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- THE FRIDAY LETTER -
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from Gilder Publishing,
for friends and subscribers)
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| http://www.gilder.com/ | Issue 358.0/October 3,
2008
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HEADLINES:
- The Week / Metcalfe: The Enernet (video)
- Friday Feature / Kessler: Paulson
Plan Will Make Money for Tax Payers
- Friday Blogger Bonus / Karlgaard: Open Letter to
Steve Schmidt
- Readings /
The
Week /
The Enernet (video)
BOB METCALFE (speaking at Gilder/Forbes Telecosm 2008): I’d like to
thank George for giving me the opportunity to share with you one of my
enthusiasms. Energy!
I’d like to tell you the short
story of how I got into energy. (And, yes George, I am an energy venture
capitalist, one of the people you were disparaging yesterday… The trend now is,
no matter what you are investing in, you call it “energy”.)
I am an Internet tycoon and one of
my many enthusiasms now is energy. The reason is very simple. There are these
trillion dollar energy markets that are poorly served. Why wouldn’t a person
whose job it is to make money for his investors go into energy?
How I got started was I was
sitting in the audience at MIT when our then new president Susan Hockfield
announced the beginning of the MIT Energy Initiative, expressing the optimism
that the energy crisis was exactly the type of problem that MIT could solve.
Since I am a loyal MIT alum and trustee, I said “Okay” and got on the team.
Another reason is that I’m at
Polaris (http://www.polarisventures.com/). We’re a diversified high-tech
venture capital firm, and here was this big hole in our portfolio. We had no
energy investments. I argued, “We’re in infotech, biotech, healthtech,
nanotech, mediatech, so why not enertech?”
Before
this, I was a pundit for ten years. So
part and parcel of my commitment to energy, I thought I would begin to
punditize about energy. I began an ongoing journalistic project called the
“Enernet”— an ongoing project mining the history of the Internet for lessons on
how we should solve the energy problem and how we’re actually going to meet the
world’s needs for cheap and clean energy….
View the video of Bob’s complete Telecosm 2008 talk “The Enernet: Lessons learned
from 62 years of Internet history”: http://www.discovery.org/v/361
|
The Gilder Telecosm Forum To
learn how to join this powerful network of talented, tech-savvy investors and
thinkers online daily to debate, discuss, and decode new and emerging
technologies and share valuable and actionable investment advice, visit www.Gildertech.com today. |
Friday Feature / Paulson Plan Will Make
Money for Tax Payers
ANDY KESSLER, Wall Street Journal (9/25/08): In 1992, hedge-fund
manager George Soros made $1 billion betting against the British pound. In
2007, John Paulson's Credit Opportunities fund correctly bet against subprime
mortgages, clearing $15 billion for the year and $3.7 billion for him. Warren
Buffett is now hoping to make big money on Goldman Sachs.
But these are small-time deals. My analysis
suggests that Treasury Secretary Henry Paulson (a former investment banker, no
less, not a trader) may pull off the mother of all trades, which could net a
trillion dollars and maybe as much as $2.2 trillion -- yes, with a
"t" -- for the United States Treasury.
Here's what's
happened so far. New technology like electronic trading meant that Wall Street's
bread-and-butter business of investment banking and trading stocks stopped
making much money years ago. So investment banks took their enormous capital
and at first packaged yield-enhanced, subprime mortgage loans into complex
derivatives such as collateralized debt obligations (CDOs). Eventually and
stupidly, these institutions owned them for themselves -- lots of them, often
at 30-to-1 leverage. The financial products were made "safe" by
insurance products known as credit default swaps, a credit derivative from
companies such as AIG. When housing turned down, the mortgages and derivatives
were worth a lot less and no one would lend Wall Street money anymore.
Then the piling on started. Hedge funds could
short financial stocks and then bid down the prices of CDOs stuck on Wall
Street's balance sheets. This was pretty easy to do in an illiquid market.
Because of the Federal Accounting Standards Board's mark-to-market 157 rule,
Wall Street had to write off the lower value of these securities and raise more
capital, diluting shareholders. So the stock prices would drop, which is what
the shorts wanted in the first place. It was all legit.
There is a saying on Wall Street that goes,
"The market can stay irrational longer than you can stay solvent."
Long Term Capital Management learned this lesson 10 years ago when it got its
portfolio picked off by Wall Street as its short-term financing dried up. I had
thought the opposite -- hedge funds picking off Wall Street -- would happen
today. But in a weird twist, it's the government that is set up to win the
prize.
Here's how: As short-term financing dried up,
Fannie Mae and Freddie Mac's deteriorating financials threatened to trigger
some $1.4 trillion in credit default swap payments that no one, including giant
insurer AIG, had the capital to make good on. So Treasury Secretary Henry
Paulson put Fannie and Freddie into conservatorship. This removed any
short-term financing hassle. He also put up $85 billion in loan guarantees to
AIG in exchange for 80% of the company.
Taxpayers will get their money back on AIG. My
models suggest that Fannie and Freddie, on the other hand, are a gold mine. For
$2 billion in cash up front and some $200 billion in loan guarantees so far,
the U.S. government now controls $5.4 trillion in mortgages and mortgage
guarantees.
Fannie and Freddie each own around $800 million in
mortgage loans, some of them already at discounted values. They also guarantee
the credit-worthiness of another $2.2 trillion and $1.6 trillion in
mortgage-backed securities. Held to maturity, they may be worth a lot more than
Mr. Paulson paid for them. They're called distressed securities for a reason.
Now Mr. Paulson is pitching Congress for $700
billion or more to buy distressed loans and CDOs from the rest of Wall Street,
injecting needed cash onto balance sheets so that normal loans for economic
activity can be restored. The trick is what price he will pay. Better mortgages
and CDOs are selling for 70 cents on the dollar. But many are seriously
distressed (15-25 cents on the dollar) because they are the last to be paid in
foreclosures. These are what Wall Street wants to unload the quickest.
Firms will haggle, but eventually cave -- they
need the cash. I am figuring Mr. Paulson could wind up buying more than $2 trillion
in notional value loans and home equity and CDOs for his $700 billion.
So the U.S. will be stuck with a portfolio in the
trillions of dollars in bad loans and last-to-be-paid derivatives. Where is the
trade in that?
Well, unlike Mr. Buffett or any hedge fund, the
Treasury and the Federal Reserve get to cheat. It's not without risk, but the
Feds, with lots of levers, can and will pump capital into the U.S. economy to
get it moving again. Future heads of Treasury and the Federal Reserve will be
growth advocates -- in effect, "talking their book." While normally
this creates a threat of inflation and a run on the dollar, and we may see
dollar exchange rates turn south near term, don't expect it to last.
First, with Goldman Sachs and Morgan Stanley now
operating as low-leverage bank holding companies, a dollar injected into the
economy will most likely turn into $10 in capital (instead of $30 when they
were investment banks). This is a huge change. Plus, a stronger U.S. economy,
with its financial players having clean balance sheets, will become a safe
haven for capital.
Europe is threatened by an angry Russian bear. The
Far East, especially China, has its own post-Olympic banking house of cards of
non-performing loans to deal with. Interest rates will tick up as the economy
expands -- a plus for the dollar. Finally, a stronger economy driven by
industry instead of financials means more jobs, less foreclosures and higher
held-to-maturity payouts on this Fed loan portfolio.
You can slice the numbers a lot of different ways.
My calculations, which assume 50% impairment on subprime loans, suggest it is
possible, all in, for this portfolio to generate between $1 trillion and $2.2
trillion -- the greatest trade ever. Every hedge-fund manager will be jealous.
Mr. Buffett is buying a small piece of the trade via his Goldman Sachs
investment.
Over 10 years this could change the budget
scenario in D.C., which can also strengthen the dollar. The next president gets
a heck of a windfall. In the spirit of Secretary of State William Seward's
purchase of Alaska for $7 million in 1867, this week may be remembered as
Paulson's Folly.
More from Andy Kessler:
http://www.andykessler.com/
__________________________________________
Friday Blogger Bonus / An Open
Letter to Steve Schmidt
RICH
KARLGAARD, “Digital Rules” Forbes.com (10/01/08): Congratulations!
John
McCain's presidential campaign was in disarray when you took it over this
summer. You whipped it into shape in weeks. You’ve kept the maverick on
message. You mocked the vain campaign of The One on YouTube; you supported
John’s game-changing pick of Palin; and you engineered a Republican convention
that drove Obama’s bounce into the ditch.
By mid-September,
John had soared ahead in polls and prediction markets. Your blitzes had gotten
into Obama's head. The Democrat looked shocked. He visibly tightened up and
lost his message and easy charm. The One looked old, aging and cracking before
our eyes.
Then
came the meltdown on Wall Street. I needn’t repeat John’s confused response and
incoherent words, because I am sure they pain you, and he, too. You would like
to have those two weeks back. You must be relieved that John performed well in
Oxford, Miss. Otherwise, his two-week poll slip might have become a landslide.
Before the debate, John Zogby and Bill Clinton were even hinting of an Obama
electoral landslide.
The
debate stopped that talk. For two days. But now the markets have opened poorly
again. Americans are worried. What are you and John going to do about it? With
five weeks to go in the race, how can you convince Americans that McCain-Palin
is the right economic choice?
Here
are some thoughts:
1.
Send Douglas Holtz-Eakin packin’. It was never a good idea, in a populist
year, to have a campaign economist with a freaking hyphenated name. Holtz-Eakin
predated your arrival, so this egg is not your fault. Get rid of him now. No,
don’t it make it official. Do it quietly. No need for campaign shakeup stories
splattered on the Olbermann network. Send Holtz-Eakin on a nice vacation. At
the very least, get him the heck off TV. Have you seen Holtz-Eakin on TV? Whoo
boy. What a snooze.
2.
Tell John to cut the greed talk. Anger is not leading. Anger is following.
Hell, everyone is angry. What people want now is hope and inspiration. Point
out that shining city on a hill, and tell Americans how we'll reach it.
3. Speak to
small businesses! For crying out loud, small biz owners and employees are the
neglected constituency in this year’s election. There are millions of them.
Small biz employs 50% of American workers and creates 70% of new jobs. Small
biz is angry at Washington. But small biz is even angrier at the prospect of
ruinous Obama-Pelosi-Reid taxes and regulations.
4.
Get Steve Forbes to be your economic spokesman. Or coach. Or something. Yes,
Steve was a Rudy man. Yes, Steve and John locked horns in 2000 while Texas Air
Guard Boy flew breezily untouched. Forget all of that. Steve Forbes knows more
about the economy, high finance and monetary policy than anyone. He can explain
it to Main Street in simple words. Small business owners love Steve! That’s all
you need to know.
You
and John have only five weeks to go. It’s now or never. Did I mention
McCain-Palin should court small businesses?
Best
of Luck,
Rich Karlgaard, Publisher, Forbes magazine
Check
out Rich’s “Digital Rules” blog:
http://blogs.forbes.com/digitalrules/
__________________________________________
Readings /
House Begins Vote on Bailout
http://online.wsj.com/article/SB122304922742602533.html
Major Industries Drop the Ball on Data Security
http://hothardware.com/News/Major-Industries-Drop-The-Ball-On-Data-Security/
Biden, Palin Clash on Taxes, Iraq in Sharp-edged Debate
http://online.wsj.com/article/SB122296343189798679.html
AT&T in No Rush to Build Out 4G Network
http://www.appleinsider.com/articles/08/10/02/att_in_no_rush_to_build_out_4g_network.html
Electricity Over Glass
http://www.spectrum.ieee.org/oct05/1863
Simpler Flexible Displays
http://www.technologyreview.com/computing/21465/?a=f
HP to Buy LeftHand Networks
http://www.byteandswitch.com/document.asp?doc_id=165035&WT.svl=news1_6
__________________________________________
Friday Letter Editor: Mary Collins George / mcollins@gilder.com
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