July 2008


If I reproduce my table, I can examine more closely the effect of war on the economy.

Year………………………………Return on Capital…………Inflation%……….Adjusted
1871-1881……………………………8.3%…………………..[-1.7%]………….10%
1881-1891……………………………6.4%………………….[-1.16%]………….7.56%
1891-1901…………………………..7.3%…………………..[-0.6%]……………7.9%
1901-1911…………………………..7.2%…………………..1.12%……………..6.08%
1911-1921…………………………..5.7%…………………..6.87%…………….[-1.17%]
1921-1931…………………………..7.3%………………….[-1.6%]……………8.9%
1931-1941…………………………..7.5%………………….[-0.3%]……………7.8%
1941-1951………………………….12.3%………………….5.84%……………..6.46%
1951-1961…………………………..7.4%………………….1.42%………………5.98%
1961-1971…………………………..5.4%………………….3.08%……………..2.32%
1971-1981…………………………..8.7%………………….8.42%……………..0.28%
1981-1991………………………….7.8%…………………..4.12%……………..3.68%
1991-2001………………………….4.1%…………………..2.66%……………..1.44%
2001-2008………………………….3.8%…………………..3.1%……………….0.7%

Now we’ll break the data into individual years.

Year………………………Inflation………Return to Capital…….Adjusted
World War I
1914………………………0.94%……………..7.13%……………..6.19%
1915………………………0.54%……………..8.7%……………….8.16%
1916………………………9.24%…………….12.9%………………3.66%
1917……………………..20.49%……………15.5%……………..[-4.99%]
1918……………………..17.47%……………15.3%……………..[-2.17%]
World War II
1939………………………[-1.42%]…………6.6%……………….8.02%
1940………………………1.01%……………10.7%………………9.69%
1941………………………4.99%……………11.7%………………6.71%
1942…………………….10.66%……………11.7%………………1.04%
1943……………………..6.13%…………….9.0%……………….2.87%
1944……………………..1.73%…………….7.2%……………….5.47%
1945……………………..2.27%…………….6.6%……………….4.33%
Vietnam
1964…………………….1.34%…………….5.3%………………..3.96%
1965…………………….1.71%…………….5.6%………………..3.89%
1966…………………….2.85%…………….6.3%………………..3.45%
1967…………………….2.90%…………….5.8%………………..2.90%
1968…………………….4.19%…………….5.5%………………..1.31%
1969…………………….5.37%…………….5.8%………………..0.43%
1970…………………….5.92%……………7.3%…………………1.38%
1971…………………….4.30%……………5.3%…………………1.00%
War on Terror
2001…………………….2.85%……………2.9%…………………0.05%
2002…………………….1.58%……………2.6%…………………1.02%
2003…………………….2.28%……………3.4%…………………1.12%
2004…………………….2.66%……………4.9%…………………2.24%
2005…………………….3.39%……………5.2%…………………1.81%
2006…………………….3.23%……………5.9%…………………2.67%
2007…………………….2.85%……………4.3%…………………1.45%
2008…………………….4.90%……………4.1%………………..[-0.80%]

There are numerous variables that have not been considered;
*existing deficit/surpluses
*demographics
*over-all size of the economy
*size [cost] of the conflict

There seems to be no immediate conclusions that can be drawn from the data across the different conflicts. It would seem that the over-all state of the economy would need to be considered as a whole. Certainly the war periods will provide significant inputs, but have no individual pattern or trend that reveal themselves from a very basic analysis.

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Ugly data.

Corporate bankruptcies are starting to accelerate;

Mervyn’s and the parent company of Bennigan’s both filed for bankruptcy protection yesterday, providing more evidence that the pace of corporate flame-outs is accelerating.

Only half way through 2008, billion-dollar bankruptcies are at their highest level in five years, according to BankruptcyData.com, which tracks bankruptcy filings. It said that seven United States-based companies with more than a billion dollars in assets have filed for bankruptcy protection so far this year, according to a Reuters report.

“We seem to be in the midst of a ‘perfect storm’ leading to more bankruptcies: high levels of debt, high energy and raw materials costs and weakness in the U.S. economy,” George Putnam III of New Generation Research, which publishes BankruptcyData.com, said in a statement.

Mervyn’s, the department store chain, blamed its Chapter 11 filing on the “state of the economy and difficult operating environment for our industry.” It said its stores will remain open as it reorganizes under court protection.

Bennigan’s, a restaurant chain, filed for Chapter 7 protection; stores owned by its parent company will close their doors.

Earlier this year, Linens ‘n Things, a retail chain backed by the giant buyout firm Apollo Management, sought bankruptcy protection after it was unable to service its heavy debt load.

One of the year’s biggest bankruptcies so far was SemGroup LP, an oil-marketing firm that Forbes has called the 12th-largest private company in the United States.

The casualties are likely to keep coming.

A recent report from Moody’s said that more than 10 percent of the speculative-grade companies whose liquidity it rates had the lowest possible rating — something that hasn’t happened in five years.

The following post describes the “Reverse Merger Arbitrage.” Actually it’s not really an arbitrage at all, as you are not selling and buying the same financial asset and locking in a guaranteed profit via a spread.

However, that being said, it is I believe an attractive speculation, albeit that you can only utilize small amounts of capital.

From http://www.gualbertodiaz.com/ Which is a sub-blog of SMB Capital in the blogroll.

I’ve been meaning to write this post for a couple of days now. This is an arbitrage opportunity that I have found to be successful and requires the minimal use of capital for about 2 weeks at a time. Rather than go public via an initial public offering, some companies are going public via a reverse merger. What these private companies do is purchase a public shell, which is a stock that is publicly traded but is basically out of business. The private company gets issued preferred stock which is convertible to normal shares on a 10:1 basis (varies on each deal).

With all these preferred shares converted to regular shares, the private company takes control of anywhere from 90-95% of the float. Talk about dilution of shares huh? So at this point you’ll have anywhere from 50 million to 300 million shares outstanding. Anywhere in the range of these numbers, the stock price will be worth pennies for years until it grows into its valuation.

So once the private company converts its preferred shares, it immediately completes a reverse merger, maintaining the private company’s equity stake of 95%. Here’s where the opportunity of arbitrage presents itself. When the company completes its reverse merger, in an effort to preserve round lots, it usually includes a provision to for any shareholders holding either 100 or 99 stocks or less to not be affected by the reverse merger.

So to illustrate how its done, let me show you what was done in the two instances that I was involved in.

In the first instance, I purchased 99 shares of MJET on May 25, 2005 at $.22 a share for a total of $21.78. In the company’s current report at the time, it stated the company’s plan of action. After the 1-29 reverse merger occurred, I then sold those 99 shares at $9.00 a share under the company’s new symbol, BLHL on June 10, 2005 for a total of $891.00.

In 17 days I received a 4090% return on my investment! In the second instance, it was still a profitable trade, although the return wasn’t as high mainly because the initial share price was so much lower.

I purchased 99 shares of TDIH at $.058 on August 25, 2005 for a total of $5.75. In the company’s current report at the time, it stated its plan of action. After the 1-21.8 reverse merger occurred, I then sold those 99 shares at $1.25 a share under the company’s new symbol, FHHI on September 1, 2005 for a total of $123.75

In 8 days I received a 2152% return on my investment. Even though it wasn’t as good as the first deal, it was still free money. I must note that later I did get back into FHHI at $.79 a share and that it is currently one of my holdings. I will be posting on the company in the near future.

So arbitrage opportunities do exist in the stock market. The reason this one exists is because so little money is involved when you compare it relatively to the rest of Wall Street. One note I need to make though: I have friends that have Scottrade and I know they had trouble with it because of some problem within Scottrade’s back office I believe. I use Etrade and experienced no problems. I believe they still kept their shares, but had to wait a little bit longer.

Although I have not been as up to date with this market as I should be, I will post on here when I know of any new reverse merger arbitrage opportunities.

Just while we are talking about allocation of capital, here are the data on current earnings;

If you actually examined the Banks margins from 1991 to the current, or peak of their share prices, it was very easy to see the massive deterioration in their margins. Compare the deterioration in margins to their “increased” earnings, and it was only one step to the question…how?

The answer was of course leverage. The rest would have been fairly obvious.

The best way to approach the consequences of deficit spending is from the perspective of “what if there was still a Gold/Dollar exchange?”

When the dollar was directly convertible to gold, a deficit in foreign trade, led directly to an outflow of gold. If China held $1Billion in paper dollars, they would exchange them for gold, thus directly reducing the amount of gold held by the US

This would then have the direct consequence of reducing the money supply [currency dollars] by $1Billion. With less currency in circulation, competition for money [currency dollars] would increase.

If I owned a business that required capital for expansion, and I wished to borrow that capital, with capital becoming more scarce, the cost of that capital would rise. Prudence would suggest that if the return on that capital would not, or could not exceed the cost of that capital, then, I would not, should not borrow that capital.

In other words, only the most sound, profitable and productive businesses would seek capital. This immediately allocates capital in a rational manner, eliminating capital being allocated to businesses that have no basis for capital, as the probabilities lie in their destruction of said capital.

Gold is thus deflationary. The same rules that govern the allocation of capital to a business, apply in equal measure to a government. Thus gold, was above the ability of the government to control and manipulate, an impartial arbiter. Being deflationary, it increased and punished the burden of excessive indebtedness.

Today, gold is a long distant memory within the allocation of capital. Money, via fiat currencies has lowered the cost of capital through inexorable inflation and credit creation.

Inflation, cheapens debt. Inflation, promotes excessive indebtedness, as, over time, the real cost diminishes as the value of money diminishes.

With America currently struggling under the collapse in housing, a credit contraction that both have threatened the viability of the financial system, how well has America allocated capital?

Lets examine the data.

Year………………………………Return on Capital…………Inflation%……….Adjusted
1871-1881……………………………8.3%…………………..[-1.7%]………….10%
1881-1891……………………………6.4%………………….[-1.16%]………….7.56%
1891-1901…………………………..7.3%…………………..[-0.6%]……………7.9%
1901-1911…………………………..7.2%…………………..1.12%……………..6.08%
1911-1921…………………………..5.7%…………………..6.87%…………….[-1.17%]
1921-1931…………………………..7.3%………………….[-1.6%]……………8.9%
1931-1941…………………………..7.5%………………….[-0.3%]……………7.8%
1941-1951………………………….12.3%………………….5.84%……………..6.46%
1951-1961…………………………..7.4%………………….1.42%………………5.98%
1961-1971…………………………..5.4%………………….3.08%……………..2.32%
1971-1981…………………………..8.7%………………….8.42%……………..0.28%
1981-1991………………………….7.8%…………………..4.12%……………..3.68%
1991-2001………………………….4.1%…………………..2.66%……………..1.44%
2001-2008………………………….3.8%…………………..3.1%……………….0.7%

It can be plainly discerned that capital is systematically being destroyed, as it’s allocation to businesses have lowered the return. Profitability has been destroyed. This is why America is now in such dire straits, capital has been allocated to rubbish.

Also, the way in which the Gold Standard maintained a deflationary milieu, thus enhancing the returns to capital. The massive deficits that the government maintain currently, simply would not have been tolerated under a Gold Standard.

Of course, even the way that inflation is measured has been altered by successive governments, thus understating the true inflationary effects on capital.

The answer is simple, restore the cost of capital by again making businesses compete for a scarce resource. Then, once again, capital will be allocated to those who can earn a return in excess of it’s cost, restoring the allocation of capital to quality, rather than allocating capital to any fool who asks, that fool would most definitely include your elected members of government.

I’ll provide a detailed analysis later in the week. For now, just the quick basics;

American Campus Communities, Inc. is a fully integrated, self-managed and self-administered equity real estate investment trust (REIT). It specializes in the acquisition, design, financing, development, construction management, leasing and management of student housing properties across the United States. American Campus Communities conducts its business through a controlling interest in American Campus Communities Operating Partnership LP and American Campus Communities Services, Inc., which serves as a taxable REIT subsidiary (TRS). Through the TRS, the Company also provides construction management and development services, for student housing properties owned by colleges and universities, charitable foundations, and others. On June 11, 2008, American Campus Communities, Inc., completed the acquisition of GMH Communities Trust, a real estate investment trust (GMH). With the close of the GMH acquisition, it owns 88 student housing properties containing approximately 54,300 beds.

This is one guessing game that will not end with the showcase showdown. In valuing a truckload of securities at 22 cents on the dollar, Merrill Lynch & Co.’s fire sale might burn some other fingers on Wall Street.

The company Monday decided to offload $30.6 billion in securities to private equity firm Lone Star Funds at 22 cents on the dollar, producing a rare data point in the market place, where banking institutions, for months, have kept their own counsel on what their various toxic assets were worth.

In doing so, the price may now serve as a benchmark (or even a ceiling) for the value of various other collateralized debt obligations owned by banks such as Citigroup Inc. and Barclays PLC.

This is capitulation from an institutional viewpoint. Merrill have basically given in, and simply want out. Thus, sell everything, take the loss, wipe-it-off the Balance Sheet and move forward.

The breakdown looks like this; selling $8.5Bn in stock (half of which is being bought by management and Temasek holdings), a fire sale of assets and an additional write-down of $5.7Bn. This write-down is comprised of a $4.4 billion loss associated with the sale of CDOs, a $0.5 billion net loss on the termination of hedges with XL Capital Assurance and an approximately $0.8 billion maximum loss related to the potential settlement of other CDO hedges with certain monoline counterparties.

This is a huge step forward, and other Banks, as stated, may well be forced, willing or not, to also chuck in the kitchen sink and take the “big bath quarter.” If they do, it will mark a return of the value investors who know their business.

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