, Old Forester Bourbon, Canadian Mist Blended Canadian Whisky, Pepe Lopez Tequilas, Chambord Liqueur, Sanctuary Wines, Don Eduardo Tequila, Sonoma-Cutrer Wines, Early Times Kentucky Whisky, Tuaca Liqueur, el Jimador Tequila, Stellar Gin, Five Rivers Wines and Woodford Reserve Bourbon. The Company’s core brand in its portfolio is Jack Daniel’s, which is a spirits brand and American whiskey brand. Its other brands are Southern Comfort and Canadian Mist. Its largest wine brands are Fetzer, Korbel and Bollab.

CLARCOR [CLC: 32.69, +0.37 (+1.14%)] Recent Price $32.82 Value Range $12.18 -$17.86

CLARCOR Inc. conducts business in three segments: Engine/Mobile Filtration, Industrial/Environmental Filtration and Packaging. The Company’s Engine/Mobile Filtration Segment sells filtration products used on engines and in mobile equipment applications, including trucks, automobiles, buses and locomotives, and marine, construction, industrial, mining and agricultural equipment.. The Company’s Industrial/Environmental Filtration Segment centers on the manufacturing and marketing of filtration products used in industrial and commercial processes and in buildings, and infrastructures of various types. The Company’s consumer and industrial packaging products business is conducted, through a wholly-owned subsidiary, J.L. Clark, Inc. (J.L. Clark). In May 2008, the Company acquired a 30% share in BioProcess H2O LLC (BPT), a Rhode Island-based manufacturer of industrial waste water and water reuse filtration systems. The Company acquired 100% of the Keddeg Company on December 29, 2008

Cree [CREE: 46.77, +0.05 (+0.11%)] Recent Price $21.84 Value Range $4.51 – $6.20

Cree, Inc. develops and manufactures semiconductor materials and devices based on silicon carbide (SiC), gallium nitride (GaN) and related compounds. The Company focuses its expertise in SiC and GaN on light emitting diodes (LEDs), which consist of LED chips, LED components and LED lighting solutions. It also develops power and radio frequency (RF) products, including power switching and RF devices. The majority of Cree, Inc. products are manufactured at its main production facility in Durham, North Carolina, in a six-part process, which includes SiC crystal growth, wafering, polishing, epitaxial deposition, fabrication and testing Additionally, it packages certain LED components and power and RF products at its North Carolina facilities, its facility in Huizhou, China and in other foreign countries through the use of subcontractors. It also operates research and development facilities in Goleta, California and Hong Kong. In February 2008, it acquired LED Lighting Fixtures, Inc.

Edwards Lifesciences [EW: 81.25, +0.12 (+0.15%)] Recent Price $61.10 Value Range $16.74 – $21.24

Edwards Lifesciences Corporation (Edwards Lifesciences) is a global player in products and technologies designed to treat cardiovascular disease. The Company focuses on specific cardiovascular opportunities, including heart valve disease, critical care technologies and peripheral vascular disease. The products and technologies provided by Edwards Lifesciences to treat cardiovascular disease are categorized into five areas: Heart Valve Therapy; Critical Care; Cardiac Surgery Systems; Vascular, and through 2007, Other Distributed Products

Interactive Data Corp [IDC: 26.00, -0.29 (-1.10%)] Recent Price$24.42 Value Range $4.90 – $6.34

Interactive Data Corporation is a global provider of financial market data, analytics and related services to financial institutions, active traders and individual investors. The Company’s customers use its offerings to support their portfolio management and valuation, research and analysis, trading, sales and marketing, and client service activities. It markets and sells its services either by direct subscriptions or through third-party business alliances. Its offerings are developed and delivered to customers through four businesses that consist of its two operating segments: Institutional Services and Active Trader Services. In May 2007, the Company completed the acquisition of the assets comprising the market data division of Xcitek LLC, as well as the market data assets of its affiliate Xcitax LLC. In August 2008, announced the closing of its acquisition of Kler’s Financial Data Service S.r.l. In December 2008, the Company acquired a 79% interest in NTT DATA Financial Corporation

ITT Educational Services [ESI: 92.29, +2.04 (+2.26%)] Recent Price $128.87 Value Range$23.33 – $33.99

ITT Educational Services, Inc. (ITT/ESI) is a provider of postsecondary degree programs in the United States based on revenue and student enrollment. As of December 31, 2007, the Company offered diploma, associate, bachelor and master degree programs to approximately 53,000 students. All of its institutes are authorized by the applicable education authorities of the states, in which they operate and recruit, and are accredited by an accrediting commission recognized by the United States Department of Education (ED). All of its programs were degree programs, except for a few diploma programs offered at six institutes that are being converted to degree programs. As of December 31, 2007, it offered 29 degree programs in various fields schools of study: information technology (IT); electronics technology; drafting and design; business; criminal justice, and health sciences. In October 2008, the Company announced that it has opened its first ITT Technical Institute in Mississippi.

Makita Corporation [MKTAY: 33.38, +0.75 (+2.30%)] Recent Price $22.81 Value Range $1.71 – $2.00

Makita Corporation (Makita), incorporated on December 10, 1938, is principally engaged in manufacturing and sale of a range of power tools for professional users worldwide. Makita’s power tools consist of drills, grinders and sanders and portable woodworking tools, primarily saws and planers. The Company also produces gardening and household products and provides parts, repairs and accessories. During the fiscal year ended March 31, 2008 (fiscal 2008), approximately 85% of Makita’s sales were outside of Japan. The Company specializes in power tools manufacturing and sales, as a single line of business, and conducts its business globally. As of March 31, 2008, Makita had over 100 service depots outside of Japan. As of fiscal 2008, 28 of these service depots were located in the United States, and 19 of these service depots were located in China.

NIKE Incorporated [NKE: 63.92, +0.36 (+0.57%)] Recent Price $48.68 Value Range $15.83 – $21.46

NIKE, Inc. (NIKE) is engaged in the design, development and worldwide marketing of footwear, apparel, equipment, and accessory products. NIKE sells athletic footwear and athletic apparel. It sells its products to retail accounts, through NIKE-owned retail, including stores and Internet sales, and through a mix of independent distributors and licensees, in over 180 countries around the world. Its products include running, training, basketball, soccer, sport-inspired urban shoes, and childrens shoes. It also markets shoes designed for aquatic activities, baseball, bicycling, cheerleading, football, golf, lacrosse, outdoor activities, skateboarding, tennis, volleyball, walking, wrestling, and other athletic and recreational uses. On March 3, 2008, the Company acquired Umbro Ltd. (Umbro). On April 17, 2008, it completed the sale of its Bauer Hockey subsidiary.

Paychex [PAYX: 31.05, +0.10 (+0.32%)] Recent Price $26.93 Value Range$4.55 – $6.26

Paychex, Inc. (Paychex) is a provider of payroll and integrated human resource and employee benefits outsourcing solutions for small to medium-sized businesses in the United States. The Company’s Payroll and Human Resource Services product lines offer a portfolio of products and services that help clients to meet their payroll and human resource needs. Its Payroll services are provided through either its Core Payroll or Major Market Services, and include payroll processing, payroll tax administration services, employee payment services, and other payroll-related services, including regulatory compliance. Paychex’s Human Resource Services primarily include human resource outsourcing services, which include Paychex Premier Human Resources and its Professional Employer Organization; retirement services administration; workers’ compensation insurance services; health and benefits services; time and attendance solutions, and other human resource services and products.

Raytheon [RTN: 50.59, +0.76 (+1.53%)] Recent Price $47.80 Value Range 12.68 – $19.58

Raytheon Company designs, develops, manufactures, integrates, supports and provides a range of technologically advanced products, services and solutions for governmental customers in the United States and worldwide. The Company operates through six business segments: Integrated Defense Systems (IDS), Intelligence and Information Systems (IIS), Missile Systems (MS), Network Centric Systems (NCS), Space and Airborne Systems (SAS) and Technical Services (TS). During the year ended December 31, 2007, the Company completed the sale of Raytheon Aircraft Company (Raytheon Aircraft) and Flight Options LLC (Flight Options), two former operating commercial aviation businesses. In October 2007, the Company acquired Oakley Networks, Inc., a privately held technology company based in Salt Lake City, Utah, which provides cyber security and data leakage prevention systems. In April 2008, the Company acquired SI Government Solutions. In July 2008, the Company acquired Telemus Solutions, Inc

Rockwell Collins [COL: 53.08, +0.74 (+1.41%)] Recent Price $38.90 Value Range $12.94 – $15.93

Rockwell Collins, Inc. (Rockwell Collins) is a player in providing design, production and support of communications and aviation electronics for military and commercial customers worldwide. The Company’s products and systems are primarily focused on aviation applications. Its Government Systems business also offers products and systems for ground and shipboard applications. Rockwell Collins also provides a range of services and support to its customers through its network of service centers worldwide, including equipment repair and overhaul, service parts, field service engineering, training, technical information services and aftermarket used equipment sales. Rockwell Collins operates in multiple countries. Rockwell Collins serves its worldwide customer base through its Commercial Systems and Government Systems business segments. On November 24, 2008, Rockwell Collins acquired SEOS Group Limited. In April 2008, the Company completed the acquisition of Athena Technologies, Inc.

Strayer Education [STRA: 190.00, -2.08 (-1.08%)] Recent Price $222.04 Value Range $15.89 – $23.60

Strayer Education, Inc. is a post-secondary education services corporation. The Company offers academic programs through its wholly owned subsidiary, Strayer University, Inc., both in traditional classroom courses and through Strayer University Online. The Strayer University is an institution of higher learning that offers undergraduate and graduate degree programs in business administration, accounting, information technology, education, and public administration at 47 campuses in Alabama, Delaware, Florida, Georgia, Kentucky, Maryland, New Jersey, North Carolina, Pennsylvania, South Carolina, Tennessee, Virginia, Washington, D.C., via the Internet through Strayer University Online, providing its working adult students a program offering over the Internet. It also owns Education Loan Processing, Inc. (ELP), which was organized to administer the Company’s student loan portfolio. As of December 31, 2007, the Company had more than 32,087 students enrolled in its programs.

- Ronald Sommer

Disclosure: This article was taken from the website Measured Approach with the permission of the original author.  Please refer to the original author for disclosure information. We hold a position in FRX.

Now, we are seeing the other side of the bailout business. In the AIG [AIG: 35.10, -0.56 (-1.57%)] case executives and others were angry because the government interfered with bonuses and other executive decisions. And, we have the government putting lids on executive pay. And, we have government wanting to rewrite mortgages, and cap interest rates on credit card debt, and so on and so on.

This is the other side of the coin.

And, now we learn from testimony given by Ken Lewis, the CEO of Bank of America [BAC: 16.09, +0.01 (+0.06%)], that Hank Paulson and Ben Bernanke put a “sock” in his mouth and strongly advised him that he say nothing to the shareholders or anybody else about the implications of the merger between Bank of America and Merrill Lynch.

Furthermore, we hear from New York’s Attorney General Cuomo that Paulson threatened to fire Lewis and remove the entire Board of Directors it Bank of America did not go through with the merger with Merrill Lynch! The reward—money from the Government to help BOA through the process.

The shareholders? Well, they lost on the value of their stock. And, they also will have higher taxes or an inflation tax that they will have to pay in the future.

In addition, why should any company, financial or non-financial even think of an acquisition in the future because the government may force the management to swallow hard, take on something that is not necessarily desirable for the company, and, of course, not inform investors as to the implications of the merger transaction?

And, why should the stockholders of any company approve any acquisition that is at all questionable? The precedent has been set that they might be approving something that will cost them considerable wealth as the stock of their company tanks, and they are given no information to give them any confidence that the transaction might be a worthy one.

What if the shareholders balk? What if they fail to approve such a merger? Will the government step in and force through the merger anyway?

Talk about a mess!

Two thoughts come to mind that I must express.

First, the combination of Paulson and Bernanke was a disaster as far as I can see. I have written about how Bernanke seemed to panic last fall and the result was the TARP. (See my post “The Bailout Plan: Did Bernanke Panic”, http://seekingalpha.com/article/106186-the-bailout-plan-did-bernanke-panic.)

Paulson didn’t do much better in his handling of the crisis and the creation and oversight of the TARP. I always thought that Paulson found the whole bailout idea not to his taste and had hoped that he would be able to get out of Washington before the collapse. Unfortunately for him—and for us—he didn’t make it. As a consequence here was a man doing something that he despised, and his heart, and mind, was really not in the effort. He has left us a very unhappy legacy!

When I reflect on the events of the last fall I keep coming up with the feeling that we would be hard pressed to have found two people less capable of handling the situation than the two that were then in charge. And, then there was the “Decider”, but he was AWOL!

The second thing has to do with the fact that the bankers, and other business leaders, are getting pelted with all the blame for the financial collapse and crisis that we have experienced. Thus we have the “bad guys” in our sights. Thus, they should pay.

But, what if the conditions that existed were created by the government and these bankers and other business leaders were just responding to the incentives initiated by the government? We had a credit bubble connected with the stock market in the 1990s. The credit bubble resulted in negative real rates of interest and consumers stopped saving. The saving rate fell from 7.7% of disposable income in 1992 to about 2.0% by the end of the decade. Then there was the huge deficits that resulted from the 2001 tax cuts and the “war on terror”. This was accompanied by negative real interest rates gain which resulted in the credit bubble in the 2000s and the housing boom. The consumer savings rate remained around two or below, even becoming negative for a short period of time.

The foreign exchange market in the 2000s indicated a fear of a renewal of inflation as the value of the dollar fell by more than 40% against major currencies. What were financial managers to do in such an environment? Generally, because spreads narrow in such times and arbitrage opportunities are based on smaller differences, you tend to leverage up and mismatch maturities. This response is a normal one to gain the needed returns on equity to keep money from leaving your fund or institution.

Is this greed? Yes, but it is also just the natural response of competitive people to the incentives that are created, in this case, by the government. The Bush 43 administration may have been composed of “Free Market Capitalists” but this “gang that couldn’t shoot straight” did more to harm capitalism than most other administrations in the history of the United States.

So, government gets it both ways. It can create the crisis. And, then it can impose itself on the economy to right the system after the crisis occurs. And, best of all, the blame can all be put on “greedy” bankers and the lack of regulation.

I am sure that before this is over we will hear many more horror stories.

- John Mason

Disclosure: This article was taken from Mase: Economics and Finance with the permission of the original author.  All disclosure questions should be refferred to the original author.

The second method is to inflate or reflate yourself out of the nominal debt burden you have created. The Federal Reserve is doing its best to create an inflationary environment so that the real value of the debt will be reduced and individuals, families, and businesses will feel comfortable enough to begin borrowing and spending once again.

The third way to reduce the burden of your debt is to repudiate the debt. That is, declare that you will not pay the debt and that those that issued the credit to you will have to take only a partial payment on the amount of funds that they advanced to you. The partial payment, of course, can be zero.

The latter two methods have an “honorable” history that goes back centuries. (Read almost anything by Niall Ferguson.) Usually, it is the government that can get away with either or both of these efforts, but in the 20th century, the private sector got much better in following the lead established by governments, especially repudiating the debt. Individuals, families, and businesses learned the ropes of debt repudiation and are now taking this knowledge to new extremes.

The case that is before everyone’s eyes these days is that of the automobile industry. Both General Motors and Chrysler argue that bondholders must take a huge cut in the amount of money they are owed by these companies so that the companies can survive and thousands and thousands of jobs can be saved. The bondholders, remarkably, have some reluctance to consent to this offer. As of this date, the aimed for restructuring of these two companies depend upon what is worked out between the companies and the bondholders.

Best guess is that the bondholders will lose. And, who will own the auto companies? Not the existing shareholders. The figure I have heard for General Motors is that existing shareholders will end up with about 1% of the ownership of the company after the restructuring takes place. And, not the existing bondholders. The biggest shareholders? The federal government and the labor unions.

The important thing, however, is that the debt problem being experienced by these automobile companies will be resolved. That is, the companies can move forward, leaner and meaner, without the terrible burden of having to honor the debts they had contracted for.

Furthermore, this is what has been proposed for the banking industry. In the plan to sell off bad assets, aren’t the banks being asked to repudiate a large portion of the debt they have on their balance sheets? The assets will be sold to investors and private equity firms to “manage” and this will get the banks out from under the burden of the “toxic assets” they have accumulated.

And, who will bear the risk of this buyout? The federal government, with the real possibility that it may, depending upon the way things work out, end up owning large portions of some of the larger banks. (An important critique of this program is presented by the economist Joseph Stiglitz in “Obama’s Ersatz Capitalism,” http://www.nytimes.com/2009/04/01/opinion/01stiglitz.html?scp=8&sq=jospeh%20stiglitz&st=cse.)

Might this plan work? Well, the people that the federal government wanted to get interested in the plan seemingly smell blood. We read this morning that Wilbur Ross and his firm’s parent company, Invesco, are leading a consortium that is going to bid on some of the assets in the government’s P-PIP. He is joining some other prominent money, like BlackRock [BLK: 225.66, -5.46 (-2.36%)], Pimco and Bank of New York Mellon, interested in getting involved in the program.

Do these people think that they might make some money out of this program? Do they believe that the risk-reward tradeoff is skewed in their direction? Damn betcha’.

Here is another case of “watch where the big money players put their money.” My guess for the future is that the evolving banking system is going to be somehow connected with the hedge funds and the private equity funds and will not have the same old “bank on the corner” feel to it that we experience now. And, somehow, this new banking system will be even harder to regulate than the current one. Otherwise, this money will not flow there. (Something to think about for the future.)

With these funds flowing into the P-PIP, one of the things the federal government is going to have to face is the huge profits that these companies will make out of the program. On the one hand, if P-PIP is successful in this way and these funds make huge profits, the banks will be freed up of their “toxic assets” and the tax payer will not be burdened with more taxes. On the other hand, the federal government will have to explain how it catered to all these “Wall Street Interests” and left the poor Main Streeter in his or her poverty.

The essence of the plan, getting back to the story here, is that the banks will have to take the “haircut”, the write down on the value of their assets. This is just another way of repudiating the debt, with the federal government standing behind the banks. Is it fair? Of course not!

A fund that made the wrong bet was Cerberus Capital Management. In a real sense, it hoped to do with Chrysler Corp. what Invesco, BlackRock, Pimco, and others, are hoping to do with the bank assets. It just got in too early when Chrysler was not in bad enough shape for the federal government to attach a “put” to the investment Cerberus made in the company. Too bad for Cerberus.

But, what about all the other debt out there? Mortgages on homes, debt on commercial real estate, consumer credit and credit cards, and small business loans? Why shouldn’t the people that accumulated all this debt get some relief as well? This is, of course, the big question and the big issue in terms of fairness. The basic answer to this is, as usual, size. The banks and the auto companies and others are big, their failures could case systemic problems for the system, and they have expensive lawyers and lobbyists working for them. Is it fair? Of course not!

The fundamental problem that is being faced around the world is a debt problem. There is just too much debt outstanding. And, actually, the amount of debt outstanding in the world is really not shrinking. Especially, as governments increase their debt to cover the debt that has been built up in the private sector. The debt problem is going to be with us for a while and will continue to get in the way, one way or another, of any kind of a robust recovery. How we get through it is going to set the stage for the type of world we have to deal with in the future.

- John Mason

Disclosure: This article was taken from Mase: Economics and Finance with the permission of the original author.  All disclosure questions should be refferred to the original author.

These figures come from the Federal Reserve statistical release H.3 “Aggregate Reserves of Depository Institutions and the Monetary Base.” I have used the “not seasonally adjusted” data.

This is unheard of! In May 2008, excess reserves were $2.0 billion and stood at 4.5% of the total reserves in the banking system. In May 2009, excess reserves totaled 93.7% of the total reserves in the banking system.

Unless someone can convince me otherwise there are, in my mind, only three reasons for this behavior. The first is the volume of bad assets currently on the balance sheets of banks that have not been recognized. The second is the volume of bad assets that banks anticipate will be forthcoming over the next year or so. The third has to do with how the banks have funded themselves in the past several years.

If these assumptions are correct, the recession cannot be called over yet and any economic recovery that might be forthcoming is going to be relatively tepid or postponed for some time. I obviously hope that I am wrong but something just does not “foot” with the data that I have reported above.

In the first category, current bad assets on the balance sheet, one would think that we know a fair amount about them. Their volume was sufficiently large so that the government put into place the TARP program and then followed that up with the idea of the P-PIP. Several banks feel sufficiently strong that they are returning their TARP money and it appears as if the P-PIP will never be actually implemented.

Financial markets have responded favorably to these events. Yet, we know that there still remain a large number of bad assets in the banking system. The current confidence has allowed some banks to return the TARP funds wanting to get the “Feds” out of their buildings and out of their compensation committees. In addition, with the relative calm in both financial and economic markets, confidence has risen within the banking system that maybe they can ride out the rest of the way to recovery, hoping that many of the remaining bad assets will turnaround or be refinanced or be worked with.

In my experience working in the banking sector, “hope seems to spring eternal” when it comes to believing that bad assets will eventually become good assets. The attitude is that “with time” the borrowers will come through.

But, what kind of confidence is it that sits on $844.1 billion in excess reserves, funds that are earning no return to the banks? Required reserves in the banking system in May only totaled $58.8 billion. What am I missing?

Let’s look at the second category, that about debt coming due or repricing in the future. We have seen more and more reports in recent weeks about the Option Mortgages that are coming due over the next 18 months or so; we read about all the commercial mortgage debt that is on the edge and this was accentuated this week with the bankruptcy filing of Six Flags; and we know that credit card delinquencies are still rising. What we don’t know is the extent of the fallout from the bankruptcies in the auto industry and how this will impact those industries and regions that have depended upon a healthy car business. In addition, personal bankruptcies and small business bankruptcies continue to rise and there is really no firm information about when the increase in these will moderate and what the effect on the banking system will be.

Finally, there is the problem of financing the banking system itself. I recommend that you take a look at the article by Gretchen Morgenson in the June 14 New York Times, “Debts Coming Due at Just the Wrong Time.” (http://www.nytimes.com/2009/06/14/business/14gret.html?ref=business.) Morgenson writes about the debt of the banking system and the need for bank balance sheets to shrink. The banking system, itself, needs to de-leverage and may have to do so unwillingly.

In this article, Morgenson refers to a study by Barclays Capital that discusses the amount of debt of financial companies coming due over the next year or two. The figures, roughly $172 billion of debt will mature in the rest of 2009 and $245 billion will mature in 2010. This means that financial institutions will have to refinance about $25 billion a month for the next 18 months or so. Part of the problem in refinancing this debt is that “many of the entities that bought this debt when it was issued aren’t around any more.” Furthermore, in general, “few buyers of short-term bank debt are around now.”

Raising equity capital is fine, but, over then next few years, the banks may have a larger hole to finance in terms of the debt that it must try to roll over. This, of course, will put more pressure on the policy makers. The policy makers have gone out on a limb in attempting to protect the need to write down bad assets. The policy makers have provided capital for some of the banks that were in the worst financial shape. The next issue has to do with the need for the purchase of bank liabilities. This may be a very tough balancing act to complete successfully.

But, maybe the government has already provided the funds to meet these emergencies. Maybe that is why banks are holding such large amounts of excess reserves. They know that over the next 18 months that they are going to have a severe funding problem. Excess reserves are the perfect answer to paying off the debt as it runs off, leaving the banks with a lot of funds that still can buy them time to “work out” the bad assets that remain on their balance sheets.

- John Mason

Disclosure: This article was taken from Mase: Economics and Finance with the permission of the original author.  All disclosure questions should be refferred to the original author.

- John Mason

Disclosure: This article was taken from Mase: Economics and Finance with the permission of the original author.  All disclosure questions should be refferred to the original author.

American Express has definitely surpassed expectations this year, beating analysts first quarter estimates despite a large decrease in profit and a devastating increase in charge-offs.  Profit decreased 58% down to $443 million or $0.32 cents a share, still crushing analysts expectations of $0.13 cents.   Visa , is up 29% year to date and beat its expectations by $0.09 cents, with earnings of $0.72 cents per share.  MasterCard also beat first quarter expectations, with earnings of $2.80 a share and is up 23% on the year.  All of these earnings led to a strong resurgence in the industry, but AXP has clearly bounced back the best.  AXP was able to beat expectations in terrible credit conditions, with deteriorating markets and the highest delinquencies ever, by cutting costs by 22%.  AXP was not the only one to face great losses in profitability, as Bank of America [BAC: 16.09, +0.01 (+0.06%)], Discover [DFS: 15.35, -0.07 (-0.45%)], and many others faced these same realities.  These are also the same banks that face the greatest downside risk due to the latest legislation.  (Impact of Legislation)

American Express will definitely be hurt by its competitors Visa and MasterCard’s ability to sustain better profit margins with these new laws.  American Express, as well as the others, thrived in the past because of their ability to offset losses with higher interest rates, where the majority of their income comes from.  This ceiling on rates will definitely minimize the gap that AXP had set earlier this year, as both V and MA are making strong strides to catch up due to minimal exposure to interest rates and delinquency. What is not being told is the impact that this will have on Visa and MasterCard, who are supposedly unscathed by this incident.  These two companies will both be hurt by a decrease in total trading volumes.   Most issuers such as Bank of America will want to cut down on their potential risk, and this will include decreasing the amount of monies they designate to their card services.  This will hurt Visa and MasterCard as they are extremely good at what they do, but must rely heavily on other banks to provide the capital for their transactions.   I feel that the effects of this legislation has already been adequately priced into the stocks, and that AXP should not lag too much into the immediate future.  However, due to lower revenues because of legislation, AXP is cutting other costs.

AXP continued to show concern for the immediate future by cutting many different business expenses.  They expect to save about $585 million after facing a charge of about $215 million in restructuring charges.  AXP plans to cut marketing and business development by about 50%, and reduce business services including travel and general business overhead costs by $ 125 million.  This restructuring will help immediately in an economy that is facing soaring unemployment and growing delinquency rates.  I also expect for AXP to raise rates to their full ability in the short term until the new mandating laws are actually enforced to help offset some of these delinquency losses.  However, the savings on employee cuts are not predicted to be as high as the first round of cuts or earlier estimates.  Also, this could certainly hurt the growth possibilities of AXP.  It appears that they are focusing on short term and are hurting their potential for growth in the future.  The predictions for near term EPS numbers have been bolstered or at least reaffirmed, but many analysts feel that projected future numbers could suffer significantly.

Outlook

The stance that AXP is taking is extremely short-sited.  They have guarded themselves well in the near term, and their 2009 numbers have prospered.   However, at what cost is this performance?  Extreme job cuts as well as cuts to marketing and business services will definitely stunt growth or turn away prospective clients.  It is important for a company to maintain a practical business operations, and while AXP shows exceptional short term promise, staying with or ahead of Visa and MasterCard, its future may have been sold short by its leaders.

- Joe Gallo

Disclosure: None.

AIG’s New Face

AIG has started the process to become a very different company than the down-trodden one of the past year. AIG first got into trouble when not only its traditional operations struggled, but its involvement in the credit default swap markets backfired. Leadership will now look to get back to the basics, stripping away non-core assets and focusing on its fundamental core. It has committed to an entirely different future by selecting six new candidates for its Board of Directors in addition to its present cast. This group AIG hopes will guide this new looking AIG to brighter future. AIG has yet to announce if any of the current board members are up for re-election. There has been a great deal of change in leadership in recent times, with both the long time CEO Martin Sullivan stepping down as AIG’s CEO, and later his successor Robert Willumstad losing his job. Even now, the current CEO, Edward Liddy, has recently announced that he will step down once a suitable successor is found. Hopefully the ever changing group should be able to progress without the ties to extreme bonus pay despite TARP funds and other public pressures. AIG has no imminent capital issues, as it still has roughly $30 billion in an untapped TALF fund that could be used for any pressing needs as well as the ability to borrow up to another $60 billion from the government. However, CEO Liddy also stated that he wished to get the company more liquid, and not need to rely on any funds given through TARP.

There has been several cases of AIG trying to shave off some of its debt by selling assets in the past months. In March, AIG transferred some ownership of its AIA and ALICO, its foreign life insurers, to the Federal Reserve for an reduction in the balance AIG owes the government. AIG, however, will continue to manage the firms. AIG also agreed to sell one of its Japanese buildings to Nippon Life Insurance. This building served as the headquarters for AIG in Tokyo, and is expected to fetch $1.2 billion in cash. However, despite these recent sales, AIG continues to have to utilize the cash given to it by the government. This is sustainable for now because there is still $30 billion in credit line left with the government aid. AIG has tried to reduce its reliance on the TARP money by these recent sales. Currently, AIG is continuing to auction off several more assets hoping to further reduce its debt.

AIG has also decided to auction its asset management unit, AIG Investments. There are currently a few suitors, with Religare Enterprises Ltd. from India and Macqarie Group from Australia currently leading the race. The bids are expected to close within about 3 weeks and the asking price is reportedly $500 million. AIG is also currently trying to sell its Taiwan life-insurance unit to raise capital. They hired Morgan Stanley [MS: 32.10, -0.21 (-0.65%)] to sell the unit, Nan Shan Life Insurance. Nan Shan has a estimated book value of $2.6 billion and is the second largest insurer by gross premiums. They also plan to offer AIA Group, its main Asian asset in an IPO sale by 2010. This deal would exclude any of AIG’s key Japanese assets. The company is expected to be worth around $25 billion, but advisers are recommending AIG only sell a smaller stake that would raise roughly $5 billion. This is in response to a weak market where Liddy was not impressed with any of the offers for the unit. This may have been because other companies were trying to strong arm the capital strained insurer or the other companies themselves had their own capital issues. AIG leadership feels that an IPO will bring the greatest capital to the firm. This is a great call on their part, for it will buy a little more time for AIA to gain some additional value as well as get a true market price. This asset is an extremely valuable one that has been very successful in Asia, and truly its one weakness in the past year was that it was tied to AIG’s name and bailout history.

Despite all the positive attempts by AIGs brass to right the ship, they continue to take punishment by the rating services. Recently, AIG’s ratings were cut drastically. Fitch lowered their life insurance and retirement units to A-, down three spots. Also, the air-craft leasing, international operations, and American General Finance units all received cuts in ratings to BBB, BBB, and BB respectively. This was determined due to struggling sales in the traditional insurance business as well as the investment losses. The balance sheets of AIG also took a recent hit, as its total value as determined by the fed fell $9.4 billion to $36.4 billion. This has been extremely tough news for AIG, and they are now forced to try to sell assets that continue to lose value.

Outlook

The position held by the AIG execs is not an enviable one. They must figure how to keep a business operation consistent and growing, while trying to strip away non essential assets, in addition to trying to figure out how to pay back $173 billion with a company who is worth about $36.4 billion. AIG has had a rough past 12 months, and are now facing credit cuts on top of everything. The size of its losses has decreased drastically, but AIG is still posting losses. They are taking all the necessary steps, trying to retain as many employees and holdings as possible while chipping away at its vast debt. However, I just don’t see how this insurance giant can ever stabilize with the vast amount of liabilities. It just seems to be unlikely for this company to ever regain stability, yet alone prominence. AIG is currently being sustained by the respirator known as the tax payer, and it is the tax payer that will ultimately be disappointed.

-Joe Gallo

Disclosure: None.

When financial institutions securitize assets and elect off balance sheet accounting treatment they are pretending that neither their securitized assets nor their related secured debt exists. Like a deadbeat dad denying paternity, securitization accounting is designed to avoid admitting responsibility by securitization sponsors.

Most securitizations are a form of secured borrowing executed by banks and other financial institutions. However, “form over substance” securitization accounting encourages securitization sponsors to act as if secured borrowings are really asset sales and thereby decrease the reporting of both their asset size as well as their debt.

When institutions use off balance sheet accounting for secured debt transactions financial ratios are distorted, and transparency is destroyed. No one can tell if securitizing institutions are well capitalized or not and whether their operating performance is consistent given the scope of their operations.

As a result of securitization accounting financial institutions like Bear Stearns, Lehman Brother, Citigroup [C: 4.20, -0.06 (-1.41%)] and Merrill Lynch appeared much less leveraged, and much more profitable, than they really were. The “granddaddy” of securitization shops, Citigroup, at one time had more than $1 trillion of assets that it reported as “off balance sheet”.  Citigroup pretended that the $1 trillion of off balance sheet assets were orphans; they just appeared one day on Citigroup’s doorstep.  Simple financial measures such as net interest spread and asset quality and profitability ratios were vastly distorted by Citigroup’s orphans.

The securitization accounting rules also facilitated the “originate for sale” shadow banking system that lead to sub-prime and other consumer and commercial lending abuses.

The new securitization accounting rules are supposed to enhance transparency and make it much tougher for financial institutions to pretend that they don’t own their assets. But, no one is really sure how the changes will play out in the real world marketplace. The new rules may enhance transparency.  On the other hand, mechanical application of new and complicated rules may confuse already incomprehensible reporting. Retro-active application of the rules may highlight how dangerously undercapitalized some financial institutions remain and may spark a new round of loss of confidence. Simplifying the rules may help restart the securitization marketplace and help the economy, but then again they may be another nail in the capital markets coffin.

I don’t know what this all means because I never understood the old rules and don’t know what the new rules will do to financial reporting. There is a Wall Street sub-culture that holds itself out to be “securitization accounting” experts. Personally, I never bought the “snake oil” that these guys were selling. I don’t think that the so called experts have a clue what is going to happen when the new rules are enacted and if they don’t know the media certainly has no clue which is why there hasn’t been much reporting of this accounting change.

It’s a good idea to fix securitization accounting rules and I support the effort; just not the way that reform is playing itself out. In fact on December 4, 2008, I wrote a letter to then President Elect Obama suggesting that reforming securitization accounting needs to be a cornerstone of financial institutions reform. The following is from my December 4^th letter:

If accounting rules matter, bad regulatory accounting rules matter even more. About 20 years ago bad regulatory accounting rules were enacted that apply to all banks and have the unintended side effect of encouraging the worst excesses of the securitization market. These rules reward banks that use the OPM model (i.e., “other people’s money”) to finance assets and penalizes banks that want to create well capitalized investment structures. These bank regulatory rules virtually mandate the “originate and sell” model of finance and need to be fixed immediately. Generally accepted accounting practices have run amok trying to work around the bad bank regulatory rules. The accounting industry is about to “reform” the rules relating to securitization accounting in FAS rule 140 but the new rules continue to make a mess of things. An interagency initiative is needed to fix this mess. And, interagency cooperation will only happen with Presidential leadership.

The problem with the current securitization accounting reform initiative is that it isn’t interagency reform but rather unilateral work of the Financial Accounting Standards Board which has at best mixed motivations. Until securitization reform is a joint effort of all constituencies that are affected it won’t work.

The U.S. needs a joint task force to address this issue including the SEC, OCC, FDIC, Federal Reserve and state insurance commissioners. Regulatory and statutory accounting rules must be conformed to financial accounting and disclosure. Securitization reform is needed but ad hoc and piecemeal reform is probably worse than no reform and what we are getting is ad hoc reform.

-Mark Sunshine

Disclosure: This article is taken from the website Sunshine Notes with the permission of the original author.  All questions regarding disclosure should be referred to the original author.

The bill was passed with an overwhelming majority of a 90-5 vote. President Obama has been behind making more stringent regulations on credit card companies even before he was in office. The White House is likely to continue to support the bill, as the bill will increase disclosure and fight interest rate increases for consumers. According to the Wall Street Journal, Senate Banking Committee Chairman Christopher Dodd stated: “Credit cards are a tremendously valuable and useful tool for consumers, providing them with relief during critical moments… This is a very important industry.… We just want it to work better.”

Among some of the regulations which will be imposed on credit card companies include not allowing issuers to retroactively change the rates on existing balances, setting a date on which bills must be sent by, and eliminating fees for payments with the exception of expedited orders. The biggest regulation is the prevention of retroactive rate increases on a consumer’s balance. Credit card companies have been using this tactic to reduce the risk of their credit exposure frequently throughout this recession. The bill will now prevent them from changing the rate until the account is 60 days delinquent.

The bill will mainly affect large credit card issuers like Bank of America [BAC: 16.09, +0.01 (+0.06%)], J.P. Morgan [JPM: 42.46, -0.09 (-0.21%)], Wells Fargo, and Citigroup [C: 4.20, -0.06 (-1.41%)]. Credit card companies like Discover Financial Services [DFS: 15.35, -0.07 (-0.45%)] and American Express [AXP: 40.93, -0.21 (-0.51%)] will also be severely impacted by this bill. These players profit from not only fees they charge consumers, but also the rates on the balances. They thrive in times when they can charge high interest rates on consumers who fall behind on their payments or people who are financially uneducated.  The legislation will mean lower profit growth in any economic recovery. In the credit card companies’ defense, many of these rate increases they have been imposing may be justified considering the increases in credit card delinquencies. According to the Federal Reserve, approximately 6.5% of consumer credit-card loans were delinquent in the first quarter. This compares to a delinquency rate for credit-card loans of 4.8% last year. With delinquencies for these loan portfolios to increase, expect many of the issuers to significantly boost their rates on existing balances before this is officially passed by the house.

The bill, if passed, will not directly affect card payment processors like Visa [V: 80.00, -0.18 (-0.22%)] and MasterCard [MA: 231.16, +1.07 (+0.47%)]. These companies operate as a “pay-as-you-go” service and do not have anything to do with a consumer’s balance or bill payments. These companies profit from transactions which customers make and charge the individual merchants for card usage. Generally they make a profit on every transaction, so the more credit card volume, the more profitable they are. The bill may indirectly affect these companies as card issuers may be more reluctant and wary about who they issue a new card to, which may slow down the transaction and volume growth they have witnessed and are expecting to see over the next 5 years.

This bill has received overwhelming support from politicians, and will likely be passed by the house and signed into law by President Obama very soon. Watch for some activity from the credit card industry, as many of the banks who have the largest number of cards outstanding to either reduce their exposure to the industry or find other tactics to make its division more profitable.

-Steve Murray

Disclosure:  The Fund the author is associated with is long JPM.

During the banking boom, Wells Fargo avoided tactics used by other banks to raise their bottom line.  Since it was founded in 1852, the bank has proven itself to be one of (if not the most) conservative banking institutions.  It does not like to be classified as a typical Wall Street bank, because that is not how it operates.  Rather than trading with its own book, or profiting off of huge fees from investment banking businesses, it prides itself by operating as banks used to.  Wells Fargo makes a majority of its money by old fashion lending (which is hard to say for many other banking institutions).

John Stumpf, CEO of Wells Fargo, took over Dick Kovacevich’s job last year.  During the height of the credit crisis, Kovacevich was quick to shoot down short sellers and fought against the media who classified Wells Fargo as just another large-cap bank that has been destroyed from the toxic assets and poor lending standards.  He has also publicly stated that the government’s decision to conduct a “stress test” and publicly release the data is “asinine” as the government frequently conducts stress tests every day.

With the recent acquisition of Wachovia last year, regulators are worried that write-downs from their books will severely affect Wells Fargo.  Wachovia’s acquisition of Golden West Financial (a large sub-prime lender) led to the down-fall of the prestigious bank.  About 2 weeks after the announcement of Wachovia’s acquisition came the government’s TARP injections to U.S. banks. Kovacevich reluctantly accepted the money as they wanted regulators to pass the deal.  In an interview with Fortune, he reluctantly explained:  “You want to do what your country and your regulators want…”  When the Wachovia deal was officially closed for $12.5 billion (almost $3 billion less than the original offer), Wells wrote down $37 billion of a Wachovia loan portfolio worth $94 billion.  Many analysts were expecting this write-down to be significantly larger than $37 billion, and bashed the stock with downgrades.

The downgrades were warranted as their TCE, or tangible common equity (a measure of a bank’s capital cushion), fell to 2.7%.  This was below the industry standard and expectation of 3%, which many consider the bare minimum to operate healthily.  Wells Fargo was able to raise $12.6 billion, more money than any non-IPO in record, to buy Wachovia.  Many felt this was a sign of things to come for the bank, as they had targeted to raise as much as $20 billion in the issuance.  Since then, Wells followed suit by unexpectedly cutting its dividend by 85%.  Defending the move, Stumpf said:  “We’re going through unprecedented times, and more capital is better than less capital.”  This cut did not ease investor’s concerns about the bank, which continued to trade down with the rest of the banking world.  Since October, the bank has been able to raise $43 billion ($25 billion in TARP, $13 billion in private fundraising, and $5 billion in cost savings from the dividend cut), which is $23 billion more than management said it would need.  Fed officials disagree though with the results of the “stress test”.

Out of the $13.7 billion, which Wells will need to raise, a large portion of the estimated write-downs come from first lien mortgages ($86.1 billion), second lien mortgages ($32.4 billion) and commercial & industrial loans ($14.7 billion).  Analysts are extremely concerned with a $355 billion pool of commercial mortgages, and a $137 billion pool of credit derivatives.  These assets were not added to Well’s books after the merger, but rather kept off-balance sheet through “Special Purpose Entities” or SPE.  If these were added to their books, some analysts believe that it would need over $20 billion in additional capital.

Wells Fargo focuses on gaining customers, and making their lives better.  Cross-selling products has been at the forefront of Wells Fargo’s success.  Whether it be credit cards to mortgages for consumers, or even treasury-management and insurance for businesses, its primary focus has been increasing the number of products they sell per customer.  Over the past 10 years, Wells Fargo has successfully increased the average number of products for retail customers from 3 to almost 6.  Growth has also skyrocketed for business customers too, as they now average almost 8 products per customer.  Growth has not been hindered by the current financial crisis though.  Both retail and business customers have been flocking to Wells to give them what they desire:  security.  This business model has served them well from both retail consumers and businesses, because the more products they have with Wells, the less likely they will move their businesses to a competitor.

These segments have proved investors and analysts wrong about its business strength during this banking crisis.  Wells Fargo pre-announced first quarter earnings results of $3 billion, which sent shares up over 30% that day as the results were more than twice what analysts were expecting.

It is pinnacle to Wells Fargo’s future success to complete these three necessary steps:  1. Continue operating as they have since their existence with conservative standards; 2. Raise enough money to cover the stress test results and to payback TARP; and 3. Successfully complete one of the largest bank mergers in history.  The latter of the three is already ahead of schedule.  The hardest step will be the distinguishing themselves from the rest of the pack as an extremely conservative banking institution, which will lead to raising enough capital to get them back on track.

-Steve Murray

Disclosure: None.