Geithner’s Victims of Last Resort by Gary North

Geithner's Victims of Last Resort

by Gary North

Recently by Gary North: The #2 Port in the Academic Storm Is About to Close



You may have heard that the Federal Reserve System is the lender of last resort. This is a misleading concept. The Federal Reserve loans the U.S. government newly created fiat money. The government issues the FED an IOU. It is backed by the full faith and credit of the United States government. But who stands behind the United States government, wallets in hand? You do. And so do I.

We are the victims of last resort.

On May 13, Timothy Geithner wrote a letter to Colorado's Senator Michael Bennet. In his letter, he presented the case against freezing the debt ceiling. The letter is here.

Geithner began with a statement that is muddled almost beyond belief. "As you know, the debt limit does not authorize new spending commitments." Quite true. The debt limit does not authorize anything. It prohibits the authorization of any further borrowing. Officially speaking, prohibiting borrowing is the idea behind the debt ceiling. That is why Congress keeps raising it. Congress does not want to cut spending. It also does not want to raise taxes in order to pay for the spending.

The sentence says the opposite of Geithner's point. We know this because of what came next. "It simply allows the government to finance existing legal obligations that Congresses and presidents of both parties have made in the past."

He therefore did not really mean that "the debt limit does not authorize new spending commitments." He meant to write this: "An increase in the debt limit does not authorize new spending commitments." Therefore, he reminded Bennet, to raise the debt limit does not authorize any new spending commitments. Geithner, in his befuddled way, was trying to offer Congress a fig leaf to cover its nakedness. By raising the debt ceiling, Congress will be perceived by the voters as spending recklessly, which is an accurate perception. Geithner was trying to say this: by raising the debt ceiling, Congress does not automatically pass new spending laws.

Millions of voters understand this shell game. If the ceiling gets raised, Congress can then vote for new spending bills. If it doesn't get raised, Congress cannot pass new spending bills without cutting existing spending. The debt ceiling inhibits Congress.

Geithner's sales pitch is simple: Congress must raise the debt ceiling in order to meet its existing commitments. He is giving Congress a way to justify this ceiling hike to constituents. "We're not wild spenders. We're merely making it possible to fulfill previous Congressional commitments made to the public. You don't want us to break our promises, do you?"

He then wrote: "Failure to raise the debt limit would force the United States to default on these obligations, such as payments to our servicemembers, citizens, investors, and businesses." This is correct. This is the famous bottom line.

Do you see what this implies? A rising debt ceiling is built into American politics. Using Geithner's logic, there is no escape from an ever-larger national debt. Every year, the ceiling will have to be raised. Medicare is in the red. Social Security is in the red. Combined, they are about $100 trillion in the hole, according to some estimates.

Who is going to buy this Treasury debt as it rolls over every 50 months (today's average maturity)? For how much longer? This money will have to come from somewhere. It will come from money that might otherwise be invested in the private sector.

Ever since November 2010, the money has come mainly from the Federal Reserve System: $600 billion in newly created money. This will stop after this week. Then what?

The constant absorption of capital by the U.S. government cannot go on forever. It will undermine the growth of the economy by transferring investment capital to the Treasury. When the economy stops growing, the deficit will get worse. At some point, investors will stop lending to the Treasury at anything except very high rates. This will turn a recession into a depression. The government will raise the debt ceiling, but it will not get the funds required to keep spending. This process of ever-rising debt will not go on. As economist Herb Stein observed decades ago, when something cannot go on, it has a tendency to stop.

This means that when the Federal Reserve finally stops buying U.S. debt, there will be a great default. I mean finally. I do not mean temporarily. I do not mean this year. The fear of another recession may keep the safe-haven money flowing into the Treasury this year. But, at some point, investors will demand higher interest rates. Geithner's letter raises this specter of higher interest rates if the debt ceiling is not raised. But this threat will also exist if the debt ceiling is raised and raised again, as it will be.

The Federal Reserve at some point will start buying Treasury debt again to keep rising rates from crippling the economy. This means price inflation will return, as it did in the late 1970s. Then it will move above that era's rate of rising prices. This is why the FED will eventually have to face the music: either hyperinflation or the Great Default. I believe that it will choose the Great Default. If it refuses, then the dollar will collapse.

In either case, the division of labor will contract. In either case, there will be bankruptcies. There will be massive unemployment of people and resources.

We are nowhere near this moment of truth. I know there are lots of people out there who say that hyperinflation is imminent. They are wrong.


Geithner is facing a default if the debt ceiling is not raised. He said that a default would call into question for the first time the full faith and credit of the United States government. He is correct. I can think of no more liberating event. The monster would go bust.

Investors around the world would lose money, he says. I surely hope so. That might keep them from financing the monster again. Anyway, for a couple of years.

He thinks there will still be buyers, but at higher rates. That would restrict the government's spending, since the government would have to pay investors rather than subsidize new boondoggles.

Default would increase borrowing costs for everyone, he wrote. He did not say why this would be the case. If the government defaults, people will invest elsewhere. It seems to me that this would be good for the private sector. Geithner needs to prove his case.

"Treasury securities are the benchmark interest rate," he wrote. They are? Why should a FED-subsidized interest rate be the benchmark? Why should an out-of-control international debtor set the standard?


"A default would also lead to a steep decline in household wealth, further harming economic growth." Think about this. A thief sticks a gun in your belly. He says, "hand over your money . . . forever." He then shares this money – after handling fees – with his fellow mobsters.

Geithner is saying that if the victims ever decide not to let the thief steal any more of their money, this will reduce household wealth. It will indeed – the household wealth of the thieves. It will increase the household wealth of the victims.

"Higher mortgage rates would depress an already fragile housing market, causing home values to fall." Fact: home values have fallen even as the U.S. Government's debt ceiling has soared. There is a reason for this. As the government has borrowed more money, thereby reducing the money available to the private sector, housing prices have fallen. He did not explain this economic fact. He did not mention it. I can understand why not.

"This significant reduction in household wealth would threaten the economic security of all Americans and, together with increased interest rates, would contribute to a contraction in household spending and investment." He meant the households of politicians, bureaucrats, and everyone who is on the take from the U.S. government.

But what about the victims? What about the taxpayers whose net worth is being used as collateral for Treasury debt? Why would a ceiling on the government's pledge of their future wealth produce a "significant reduction" in their future household wealth? He needed to explain this.

Keynesian economists need to explain this.

Keynesian financial columnists need to explain this.

They never do.


"Default would also have the perverse effect of increasing our government's debt burden, worsening the fiscal challenges that we must address and damaging our capacity for future growth." So, if Congress votes to cap the government's debt, this will produce even greater debt. We must therefore seek national solvency through additional debt. Solvency through debt! I am reminded of another group of slogans: war is peace, freedom is slavery, and ignorance is strength.

What else would a default do? "It would increase rates on Treasury securities, which would significantly increase the cost of paying interest on the national debt." Yes, it would. But the question arises: If the government defaults on its debt, why would it bother to pay any interest at all? The whole idea of default is to stop paying.

It's just like people who owe more on their homes than the homes are worth. They stop paying. If they are evicted – most are not for months or years – they will rent. They will pay less in rent than they pay on their mortgages. In the meantime, they pay nothing except property taxes. (Governments will foreclose when lenders won't.)

The idea of the debt ceiling is to keep the government from running up its tab, based on the future net worth of taxpayers. The idea behind opposing any increase of government debt is this: "Let's stop any new spending projects." Higher interest rates, if they come as Geithner said they will come, will reduce the ability of the government to start new wealth-distribution boondoggles. The money that would have funded the new projects will have to go to creditors in the form of interest payments.

Why is this bad?

It is bad if you are a member of a group that gets payoffs from the Federal Godfather. It is not bad if you are not.

He said that a default will lead to weaker growth. It will lead to more unemployment. A sagging economy will lead to lower tax revenues and "increased demand on our safety net programs." Whose safety net programs? "Ours."

Why will unemployment rise if the government cannot spend borrowed money? Why won't taxpayers save more money, leading to greater economic output and therefore reduced unemployment? Why is it bad for the economy to allow taxpayers to spend more of their own money the way they want to? These questions apparently did not occur to Geithner, or if they did, he chose not to consider them.

A default will lead, he said, to a reduction in "productive investments in education, innovation, infrastructure, and other areas. . . ." He said "investments." That is a political code word for "government subsidies." A default would mean that the government will have to spend less in those areas of the economy in which (1) politicians buy votes, (2) salaried, Civil Service-protected bureaucrats spend money to innovate, and (3) the teacher unions prosper.

He warned that "Treasury securities are a key holding on the balance sheets of every insurance company, bank, money market fund, and pension fund in the world." This is true. This means that taxpayers' future wealth has been mortgaged to provide securities for these outfits. So, if we take this argument seriously, how will the government ever stop increasing the debt ceiling? It won't. The Federal debt system has addicted the world's financial institutions to the promise that American taxpayers are the victims of last resort.

The U.S. government borrows by promising that American taxpayers will fork over the money. The mob has bought itself fiscal credibility. It has guns and badges, and it can finance itself by assuring investors that these guns and badges will be used.

How can this ever be stopped? Geithner or his successors will be able to use this argument forever.

There are two ways that it can be stopped: (1) hyperinflation by the Federal Reserve, which will buy the Treasury's IOUs when other investors cease; (2) default whenever the Federal Reserve stops buying new Treasury debt. One or the other must happen, because (1) the Congress keeps running $1.5 trillion annual deficits, and (2) the Social Security and Medicare liabilities are unfunded.

In the meantime, Geithner implores Congress to kick the can one more time. He will be back for another increase in a year. He is a cheerleader. "Kick it again! Kick it again! Harder! Harder!"


He said that a default would raise questions about the solvency of the institutions that hold Treasury debt. This could cause a run on money-market funds. It could be "similar to what occurred in the wake of the collapse of Lehman Brothers." He said that this could "spark a panic that threatens the health of the our entire global economy and the jobs of millions of Americans."

This sounds terrifying, but is it true? We have heard all this before: in September and October of 2008. Geithner's predecessor, Hank Paulson, and Ben Bernanke warned high-level Congressmen that this was about to happen. That was how they got Congress to fund TARP. But they never proved that a collapse was imminent. In a persuasive presentation, former budget director David Stockman has shown that no such collapse was imminent.

"Even a short-term default could cause irrevocable damage to the American economy." Irrevocable! Really? Is the American economy so dependent on Treasury interest payments that everything that Americans do or own is at risk? Why? Because "Treasury securities enjoy their unique role in the global financial system precisely because they are viewed as a risk-free asset." I see. Risk-free assets. But risk is inescapable in life. Geithner said that this does not apply to buyers of IOUs from the U. S. Treasury. Not yet, anyway.

When an IOU issued by an agency that is running a $1.6 trillion annual on-budget deficit is regarded as risk-free by investment fund managers, then my strong suggestion is that you not allow those fund managers to handle your retirement portfolio.

"Investors have absolute confidence that the United States will meet its debt obligations on time, every time, and in full." They do? Really? Then they are incapable of reading a balance sheet.

"That confidence increases demand for Treasury securities, lowering borrowing costs for the Federal government, consumers, and businesses." It does? Really? Let me understand this. The demand for Treasury securities increases, because investors with "absolute confidence" in the Treasury's IOUs hand over their money to the Treasury. Yet this transfer of funds somehow lowers borrowing costs for consumers and businesses. I am a bit confused. If the Treasury gets the capital, how can consumers and businesses also pay less for capital? If money goes to the Treasury, how is it simultaneously made available to consumers and businessmen?

You see my problem. I am not a Keynesian. I have this theory that money transferred to X cannot be simultaneously transferred to Y. If money is spent by X on what he wants to buy, it cannot be spent by Y on what he wants to buy. But this is not the case in the world of Keynes.

"A default would call into question the status of Treasury securities as a cornerstone of the financial system, potentially squandering this unique role and the economic benefits that come with it." I ask: Whose economic benefits? The fellow holding the badge and the gun or the fellow with the wallet?

"If the United States were forced to stop, limit, or delay payment on obligations to which the Nation has already committed," he said, "there would be a massive and abrupt reduction in federal outlays and aggregate demand." Again, I have this problem. I am not a Keynesian. I understand cause and effect as follows. If spending by Y (the government) decreases, this leaves more money in X's (the taxpayer's) wallet. When X spends his money without the middleman of the guy with the badge and the gun, aggregate demand does not change. I realize that this is not true in Geithner's parallel universe, but that's how aggregate demand works in my world.

I guess I need a formula. Without a formula, economists cannot perceive cause and effect. So, here goes: $X + $Y = $X + $Y.

To understand this, we need story problems. We all hate story problems, but they help us understand.

(1) "If X spends $1.6 trillion dollars, and Y spends no dollars, how much is aggregate demand?"

(2) "If Y sticks a gun in X's belly and says 'hand it over,' and then spends $1.6 trillion, how much is aggregate demand?"

(3) "If Y comes to X and says, 'hand it over, but this is a loan,' and X forks it over, when Y spends $1.6 trillion, how much is aggregate demand?"

Geithner does not operate in terms of this formula. So, he said that when the government (Y) stops spending, there will be a decrease in aggregate demand. Somehow, the excess money that is now in X's wallet will disappear. "This abrupt contraction would likely push us into a double dip recession." He did not define "us." He wanted Senator Bennet to believe that if Y spends less money, X will suffer a double dip recession. We're all in the same boat, he implied. Why? Because . . . a drum roll, please . . . we owe it to ourselves!

This is Keynesianism's parallel universe. It is a world of endless increases in the U.S. government's debt ceiling. It is a world of endless increases in the Federal Reserve System's monetary base, filled with IOUs from the U.S. government. It is a world in which guns and badges turn stones into bread.


Here is Geithner's conclusion: "It is critically important that Congress act as soon as possible to raise the debt limit so that the full faith and credit of the United States is not called into question." He went on to say: "I fully expect that Congress will once again take responsible action. . . ."

He and I define "responsible action" differently. He defines it as "authorize people with badges and guns to borrow more money in terms of their ability to get their hands on enough taypayer money to keep paying interest." It is a system in which the taxpayer is the victim of last resort.

I have a different conclusion. I think that Congress will authorize another increase in the debt ceiling. It will do this multiple times. As this limit is increased, there will be a reduction in the number of investors who have absolute confidence in the full faith and credit of the United States government.

Congress is not going to balance the budget, because there seem to be no negative consequences for not balancing the budget, either political or economic. So, the debt will get larger.

At some point, interest rates will rise. Then we will see the negative consequences that Geithner described in his letter.

Geithner is arguing for a delay. That is what most politicians argue for. Today, most politicians have adopted the faith of Dickens' Mr. Micawber: "Something will turn up." They are right: the debt ceiling, then interest rates, then the monetary base, then M1, then the money multiplier, then prices. So will unemployment. Up, up. up.

The key is the money multiplier. When it finally moves up, price inflation will move up with it. Until then, the Federal Reserve can join with Congress in the game of kick the can. The debt ceiling will rise.

Inside the can are lots of IOUs. They are IOU's signed by Congress on our behalf. We are the targeted victims of last resort.

We won't be. At any rate, future voters won't be. The creditors will be.

There will be a Great Default when voters finally say, "We're not going to pay." On that day, your net worth had better not rest on a pile of IOUs issued by the U.S. government. Otherwise, you will be like Thomas Mitchell, in "Gone With the Wind," sitting at his desk in 1865, mad as a hatter, insisting that he was rich. Why? He had lots of government bonds issued by the Confederacy.

So, the victims of last resort will not be the taxpayers after all. They will be the trusting people who retain absolute confidence in the full faith and credit of the United States government right to the bitter end. Either hyperinflation will ruin them or default will, or maybe both: as the Confederacy experienced.

June 29, 2011

Gary North [send him mail] is the author of Mises on Money. Visit He is also the author of a free 20-volume series, An Economic Commentary on the Bible.

Copyright © 2011 Gary North

Published in: on June 30, 2011 at 2:35 pm  Leave a Comment  

Miscellaneous news on AGNC, TNH, and SCCO.

American Capital Agency Corp. (AGNC) news:

Title of article is "Mortgage REIT dividends look risk free this summer".  I generally agree that the MREITs are going to do well this summer.  It takes awhile for an inverted yield curve to develop and wreck their profits.  But the people who write these articles do not understand how the Federal Reserve works.  The chairman of the Federal Reserve Board, Ben Bernanke, says he's keeping a key interest rate low for an extended period of time.  That interest rate is known as the Fed Funds Rate.  It is the rate that banks charge each other for overnight loans to meet reserve balance requirements.  However, the big banks have over $1 trillion in excess reserves.  They aren't lending to each other over night because they are stuffed full of reserves.  Commercial bankers are keeping the Fed Funds rate low not Ben Bernanke.

Its a good thing they commercial bankers aren't expanding lending because if they did loan those excess reserves, then prices would more than double from what they are today.  Think $10/gallon gasoline.

Conclusion: Don't buy AGNC for an investment, but you can buy it for a short term trade.  In the not too distant future interest rates will rise and destroy its asset values and net income profits.

Terra Nitrogen (TNH) news:

Shares of Terra Nitrogen Company, L.P. (NYSE: TNH) fell by 6.44% or $-9.13/share to $132.75. In the past year, the shares have traded as low as $66.38 and as high as $143.50. On average, 44595 shares of TNH exchange hands on a given day and today's volume is recorded at 52049. The shares are currently trading above the 50-day moving average which indicates that the shares have been experiencing strong upward momentum as the 50 DMA is above the 200 DMA. The stock may come back down to test the 50-day moving average, so look for a move back to the $124.35 area where the stock will likely see buying pressure.

Conclusion: Buy it way down in the $90.00 range when it is on sale.

Southern Copper (SCCO) news:

Southern Copper (SCCO) Showing Bearish Technicals With 7.23% Dividend Yield

Southern Copper (NYSE:SCCO) closed Wednesday's winning trading session at $32.25. In the past year, the stock has hit a 52-week low of $25.65 and 52-week high of $50.35. Southern Copper (SCCO) stock has been showing support around $31.50 and resistance in the $33.34 range. Technical indicators for the stock are Bearish. For a hedged play on Southern Copper (SCCO), look at the Aug '11 $32.00 covered call for a net debit in the $30.65 area. That is also the break-even stock price for this trade. This covered call has a duration of 51 days, provides 4.96% downside protection and an assigned return rate of 4.40% for an annualized return rate of 31.52% (for comparison purposes only). A lower-cost hedged play for Southern Copper (SCCO) would use a longer term call option in place of the covered call stock purchase. To use this strategy look at going long the Southern Copper (SCCO) Jan '12 $25.00 call and selling the Aug '11 $32.00 call for a total debit of $6.40. The trade has a lifespan of 51 days and would provide 2.64% downside protection and an assigned return rate of 9.37% for an annualized return rate of 67.1% (for comparison purposes only). Southern Copper (SCCO) has a current annual dividend yield of 7.23%. [THA-Seven Summits Research]

Conclusion: Technical analysis means nothing without an understanding of the fundamentals of the copper commodity price.  Wait until this stock drops to $23.04 (which is 12x average earnings).  The dividend isn't safe.

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Published in: on June 30, 2011 at 2:03 pm  Leave a Comment  

First look at American Electric Power (AEP).

I read some article on high dividend stocks and it mentioned American Electric Power (AEP).  That made me curious because I hadn’t examined this company yet.  This is what I found.

American Electric Power is one of the largest regulated utilities in the U.S. AEP’s electric utility operating companies provide generation, transmission, and distribution services to more than 5 million retail customers in 11 states.  About 80% of AEP’s power is generated using coal. Approximately 55% of AEP’s revenue comes from operations in Ohio, Texas, and Virginia.

American Electric Power (AEP)

Market price: $37.43

Shares: 481.79 million

Link to 3 year chart:

Dividend record: (strong dividend growth)

Dividend: $0.46 quarterly

Dividend yield: 4.92%

EPS: $2.61

Dividend payout ratio: 70% ($1.84 dividend/$2.61EPS)

This stock will become a high dividend stock (yielding 6%) at a price of $30.66 per share

Earning power: $2.50 average for five years @ 481.79 million shares

(Earning adjusted for changes in capitalization)

            EPS       Net inc.             Adj. EPS

2006     $2.53    $1,002 M           $2.08

2007     $2.72    $1,086 M           $2.25

2008     $3.42    $1,380 M           $2.86

2009     $2.96    $1,357 M           $2.82

2010     $2.53    $1,211 M           $2.51

Five year average earnings $2.50

Value price territory at 12 times average earnings begins below $30.00 per share

Market price at 14.97 times average earnings

Speculative price territory at 20 times average earnings begins above $50.00 per share

Balance sheet: Looks okay to me.  The current ratio and quick ratio have me a little concerned.


Book value: $28.69

Price to book value: 1.30 (good)

Current ratio: 0.80 (over 2.0 is good)

Quick ratio: 0.51 (over 1.0 is good)

Conclusion: Add to watch list with alert set to $30.00 per share.  Start deep analysis when price approaches $30.00.  Sell above $50.00.

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Published in: on June 29, 2011 at 12:16 pm  Leave a Comment  

Seeking Alpha contributor sees no risk with buying AGNC. He is blind.

Seeking Alpha contributor Mike Maher wrote a positive article on American Capital Agency Corp. (AGNC) on June 23rd, 2011.  He claims that each new equity offering is an opportunity to buy AGNC because a month later the stock will have climbed higher above the old price that exisited before the drop.  Where have we heard this before?  Does the phrase “house prices always go up” ring a bell in your mind?  The two year chart of AGNC does conform to Mr. Maher’s observations, but that doesn’t mean that there is no risk of AGNC going down from its current level.  Text from Mr. Maher’s article appear indented below.

Mr. Maher wrote:

Wednesday’s close of trading brings a familiar press release for holders of American Capital Agency (AGNC): news of a secondary offering. The firm originally announced it was selling an additional 36 million shares, with an overallotment option for another 5.4 million shares. Later, AGNC said it had sold 43.2 million shares, raising approximately $1.2 billion. Underwriters have the right to purchase 6.48 million shares to cover overallotments. Proceeds will be used to purchase more securities and for general corporate purchases. Shares are only dropping about 2%, perhaps signaling that the market was expecting another offering.

He got this right, “These massive offerings are the only way the firm can grow rapidly…”  The executives of AGNC are compensated for the amount of equity (book value per share).   All of a sudden the massive equity offerings make sense.  Here is the applicable risk factor from the 2010 annual report.  Read it for yourself.

Our Manager’s management fee is based on the amount of our Equity and is payable regardless of our performance.

Our Manager is entitled to receive a monthly management fee from us that is based on the amount of our Equity (as defined in our management agreement), regardless of the performance of our investment portfolio. For example, we would pay our Manager a management fee for a specific period even if we experienced a net loss during the same period. The amount of the monthly management fee is equal to one twelfth of 1.25% of our Equity and therefore is only increased by increases in our Equity. Increases to our Equity would be primarily from equity offerings, which could result in a conflict of interest between our manager and our stockholders with respect to the timing and terms of our equity offerings. Our Manager’s entitlement to substantial nonperformance-based compensation may reduce its incentive to devote sufficient time and effort to seeking investments that provide attractive risk-adjusted returns for our investment portfolio. This in turn could harm our ability to make distributions to our stockholders and the market price of our common stock.

As I wrote in March, AGNC is making these offerings a habit and this is the 5th offering since last September. The previous article shows each of the earlier offerings has been an opportunity, with shares being higher a month after the news. This offering should prove to be the same. These massive offerings are the only way the firm can grow rapidly and it seems like investors should get used to them. Since shares currently trade above book value, which was last reported as $25.96 at the end of March, it makes sense to use the strong stock price to raise more money and expand the business. The fact that AGNC is able to continually tap the equity markets and still see shares run up to new highs into the dividend is a testament both to the management of the firm and to investors’ interest in the massive dividend, currently at $1.40 per quarter. While it would be nice to see this dividend rising as new shares are offered and the business expands, it’s hard to complain about a 19% yield without sounding greedy. Management has proven itself to be an excellent operator, so I trust in both their ability and their judgment.

AGNC’s book value will crumble when short term interest rates rise faster than long term interest rates.  I have written why interest rates will rise here:

The management of AGNC freely admits that higher interest rates may adversely affect their book value or their net interest income.  They use the weasel word “may” because they think their active management will be able hedge rising interest rate with swaptions and other financial devices.

Because we invest in fixed-rate securities, an increase in interest rates on our borrowings may adversely affect our book value or our net interest income.

Increases in interest rates may negatively affect the market value of our agency securities. Any fixed-rate securities we invest in generally will be more negatively affected by these increases than adjustable-rate securities. In accordance with GAAP, we are required to reduce our stockholders’ equity, or book value, by the amount of any decrease in the fair value of our agency securities that are classified as available-for-sale.  Reductions in stockholders’ equity could decrease the amounts we may borrow to purchase additional agency securities, which may restrict our ability to increase our net income.  Furthermore, if our funding costs are rising while our interest income is fixed, our net interest income will contract and could become negative.

The shares are not dropping as much as they have in the past on the news of the offering, at $28.32 after hours, down $0.50 from the close of trading Wednesday. This makes a quick trade in the name less attractive, since there will be less ground for shares to make up after the offering. Expect heavy volume Thursday, but each of the last four offerings have been opportunities to get into the name at a discount and I see no reason this offering is any different. As long as the dividend is not cut and book value continues to climb, AGNC is a buy and these offerings are opportunities.

Disclosure: I am long AGNC.

True, he sees no reason to not buy AGNC’s recent drop in price.  But I do.  If you want to really understand the risks associated with AGNC and other mortgage REITs, then read some of my past articles on AGNC:

Disclosure: I do not own AGNC.  I don’t plan on owning AGNC because of its potential dividend cut, poor earning power, and weak balance sheet.

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Link to original Seeking Alpha article:

Published in: on June 28, 2011 at 7:03 pm  Leave a Comment  

My 2 cents on Mortgage REITs: Where Danger Lurks

This is a good article on the dangers of mortgage REIT such as AGNC and NLY.

However, I disagree with the author on this statement, “When the economy accelerates again, which I believe could be very soon, rates are likely to rise, perhaps dramatically, even if the Fed doesn’t tighten anytime soon.”

The economy is not going to accelerate unless the commercial bankers expand lending.  Bankers are terrified of more bad loans.  If they cease being terrified and expand lending, then their 1.3 trillion dollars of excess reserves will become part of the money supply.  This will increase the M1 money supply and prices would more than double from where they are no.  See Murray Rothbard’s book “The Mystery of Banking” for more details on how the fractional reserve process works.

I think we are years away from commercial bankers being brave enough to lend their unprecedented excess reserves that the Federal Reserve printed out of thin air.

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Published in: on June 27, 2011 at 4:23 pm  Leave a Comment  

A first look at a potential high dividend stock – Brookfield Infrastructure (BIP)

I read an article from Double Dividend Stocks titled “5 Defensive Utility Dividend Stocks With Increasing Institutional Buying”.  It mentioned a company named Brookfield Infrastructure Partners L.P. (BIP) that had some qualities that might make it a worthwhile high dividend stock during a broad stock market correction.  Let’s take a first look at Brookfield

Brookfield Infrastructure (BIP)

Market price: $24.85

Shares: 112.96 million

Dividend record – The company has only been around since 2007.  No dividend cuts in its history.

Dividend: $0.31 quarterly

Dividend yield: 4.99%

EPS: $4.55

Dividend payout ratio: 27% (the dividend appears safe)

Earning power – $1.14 average earnings @ 112.96 shares

(Earnings adjusted for changes in capitalization – BIP has issued many shares)

            EPS       Net inc.             Adj. EPS

2006     –           –                       –

2007     $0.05    $1.1 M              $0.01

2008     $0.72    $28 M                $0.25

2009     $0.52    $25 M                $0.22

2010     $4.25    $462 M              $4.09

Four year average earnings $1.14 per share

Value pricing at below 12 times average earnings = $13.68

Speculative pricing above 20 times average earnings = $22.80

Today’s market price: $24.85 is trading at 21.8 times average earnings

If 2011 net income can match 2010 net income, then the five year average earnings will grow to $1.82 and today’s market price would be trading at 13.7 times average earnings.  Warning: I haven’t looked into BIP’s business enough to know if 2011’s profits will be close to 2010’s.  Although the linked article shows some large expected EPS growth.

Strength of balance sheet: Appears strong, but how is it growing so quickly?  I don’t know yet, but the low current ratio and quick ratio shows a lack of current assets to cover current liabilities.


Book value per share: $44.13 ($4,985 M equity divided by 112.96 shares)

P/BV: 0.56 (really good)

Current ratio: 0.95 (over 2.0 is good)

Quick ratio: 0.18 (over 1.0 is good)

Conclusion: It is unclear at this point in time if this stock is speculatively priced or investment priced.  It has had one good year out of four in 2010, but is its 2010’s performance the new norm.  This company deserves to go on a watch list with an alert set at $21.88.  A thorough analysis would be necessary when its stock price drops between $21.88 and $13.68.  The company would begin yielding above 6% when its stock price drops to $20.66 (assuming it keeps its $0.31 dividend quarterly).

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Excerpts below from the article on BIP

Market: Electric Utilities

Market Cap: $3.92 billion

Institutional Transactions: 2.35%

Institutional Ownership: 55.12%

Brookfield Infrastructure (BIP): It’s a bit of a misnomer to call BIP a utility, since this is just one part of their many businesses – they also own oil & gas pipelines, port facilities, timberlands, and healthcare facilities. These other parts have helped them achieve higher ROE and EPS growth numbers, which you’ll see in the following tables.

BIP is the only stock in this group that exceeds all of the broad sector averages., due to its diversification into other higher margin businesses.

Dividend yield: 4.95%

Dividend payout ratio: 40.75%

Return on equity: 22.69%

Return on investment: 10.97%

Total debt/equity: 1.44

Operating margin: 62.39%

Valuations: Although utilities aren’t considered a growth sector, by any means, 2 of these stocks actually look undervalued on a next year PEG basis: BIP and HE. Additionally, BIP’s 5-year PEG is only .92. The Price/Book figures for these 2 stocks are also much lower than sector standards, and BIP has a very low Graham P/E x P/Book figure of 4.63.

EPS growth this year: 717.31%

Price to earnings ratio: 5.51

EPS growth next fiscal year: 95%

PEG; next fiscal year: 0.06

PEG; next 5 years: 0.92

Price to book value: 0.84

EPS growth next 5 years: 6.00%

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Published in: on June 27, 2011 at 1:48 pm  Leave a Comment  

TIP OF THE WEEK – Get out of debt, save, and start your own business

Get out of debt, save, and start your own business serving unfulfilled customer needs.

Jason Brizic

June 24, 2011

One of your goals should be to insulate yourself from the coming economic calamity that will result from the insane actions of money-printing central bankers and deficit spending politicians.  Starting a side business to provide a second stream of income is a very good idea.  Many millions of people have lost their jobs.  This will continue to occur due to misguided Keynesian economic policies.  But where do you get the capital to start your business?

Savings are crucial to capital formation.  You use your savings to purchase producer’s goods that you will use to produce goods for others to consume.  The classic example is the lemonade stand.  You start with some money you saved.  You use your savings to buy lemons, sugar, ice, a large cooler, cups, some signage, and some wood to build you lemonade stand.  You didn’t need a business loan from a local banker (debt) to start your lemonade stand.  You started small with just a little bit of savings and a little entrepreneurial savvy of where some thirty customers might be located.

The key to savings is getting out of debt first.  Creating and sticking to a budget that includes savings will allow you to build capital in order to pursue some entrepreneurial efforts without quitting your current job. 

You can get out of debt in several years before massive price inflation hits your checkbook and impairs your ability to save.  I suggest you save between 10 – 15% of your pretax income.  Use this money to repay debts.  When the debts are gone you will have the budget and discipline to save 10 – 15% because you just did it while paying down your debts.

Gary North provides a free get out of debt course with specific action steps to follow.  This is similar to what Dave Ramsey teaches, but it is free.

Invest in value priced high dividend stocks, precious metals, and rental real estate when you need to diversify some of your savings you are earning from your successful side business.

For more tips, go here:

Published in: on June 24, 2011 at 2:59 pm  Leave a Comment  

Which integrated oil majors will become high dividend stocks?


Today's new about the US government planning to sell 2 million barrels of oil per day for 30 day from the strategic oil reserve got me thinking about which oil majors are high dividend stocks?  The answer is none.  But some itegrated oil majors are close in the 4-5% dividend yield range.  A significant stock market correction could make some of the high dividend stocks yielding over 6%.
Exxon Mobil (XOM) yields 2.40%
Cheveron (CVX) yields 3.14%
Royal Dutch Shell (RDS) yields 4.90%
Total (TOT) yields 5.76%
BP (BP) yields 3.95%
Petroleo Brasilero (PBR) yields 4.47%
Conoco Phillips (COP) yields 3.62%
If the US government is temporarily successful at increasing the US domestic supply of oil, then oil prices should fall in the short term.  This in turn will drive the oil stocks lower.  That will drive oil stock dividend yields higher and it might possibly provide some attractive buying opportunities for price appreciation once the effects of the governments actions wear off.
I'm going to start by examining the highest dividend stock on this short list: Total (TOT).
Total (TOT)
Market price: $54.70
Shares: 2.35 billion
Dividend: $1.61 semi annual
Dividen yield: 5.76%
Recent EPS: $7.60
Dividend payout ratio: 84.7% (that sort of high, but tolerable)
Earning power: $4.64 average earnings over five years @ 2.35 billion shares
(Earnings adjusted for changes in capitalization – slight increase in shares)
          EPS      Net inc.          Adj. EPS
2006   $5.09     $11,788 M     $5.01
2007   $5.80     $13,181 M     $5.61
2008   $4.71     $10,590 M     $4.51
2009   $3.78     $8,447 M       $3.59
2010   $4.71     $10,571 M     $4.50
Five year average adjusted earnings = $4.64 per share
Market price is at 11.78 times average earnings.  Total appears to be value priced right now.
Value territory starts at or below 12 times average earnings = $55.68
Speculative pricing is at or above 20 times average earnings = $92.80
Balance sheet strength:
Book value per share: $27.84
Price to book value ratio: 1.964 (good)
Current ratio: 1.40 (over 2.0 is good)
Quick ratio: 0.87 (over 1.0 is good)
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Published in: on June 23, 2011 at 11:40 pm  Leave a Comment  

American Capital Agency announced an new offering for 49.69 M-I-L-L-I-O-N more shares says Dr. Evil.

AGNC can only grow by issuing new shares.  The $1.2 billion in proceeds from its newest equity offering will be leveraged 6x-8x to add at least another $7.2 billion to its portfolio of agency securities.  Those agency securities are backed by the bankrupt US government.  Imagine that Greece was backing up Greek mortgage backed securities.  What security is that!  Well, the US is worse off than Greece when you consider the liabilities of Social Security and Medicare.  Owners of AGNC will get burned someday when the inverted yield curve returns and deficits do begin to matter.  But until then greater fools can collect a handsome dividend yield.

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American Capital Agency Announces Pricing of Public Offering of Common Stock


BETHESDA, Md., June 22, 2011 /PRNewswire via COMTEX/ — American Capital Agency Corp. /quotes/zigman/110324/quotes/nls/agnc AGNC -1.98% ("AGNC" or the "Company") announced today that it priced a public offering of 43,200,000 shares of common stock for total estimated gross proceeds of approximately $1.2 billion.

In connection with the offering, the Company has granted the underwriters an option for 30 days to purchase up to an additional 6,480,000 shares of common stock to cover overallotments, if any. The offering is subject to customary closing conditions and is expected to close on June 28, 2011.

AGNC expects to use the net proceeds from this offering to acquire additional agency securities as market conditions warrant and for general corporate purposes.

Citi, J.P. Morgan Securities LLC, UBS Securities LLC and Wells Fargo Securities, LLC are joint book running managers for the offering. JMP Securities LLC, Mitsubishi UFJ Securities, Nomura Securities International, Inc. and RBC Capital Markets are co-managers for the offering.

The offering will be made pursuant to AGNC’s existing effective shelf registration statement, previously filed with the Securities and Exchange Commission. The offering of these securities will be made only by means of a prospectus and a related prospectus supplement. Copies of the prospectus and prospectus supplement may be obtained, when available, from Citi, Brooklyn Army Terminal, 140 58th Street, 8th Floor, Brooklyn, New York 11220, telephone: (800) 831-9146; J.P. Morgan Securities LLC, c/o Broadridge Financial Solutions, 1155 Long Island Ave, Edgewood, NY 11717, telephone: (866) 803-9204; UBS Securities LLC, Attention: Prospectus Department, 299 Park Avenue, New York, New York 10171, telephone: (888) 827-7275; or Wells Fargo Securities, LLC, Attn: Equity Syndicate, 375 Park Avenue, New York, NY 10152-4077, telephone: (800) 326-5897, email:

This press release does not constitute an offer to sell or the solicitation of an offer to buy shares of common stock, nor shall there be any sale of these securities in any jurisdiction in which such offer, solicitation or sale would be unlawful prior to registration or qualification under the securities laws of any such jurisdiction.

American Capital Agency plans $1B offering

Washington Business Journal – by Jeff Clabaugh

Date: Wednesday, June 22, 2011, 5:56pm EDT


Banking & Financial Services

Bethesda-based American Capital Agency Corp., which buys government-backed residential mortgage securities, is planning its largest stock offering since going public three years ago, potentially raising more than $1 billion to fund its investments.

The real estate investment trust, an affiliate of private equity firm American Capital, Ltd. (NASDAQ: ACAS), says it will sell 36 million shares of common stock in a secondary offering, and give underwriters the option to purchase an additional 5.4 million shares.

American Capital Agency stock (NASDAQ: AGNC) ended Wednesday trading at $28.85 per share.

American Capital Agency raised about $780 million from a secondary offering in March, and another $655 million in January.

The REIT’s profits more than doubled last quarter as net interest income from increased investments rose five-fold. Its investment portfolio has ballooned to $28.3 billion as of the end of the first quarter.

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(RTTNews) – American Capital Agency Corp. (AGNC: News ) announced after the close Wednesday that it plans to make a public offering of 36,000,000 shares of its common stock. The stock is now down 0.56 on 442K shares.

American Capital Agency posted gains in early trade Wednesday, but settled into a range for the bulk of the session. Shares finished up by 0.35 at $28.85. The stock rebounded off of support, following nearly a 2-week decline.

Published in: on June 22, 2011 at 7:04 pm  Leave a Comment  

3 So-called High Dividend Stocks The Dumb Money Is Buying. You can do better.

Book value per share: $1.90 (Really?  That’s bad)  I calculated it at $1.97 which is still horrible

Price to book value: 35.81 (Wow!!  That’s horrible)

Current ratio: 1.07 (Less than 2.0 is bad)

Quick ratio: 0.37 (Less than 1.0 is bad)

Pfizer (PFE)

Market price: $20.43

Shares: 7.90 billion

Dividend record:

            Dividend yield: 3.92%

            Dividend: $0.20 quarterly

            Dividend payout ratio: 76% ($0.80 annual dividend divided by $1.05 recent EPS)

Earning power: $1.12 per share @ 7.90 billion shares

            Earnings adjusted for changes in capitalization

            EPS       Net inc.             Adj. EPS

2006     $2.66    $11,019 M*        $1.40

2007     $1.17    $8,140 M           $1.03

2008     $1.20    $8,104 M           $1.04

2009     $1.23    $8,635 M           $1.09

2010     $1.02    $8,257 M           $1.05

* Net income was $19,332 M but $8,313 M was from discontinued operations.  I removed the discontinued ops so the earnings wouldn’t be skewed too much.

Five year average earnings = $1.12

Value below 12x average earnings = $13.44

Market price at 18.24x average earnings = almost speculatively priced

Speculative above 20x average earnings = $22.40

Strength of balance sheet: Fairly stable


Book value per share: $11.17

Price to book value: 1.83 (good)

Current ratio: 2.00 (Over 2.0 is good)

Quick ratio: 1.66 (Over 1.0 is good)

Johnson & Johnson (JNJ)

Market price: $66.49

Shares: 2.74 billion

Dividend record:

            Dividend yield: 3.43%

            Dividend: $0.57 quarterly

            Dividend payout ratio: 51.7% ($2.28 annual dividend divided by $4.41 recent EPS)

Earning power: $4.39 per share @ 2.74 billion shares

            Earnings adjusted for changes in capitalization (PFE has been buying back shares)

            EPS       Net inc.             Adj. EPS

2006     $3.73    $11,053 M         $4.03

2007     $3.63    $10,576 M         $3.86

2008     $4.57    $12,949 M         $4.73

2009     $4.40    $12,266 M         $4.48

2010     $4.78    $13,334 M         $4.87

Five year average earnings = $4.39

Value below 12x average earnings = $52.68

Market price at 15.14x average earnings = priced for investment

Speculative above 20x average earnings = $87.80

Strength of balance sheet: Strong (That’s what I like to see…shareholder equity covering up the liabilities – nice.)


Book value per share: $21.51

Price to book value: 3.09 (decent)

Current ratio: 2.05 (Over 2.0 is good)

Quick ratio: 1.57 (Over 1.0 is good)

Disclosure: I don’t own any of these stocks.


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3 High Dividend Stocks The Smart Money Is Buying

By Jonathan Chen

Created 06/20/2011 – 11:59am


In times of uncertainty, investors look to high-dividend paying stocks for some sort of normalcy. Every investor looks for dividends to juice yields and returns, as dividends are an important source of income for many, especially retirees.

We also want to be playing the same game the "smart money" is playing. The hedge funds, the legendary investors, the institutions. They are all known as the "smart money," so why should they benefit and not us?

Here is a list of a few low-risk, high dividend stocks that will allow investors to play the same game the "smart money" is playing, and hopefully, generate the same returns.

Philip Morris International Inc. (NYSE: PM [2]) is a low-risk, large-cap stock that sports a hefty 3.7% dividend yield, in addition to strong growth from outside the U.S. Philip Morris International was spun off from Altria (NYSE: MO [FREE Stock Trend Analysis] [3]) last decade as a way to unlock the value from the company’s international presence, and not deal with the regulatory scrutiny here in the U.S. Shares trade at 13.6 times earnings, and have risen 17% this year, best among the tobacco stocks only behind Lorillard (NYSE: LO [4]). Capital Research Global Investors, Blackrock, and State Street are among Philip Morri’s largest investors.

Pfizer Inc. (NYSE: PFE [5]) is another low-risk defensive play, and sports a dividend yield of 3.9%. The company is currently in the process of divesting businesses as a way to unlock shareholder value. Shares have been stagnant for what seems like forever, but it looks as if shares are starting to perk up a bit. The company has a rock solid balance sheet, trades at less than 9 times earnings, and counts State Street, BlackRock and Vanguard among major shareholders. The stock is also a hedge fund favorite.

The last name to consider is Johnson & Johnson (NYSE: JNJ [FREE Stock Trend Analysis] [6]). The New Brunswick-based company is the maker of things like Band-Aids, Tylenol, and other products we use everyday, but don’t really think about it. Johnson & Johnson has one investor in it that will make other shareholders sleep better at night: Warren Buffett.

Late last year, the company issued one of the lowest yields over U.S. Treasuries on record, indicating the strong demand for its debt. Johnson & Johnson boasts a triple-A credit rating from Standard & Poor’s, a distinction shared by only three other U.S. industrial firms. It trades at just 12.8 times earnings, and is one of the safest companies out there.

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Published in: on June 21, 2011 at 4:15 pm  Leave a Comment