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As one of ~300 million Americans, we each now own about 0.000000002663333% of AIG.
I think the Fed did the right thing here by requiring some financial benefit in return for such a huge loan. Not only do taxpayers get a 79.9% equity stake in AIG, but we also are collecting some hefty interest on the deal, to the tune of LIBOR plus 8.5 percent.
From MarketWatch:
"The Securities and Exchange Commission said Tuesday that it will try to limit so-called "naked" short selling of shares in Fannie Mae, Freddie Mac and big brokerage firms. The SEC will issue an emergency order stating that all short sales of shares in these companies will be subject to a "pre-borrow" requirement, said Christopher Cox, chairman of the SEC. This will last for 30 days, he said. The SEC is also planning more rule-making focused on short selling in the broader market, Cox said."
Is this some sort of joke? Naked short selling is illegal, and for good reason. Short selling involves borrowing shares from holders who are willing to lend them out, selling them, and promising to repay the shares at some point in the future. So called "naked" short selling, or selling shares without actually borrowing them, is illegal because it can result in constant selling pressure due to the sale of more shares than are available for sale.
Now the SEC is saying that "naked" shorting will be illegal for 30 days for certain financial stocks. Seriously? So they are admitting that "naked" shorting is running rampant (a position that has been claimed for years) and they have not been enforcing the law? Add that to the list of reasons why this market could be taking it on the chin. First the SEC eliminated the "up-tick" rule, and now they are allowing "naked" shorting. Shameful...
It seems like Congress goes into attack mode anytime somebody is making a lot of money. In some cases I agree with our elected officials and in other cases their arguments make little sense if you look at the big picture. Take the oil companies for instance. We all know the industry is swimming in money. If Congress aims to repeal subsidies these firms get from the federal government, I have a hard time opposing the idea. Our country does not need to subsidize our oil companies. However, if you propose some kind of excess profits tax simply because oil prices are high, that is ridiculous. We live in a market economy and markets are cyclical. You can't tax companies during boom times just because you feel like it.
Anyway, the topic du jour is the taxation of hedge funds and private equity funds. Again, we have a group of wealthy people who are making billions and paying the same (if not less) taxes as the average worker. To figure out where I fall on issues like these, I try not to bring politics into it at all. To me, it's logic-driven reasoning that should rule the day and help form an opinion.
I haven't been following the issue that closely, but the sticking point is the fact that hedge fund and private equity fund general partners split investment profits with their limited partners. The investment managers serve as general partners and collect 20% of the profits from the investments they make, which is often taxed as long-term capital gains, at a rate of 15%. The fact that someone can make $100 million and only pay 15% in taxes is evidently upsetting a lot of people in Washington.
At first blush it might seem like the 15% tax rate makes sense. If a hedge fund has $100 million in assets and earns 10%, there is $10 million in profit to be divided up. Assuming an 80/20 split, the manager makes $2 million and the limited partners share $8 million based on their ownership percentages. Since the $10 million in profit was the result of capital gains, then it is easy to see why some feel the 15% tax is fair.
There is one difference though, that seems very important. The whole point of having a low capital gains tax rate (relative to income tax rates) is to incentivize people to invest in businesses and put their capital at risk. Such actions are the life blood of our capitalist system. In return for risking your own money by investing in other ventures that need funding, you are rewarded with a lower tax rate on any profits you earn.
The problem is, hedge fund managers aren't risking their own capital a lot of the time. They are pooling money from their investors and managing it for them. Sure, they don't earn anything unless they produce positive returns, but if they lose money, they don't lose as much, if at all, because they typically have less capital at risk, if they invest in the fund at all. This seems like the most logical reason why one would be against the 15% tax rate for hedge fund managers.
Now, it's true that most fund managers have invested some of their own money in the funds they manage. Perhaps what the tax law needs to say is, when you have your own money at risk, you can claim profits as a capital gain, but when your investors are simply sharing a portion of the profit earned on their capital, in return for your management ability, then that income should be treated as a management fee, and therefore taxed at ordinary income tax rates.
It's a tough issue for sure. I just hope the law going forward reflects reality, meaning that if you get a tax break for capital gains, it better actually be your capital that was put at risk in order to produce the gains in the first place. A fair compromise in my eyes would be to allow managers to pay 15% on the portion that is their own capital at risk, and ordinary income tax rates on fees earned on limited partner's assets that are paid out to the general partner. That way, the whole point of the 15% capital gains tax rate (reward risk taking with lower taxes) is preserved.
What do you think?
I'm curious what readers think about this. After coming up short in his bid to become Vice President in 2004, Senator John Edwards worked for Fortress Investment Group (FIG) as a consultant. Given that Edwards has been focusing his political campaigning on helping solve the poverty problem in our country, is he being a hypocrite by working for a hedge fund, whose main job is helping rich people get even richer?
I'm not sure where I fall on this issue. At first blush it does seem like a questionable decision on his part. However, does the fact that he worked for Fortress really mean he is somehow abandoning the poor? Fortress is going to do what they do regardless of whether or not Edwards is there. There is no way his role at the firm had any financial benefit for Fortress clients. He might have given them a well respected politician in their corner, but he didn't boost their investment returns, so he didn't directly help the rich get richer. That is going to happen regardless.
Of course, Edwards is going to say it was, in part, a learning experience. He clearly doesn't have much financial markets knowledge. But he did admit that the money was nice too. Does someone who supposedly wants to help the poor have to purposely avoid earning a nice living because of his political platform?
It's an interesting topic. I'm curious to hear what you all think. And I know it's a political discussion, but let's keep it polite, not partisan. We can speak in terms of politicians in general, regardless of party affiliation.
Doug Kass, managing partner of Seabreeze Partners, predicted a Democratic sweep on CNBC's Kudlow and Company program yestertday afternoon. The result, he thought, would be a severe sell-off in the market. Much like Kass's calls for doom and gloom on Wall Street have been wrong in recent months, they were wrong this time as well. Now you can say that the Rumsfeld resignation helped boost stocks, which I cannot dispute, but the Dow was only down 25 points or so before that news hit the wires.
So why the positive reaction on Wall Street? There are weak spots. Healthcare stocks are down. Pfizer (PFE) down 2 percent is attractive. Sallie Mae (SLM) got hit too, as the Dems want more affordable college loans. But other areas, such as oil, are actually up and in some cases up strongly. Fears of a windfall profits tax are overblown. The idea is silly in a market-based economy. I'm glad that the Dems really aren't pushing hard for it. As much as I don't like the fact that big oil is getting tax breaks (I think that is one place the Dems can try and raise taxes and not take heat for it), passing on some of their profits to the government during good times is not a viable idea.
Anything truly outlandish would likely get vetoed by President Bush. The Dems will want to get things done, and if Bush shows any willingness to compromise on anything, we might get a handful of things done in Congress over the next two years. That is more than we can say about recent memory, so that is a positive development for the American people, and the stock market.
Regardless of what the Republicans say, Democrats are not bad for the economy and stocks. The numbers simply don't support that view, in fact, they show the opposite. My very first post on this blog two years ago looked at the market and the economy under Democratic and Republican administrations. Economic growth, employment, fiscal responsibility, inflation, and stock market returns are all better under Dems. Now I know that Bush is still President, but the point is made merely to refute the idea that Dems having more power with respect to policy means lower stock prices. It's simply untrue.
Stock markets will always react to elections in some way and this year should be no different. Fortunately, the volatility that is created, either in specific sectors or the broad market, is often overdone. This could create opportunities this coming week.
First, let's tackle the broad market. This is fairly simple to gauge. Markets hate uncertainty, so any result at the polls on Tuesday that brings into question the political climate over the next two years should make some people nervous. However, any short-term weakness we see from this uncertainty should be expected to be fairly short term in nature. Traders always shoot first and ask questions later. Cooler heads usually prevail, and investors will jump in to correct any inefficiencies that were created by quick, emotional, and merely reactionary decision making.
As for individual sectors, the stock price movements will likely be very evident this year. Dems are talking about windfall profits taxes for big oil, as well as healthcare costs spiraling out of control. These two sectors will likely get sold if the Dems turn in a solid performance at the polls. So would contractors who have been making billions over in Iraq. Think Halliburton (HAL).
The question we need to ask ourselves, though, is how will this affect the next two years, really? Even if the Dems take both the House and Senate (I think this is quite unlikely) Bush will show us a new side of his; the veto side. Markets tend to like gridlock because it can result in compromise, which ultimately means things actually get done on Capitol Hill. However, Bush is hardly one to be receptive to compromise, so I wouldn't hold my breath.
Overall, I think we can get some buying opportunities if certain sectors see sharp sell-offs on the heals of the election. Let's keep an eye out for this and if anything peaks my interest, I'll let you all know (and feel free to do the same).
And don't forget to vote on Tuesday!
Fortunately, President Bush decided not to throw us a curve ball today with his appointment of Ben Bernanke as the next Fed Chair. Recent history clearly had the market a bit spooked with Greenspan's successor yet to be named, but a relief rally on Wall Street is underway. Bernanke really has only been in the spotlight in recent months, as potential replacements were discussed. Nonetheless, his credentials are strong and I think the market was hoping he'd be Bush's top choice.
I still believe Greenspan wants to "finish what he started" and will likely bring Fed Funds up to 4.5% before he moves on in late January. If this view proves true, and Bernanke doesn't continue boosting short-term rates, we could see a nice market rally back to the upper end of the trading range between now and sometime in the first quarter, as the rate hike barrage would be over. That would certainly be welcomed by investors, myself included.
President Bush is a huge fan of markets. Rather than take meaningful action toward surging oil prices, he'll simply let the market correct itself. With the Chinese currency pegged to the U.S. dollar, the Administration is pressuring China to let it float. Let the markets determine currency values, not governments.
I think that's a great position actually. Markets do work, so we may as well let them. When it comes to free trade then, it's no surprise that Bush says he supports global free trade. After all, the global economy is a perfect example of a enormous market for goods and services at work. And it does work, very well in fact.
So it's no wonder that when the Bush Administration imposed steel tariffs in 2002, many of his supporters were irrate. The tariffs were imposed to stop cheap steel imports from flooding the U.S. market, hurting U.S. steel producers by increasing competition and lowering prices.
Dozens of U.S. steel companies had filed for Chapter 11 bankruptcy protection since the last 1990's due to an inability to compete effectively in the global market for steel. The tariffs were lifted in 2003 after the World Trade Organization pressured the U.S. and threatened to strike them down. Bush attempted to claim that the tariffs had served their purpose for a year, and now it was time to eliminate them, but everybody knew that it was simply a huge mistake, and fortunately there was enough pressure overseas that they were overturned.
However, the Bush Administration once again is attempting to close down the U.S. to free trade. The U.S. has reimposed quotas on Chinese textile imports such as cotton patnts, shirts, and underwear. How does reinstating quotas support the notion of free trade?
U.S. retailers have been urging Bush to not to reimpose the quotas. The reason is simple, prices for the U.S. consumer will go up as a result. Inflationary pressures are the sole reason the Fed has been raising interest rates. Quotas and tarriffs will only serve to increase prices, which will result in higher interest rates and lower economic growth, here and abroad.
Economic policies like these will only hurt the U.S. economy, and as a result, prevent a new bull market from getting underway anytime soon.
The last of the three presidential debates for 2004 concluded last evening. We've heard plenty of election coverage, so I won't get into much of the politics here, but one question is relevant to me and my clients. Will next month's election (or any presidential election for that matter) affect the stock market's future returns. And if so, how?
Much of the country has concluded during President Bush's first term that his policy of reducing taxes on income, capital gains, and dividends has helped bring investors back to the market after many portfolios were dismantled in the first three years of the new millennium. Some have worried that the market would react negatively to a Kerry victory in November due to his desire to raise taxes for those individuals earning more than $200,000 a year.
We have also heard that academics have found that the market itself performs better under Democratic Presidents, as opposed to Republican ones. Interesting contradiction, isn't it? Rather than listen to the pundits on television, I decided to take a look at the research myself and determine which, if any, political side is better for the stock market. Stock prices are proven to follow corporate earnings over the long term, and most won't argue that the best predictor of company profits is economic growth. Here is what I found.
There are two sets of numbers highlighted below. The first are the most commonly used economic statistics used to measure the health of the economy; GDP growth, unemployment, inflation, growth in federal spending, the budget deficit, and the national debt. These numbers came from research completed by the Bureau of Labor Statistics (BLS) and the Bureau of Economic Analysis (BEA), both non-partisan bodies that the White House and others rely on for unbiased data continually. This data is for the 40-year period from 1962 through 2001. The results are very interesting, especially if you favor the Republican political view that seeks to lower taxes and reduce government spending, as opposed to the "perceived" idea that Democrats prefer to "tax and spend."
From 1962-2001:
GDP Growth: 3.9% (D) 2.9% (R)
Unemployment Rate: 5.1% (D) 6.8% (R)Inflation Rate: 4.3% (D) 5.0% (R)
Growth in Federal Spending: 7.0% (D) 7.6% (R)
Growth in Federal Spending (Ex-Defense): 8.3% (D) 10.1% (R)
Yearly Budget Deficit: $36 Billion (D) $190 Billion (R)
Total Increase in the National Debt: $720 Billion (D) $3.8 Trillion (R)
(Sources: BLS & BEA)
The first point to make is that while Republicans are billed are fiscally conservative and tax reducers, over the last forty years Democratic Presidents have actually spent less and been much better balancing the U.S. budget. And while Republicans have taxed Americans less, that has not translated into better economic prosperity, as measures of inflation, GDP growth, and unemployment all have been better under Democratic leaders.
Now, that's fine, but the real question is how this relates to stock market performance. Despite what the economic numbers above reflect, what happens to stock prices while each party is in office should be the real question. If Republicans are indeed better for the markets, then you can argue that even though favorable economic statistics sound good, they won't really help grow your investment portfolio. Not surprisingly, though, the stock market did prefer better economic conditions, as you can see below.
Avg S&P 500 Returns: Democratic Presidents vs Republican Presidents (1926-1997)
15.1% (D) 10.7% (R)
(Source: Stock Traders Almanac)
For some, these statistics will be important when you go out and vote for our next President on November 2nd. For others, they won't be. However, as a money manager I was curious to see if the claims made frequently in the media are actually true, so I thought I'd share my findings.