I am not in favor of the Federal Reserve as a greater regulator over the financial system.  Why?  They can’t even do their own job right, or use the tools that they have today effectively.

Is the stock market too frothy?  Let them adjust margin ratios.

Are they worried about the solvency of investment banks?  Let them increase the level of capital that needs to be held against investment banks.  Hedge fund worries?  Same drill.

There should be a bright line distinguishing the regulated from the non-regulated financial companies.  Capital requirements on loans from the regulated to the non-regulated shoul be very high, forcing the non-regulated entities to be mainly equity-financed.

Beyond that, the Federal Reserve has enough of a hard time with their existing mandate, balancing inflation, unemployment, and the health of the banks that they regulate.  Adding additional balls for them to juggle will make their paralysis greater.

Better we should consider giving the SEC some real teeth, and funding it appropriately to do it.  Let the next President put forth a good proposal to make it happen.

One thing that is different about me as a blogger — I not only write about the economy, but I am actively trying to apply my views through investing.  So, sometimes readers will get the micro-level aspects of investing.  This evening I got the unwelcome surprise of additional fees on some of my ADRs — It seems that the SEC has allowed for the passthrough of custody fees to shareholders.

Now, I know that there are implicit fees on sponsored ADRs, and both of the ADRs that I got hit with fees on are sponsored.  My question is this: did the banks sponsoring the ADRs give up their other fees in order to charge explicit fees to the shareholders?  I expect not.  I am considering writing to the companies whose shares I own, in order to get them to consider choosing another bank that will not charge fees to its ADR holders.

It is not just one bank — both BNY Mellon and JP Morgan took fees from me.  Particularly galling were the fees on SABESP, where since the dividend was taken in two parts, they took two equal fees, even though one dividend was tiny and the other big.

I don’t begrudge legitimate fees, but I really dislike fees that surprise me.  Consider this as you invest in ADRs, and contact the Investor Relations areas of those companies to choose banks that will not charge ADR holders.

Full disclosure: long SBS

Well, June was nothing great.  I was ahead of the indexes, but that doesn’t mean much in absolute terms.  For the year, I ended June ever so slightly negative.  Good in relative terms, but I aim for better.

July has been ugly for me — I am down considerably more than the market, but these things happen… energy is off, and though I am market weight, the names I own have considerable operating leverage.

While I was on vacation, I did the following trades: bought some International Rectifier, Smithfield Foods, and Officemax.  I enjoyed my time off, and disciplined my computer use to half and hour around lunch, and some time after the kids went to bed.

I am still working on my portfolios reshaping, and should have some trades by early next week.

Full disclosure: long IRF SFD OMX

I’ve never been a fan of General Motors [GM].  At RealMoney, I had somewhat more than 70 notes on GM across five years, though I stopped writing about it because I got bored of waiting for the disaster.  Oh, also, the market moved temporarily against my views, and I had better things to write about with the pains in depositary  and credit-sensitive financial stocks.

One of my basic rules is that heavily indebted corporations with bloated cost structures facing stronger competition are rarely good investments. How will the equity get dividends?  Who would buy the company out?

You can’t cut your way to greatness, particularly when there is high debt and high overhead costs.  Those costs need to be spread over a large volume of cars/trucks.  Cutting volume will not help much, except for cash flow in the short run.  In the long run, the accrual items will bite, whether pensions or other fixed obligations.

As Felix points out, bankruptcy may offer options.  That said, the surviving company would be much smaller and less significant to the US economy.  I also doubt that Chevrolet could be spun off without a fraudulent conveyance suit from the senior bondholders.

When I was a corporate bond manager, I sold all of my inherited GM exposure at significantly over par in 2001 (spreads were under 200 bp).  I did not want my clients to face the degradation of value from a mismanaged company.  Not owning GM and owning a tiny amount of Ford debt was a big bet relative to the indexes, but it was one that paid off.

My advice remains the same.  Underweight GM and Ford, both equity and debt.  It may take a while, but eventually the overindebted companies with high fixed costs will be outcompeted by their Japanese rivals.

Ugh.  I’m still not home yet, but after my recent 48-hour news blackout, the news on Fannie and Freddie is pretty amazing.  Now, I would not be so certain that an interpretation of SFAS 140 would force Fannie or Freddie to raise capital — GAAP accounting often has little to do with regulatory capital rules.  Only if OFHEO decides to mimic the treatment in GAAP would it force capital-raising, absent any net worth covenants on their debt that might be poorly written.

All that said, the problems with Fannie and Freddie are not primarily accounting-driven, but are being driven by diminishing housing prices, which erodes their margin of safety on their lending and loan guarantees, and diminishes the value of the mortgage insurance that they rely on for some of their business.  Writedowns from these items are what hurt.  It is likely that Fannie and Freddie need to raise capital, but the great questions are how much is needed, and how much can the market stomach?

At times like this, I run through my pecking order of the “financing methods of last resort.”

  • Have you maxed out trust preferred obligations? Other subordinated debt?
  • Have you maxed out preferred stock?
  • Have you issued convertible debt to monetize volatility?
  • Have you diluted your equity through secondary IPOs, rights offerings, PIPEs, and/or deals with strategic investors?
  • Have you sounded out investors in your corporate bonds about debt-for equity swaps?
  • And, unique to Fannie and Freddie, have you asked the US government for a capital infusion or a debt guarantee?

All of these financing methods carry a cost.  (And, as with most situations like this — if it were done, best it should be done quickly.  Delay usually means that cost of financing rises.)  Most of the cost is dilution to existing shareholders, whether common or preferred.  The debt guarantee, or investment by the government has costs for the US taxpayer, which I would rather not see.

Clearly, Fannie and Freddie have room to raise more capital, but the room is not unlimited.  As the Financial Guarantors found, when your stock price gets too low, the jig is up.  You can only raise so much capital relative to the size of your current market capitalization before the market chokes.  After all, most capital raising requires a discount to current price levels, and somehow the diluted value of the equity needs to represent a premium price where new capital gets put in.

In short: it’s tough to get new investors to pay for past losses.  Capitalize a new company?  Could be done, and has already happened with the Financial Guarantors, which has largely sealed the fate of the tarnished incumbents.  That said, why would the US government want a competitor to Fannie or Freddie, aside from GNMA?

As for the US Government, perhaps this all waits for a new President and Congress to act.  Personally, I think that any help extended to Fannie or Freddie should have strings attached.  Investments, or debt guarantees should allow the US government to profit if things turn around.  Other things to explore: only guaranteeing new liabilities, or, expanding the role of GNMA, which is a full-faith-and-credit of the US Government lender.

The one thing I don’t want to see is a bailout that benefits the shareholders of Fannie or Freddie.  They have long had private profits with many public subsidies for years.  Now it is time for the shareholders to bear the losses; let public money only step in to keep senior obligations whole, if it steps in at all.

(Note: these are my private opinions, and not those of my employer.)

Readers have suggested some additional tickers for me.  Here they are:

GE, MSFT, BMY, BA, ANAT, KCLI, and DE

Beyond that, there was my country screen — cheap names in Taiwan and Korea that trade in the US?

WF SHG LPL KEP KB IMOS AUO

Then for the industry screen.  Here’s the most recent list of cheap industries; I used the ones labeled “Dig Through”:

Remember, this can be used in momentum mode (red) or value mode (green).  I’m using it in value mode, and it gave me a flood of tickers — remember, in this screen, Price-to-book times Price-to-next year’s earnings must be less than 10.  That’s usually a pretty strict criterion, but this time it turned out 121 tickers:

ABD ABG ACE ACGL AEG AEL AFG AGII AIG AMCP ASI AWH AWI AXA AZ BBI BBW BC BKI BWINA BWINB BWS BZ CAB CHB CINF CMRG CNA CNO CONN CPHL CRH DSITY EBF EIHI FFG FMR FNF GBE GIII GLRE GNW GT HALL HMN HSTX IHC INDM ING INT IP IPCR KGFHY KPPC LFG LGGNY LIZ LNY M MERC MGAM MHLD MIG MIGP MRH MRT MSSR MTE MW MYSZY NP NSANY NSIT NYM OB OSK OXM PAG PCCC PEUGY PL PMACA PNX PSS PTP PTRY RCL RE RNR ROCK RSC RT RUSHA RUSHB RUTH SAH SEAB SEOAY SIGI SMLC SSCC SSI SUR SWCEY SWM THG TI TRH TUES TWGP UFCS UFS UNM UPMKY USMO UTR VOXX VR WHR XL ZFSVY

Well, the quantitative ranking method will have its work cut out when I build the main spreadsheet — it will take some effort to scrub the accounting data, and come to some buy decisions, but that’s my next task.

Here is my initial list of replacement candidates for the third quarter 2008 portfolio reshaping:

AA    ACMR    ACS    ACXM    ADP    AEM    AEO    AET    AFFM    AHL    AIB    AINV    ALL    AME    AN    APA    ARP    ATWO    AVID    AVZA    AXS    AYR    BAGL    BCPC    BDK    BGC    BHI    BJS    BKS    BLL    BP    BRO    BRS    BSET    CAM    CBI    CBK    CCK    CCRT    CDNS    CFI    CKH    CMI    COG    COLM    COMS    CPB    CRDN    CROX    CSCO    CSL    CTB    DD    DELL    DFG    DLM    DRYS    DUK    DVN    EGLE    ENH    EP    ETP    FAST    FCX    FDRY    FITB    FLEX    FLXS    FRPT    FRZ    FSR    FTEK    FTO    GFF    GHM    GIL    GMT    GNK    HAIN    HAL    HAR    HAST    HCC    HCN    HCP    HELE    HK    HLYS    HNT    HNZ    HOC    HON    HRS    HRZ    HTH    INFS    IPSU    IR    IRE    ISCA    ISYS    IVN    JCI    JNX    JOSB    KCI    KEY    KMX    KOF    LMC    LPX    LRCX    LSTR    LZB    MAN    MAS    MCRL    MGIC    MHK    MHP    MI    MKSI    MOT    MPS    MPWR    MWA/A    MXGL    MYE    NBR    NBTY    NFX    NG    NM    NRG    NSHA    NTGR    NVS    NWLIA    OC    OCR    ODP    OIS    OKE    OMAB    ONNN    ORI    OSK    OXY    PAYX    PBI    PBY    PCZ    PHX    PKD    PKI    PPC    PPG    PRE    PRU    PTEN    PVA    PWR    PXP    PZZA    RCII    RDC    RDK    ROP    RS    RTN    SAFM    SCX    SENEB    SFY    SGIC    SGY    SI    SII    SJM    SKM    SKX    SLB    SLGN    SNDK    SNG    SNX    SNY    SPSS    STZ    SVR    SVU    SWN    TECUA    TEX    THOR    TLK    TMS    TPX    TRMA    TRN    TRV    TSC    TSO    TTC    TXT    UNF    UNT    URI    USU    VE    VLGEA    VLTR    VZ    WAG    WDC    WFT    WGOV    WNC    WRB    WTI    WTIU    WTM    WY    XEL    Y    ZNT    ZZ

Quite a melange, huh?  Well, my quantitative techniques will winnow the list down.  At this phase in the cycle, I am likely to lower my weights that I apply to future earnings.  Profit margins are declining in many places.

The second quarter was good for me on a relative basis, though being away from home, I suspect I am off a tiny amount in the first half, and that I was a little ahead of the S&P 500 in June.  The first two days of the quarter have not been kind, either.  Well, the quarter is young, and we have a lot of the year remaining.  The market is short-term oversold by my oscillator.  When I have opportunities I add a little here and there.

Over the long weekend, I should post the results of my industry and country screens.  I might begin my quarterly reshaping while on the road.  Pretty amazing what one can do with a PC, the Internet, and Bloomberg out in the middle of nowhere.

I try to ignore short term market moves, and just focus on what I have done well with in stock-picking.  Usually that ends up working well for me, though one can never tellwhat the future will hold.  No stock-picking method is perfect.  I try to make mine a little better by structuring my process highly, making fewer decisions, and making the structure of my decisions easier.  I don’t have to choose the best stocks, just a few stocks that will do better than the stocks that I am selling.  Keep repeating that formula, and the results can be quite good.

If you have other replacement candidate ideas, please feel free to pass them on to me and the rest of the readers.  I usually throw them into the mix, and sometimes I buy one of them.

It is a wondrous thing to be the global reserve currency.  We can run government deficits of any size that we want, and the rest of the world gets to fund us by buying our debt.  Thus, when I look at calls for still greater stimulus (through Government spending and borrowing) from men like Bill Gross, Larry Summers, and Bob Shiller, I just groan.  When does the rest of the world say “Enough!”, particularly the Persian Gulf States and other oil exporters who don’t have as much of an economic reason to support the US Dollar, because they don’t have to promote exports to the rest of the world.  But, perhaps for political reasons, they keep buying US debts.

This will not end well; the only questions are when, and how severe?  On this issue, I’m not sure it matters who the next president is, because the US no longer independently controls its own destiny.  (Great question for the debates: “Sir, what will you do as President to strengthen the Dolllar’s position as the global reserve currency?”  I would expect the intelligent equivalent of a stutter.)  The main barrier is that there is no good replacement for the Dollar as the global reserve currency.  The Euro could still fail; large-scale monetary unions need to be political unions for them to succeed in the long run.  The rest of the currencies are too small, or their banking systems insufficiently liberalized.

But, maybe the world could live without a single reserve currency.  Currencies could compete against each other, and gold, and other commodities.  This is an age of computers; I’m not sure why there would have to be one standard of value, particularly, when the standard of value varies so much.

I’m still away on vacation, so I may not post a lot until I am back on July 8th.  I did do a trade today; I bought some Smithfield Foods (rebalancing buy).  I suspect they will export a lot more as time goes on, and perhaps one their new major owners agrees.  After all, China’s staple meat is pork, and Smithfield is a high-quality provider.  This is just another way that I consider global demand, rather than local demand.

Bringing this piece full circle, perhaps China found a better way to recycle dollars; at least this investment brings home the bacon.

Full disclosure: long SFD