-->Blind Faith

The Daily Reckoning

Paris, France

Wednesday, 30 April 2003

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*** Consumer confidence shoots up...mortgage financing
doubles...

*** Dow up too...gold down slightly...

*** States cut spending...house prices fall...Japan's long,
slow, frustrating bear market...and more!

--------------------

Now that the war jitters are over...we have only the economic
jitters to bug us, the very same ones we had before the war
began.

But the lumpeninvestoriat have neither a clue nor a prayer.
The happy schmucks don't read the Daily Reckoning and don't
seem to be aware of the vulnerability of the dollar, the
national savings rate...debt...

..bankruptcies...jobs disappearing to China...falling profit
margins...the fall of Rome...the deplorable state of French
railroads...the decline in manners and architecture following
WWI...the humbug of Democracy and contemporary opera...or any
of the other end-of-the-world-type problems we worry about.

Yesterday, for example, we reported the remarkable news that,
according to Stephen Roach, the U.S. current account deficit
seems to be headed for 6.5% to 7% of GDP...which would
require $3 billion of imported capital every day in order to
balance the books.

Where on earth will the money come from?

By our rough calculations, it would take the entire savings
of all of Christendom and most of the rest of the world, too.
Or else, the whole shebang falls apart.

But the lumpen seem to have not a care in the world. The Dow
has been up two days in a row...and the latest consumer
confidence numbers show the biggest increase in wishful
thinking since Bush père was president. Jobs are still
scarce...and may be getting scarcer, but homeowners are still
mortgaging their homes as if they never had to pay them back.
They seem to think the IMF is lending the money...or that
Alan Greenspan has personally guaranteed that housing prices
will continue to rise so that they can live forever by
'taking equity out' of their miserable barracks.

House prices may or may not be in a bubble, but mortgaging
them definitely is. Countrywide Credit, a leading mortgage
monger, reports that it made 682,000 loans in the last
quarter, up 101% from the same quarter last year.

What a happy race we Americans are!

So blessed by circumstance...so favored by nature! Our
soldiers can go around the world and kick any foreigners'
butts they want...and these same foreigners then lend us
money on the inflated value of our houses (because the house
itself is little different from the one we had 10 years ago,
which was worth only half as much money).

We wish to take a moment to doff our cap and thank the
Chinaman...the Indiaman...the Germanman. The worker in China,
for example, schleps in an unheated factory 12 hours a day, 6
days a week...and then is thoughtful enough to save 25% of
his take home pay - so that we Americans can continue to live
in a style that is beyond his imagination and beyond our
means.

If only it could last forever!

And who knows? Maybe it will...we will see...

Eric?

------------

Eric Fry from the belly of the beast...

- Perky consumers helped perk up the major stock market
averages for the second straight day. The Conference Board's
consumer confidence index soared to 81.0 in April from 61.4
in March - the largest one-month gain since March 1991, when
the first Gulf War concluded.

- The feel-good vibe spilled over into the stock market
yesterday, as investors stepped in to buy one or two of their
favorite overvalued stocks. By the closing bell, the Nasdaq
had gained 9 points to 1,471 - its highest level of the year.
The Dow added 31 points to 8,502.

- Prior to the robust April reading, consumer confidence had
declined for four consecutive months. The expectations
component of the index jumped to 84.8 from 61.4...Hope
springs eternal.

- Back here in the present, however, conditions haven't
changed all that much. State governments are still strapped
for cash, unemployment is still heading higher and Secretary
of Defense Donald Rumsfeld is still threatening military
action against any country that refuses to adopt English as
its official language.

- Despite all of that, it's nice to see stocks moving higher
for a change. And it's nice to see the little guy make a buck
in the stock market again, just like old times.
Unfortunately, it looks like taxes may be on the verge of
heading higher...just like old times...like, say, during the
Carter Administration.

- The National Conference of State Legislatures estimates
that the states collectively face deficits in the $80 billion
range for fiscal year 2004 (California takes the cake with a
budget gap that is likely to exceed $35 billion). Lawmakers
have covered nearly $30 billion of the $80 billion shortfall
through a combination of tax and fee increases, borrowing,
and program cuts. But that means they have more than $50
billion to go.

- For now, state lawmakers are holding off on implementing
any major new taxes. Instead, they are making the"tough
choices" like raising sin taxes and slashing benefits to the
poor. After all, the poor are not well organized, and they
don't scream quite as loudly as the rich.

-"Twenty-one states have targeted K-12 education spending
for cuts," Stateline.org reports."Twenty-six states plan to
cut higher education spending. Twenty-seven states have
targeted Medicaid, a joint state-federal program that
provides healthcare to more than 40 million low-income
Americans. In Massachusetts, 50,000 long-term unemployed lost
Medicaid coverage April 1 due to budget cuts...Other areas
getting hit include prisons, state employee benefits and
wages, and environmental programs."

- Tax hikes are all but inevitable. Not to worry, the
citizenry can always pay their taxes by tapping their ever-
rising home equity.

- Last week, we aired the views of David Rosenberg, a Merrill
Lynch economist who worries that a housing bubble spans the
50 United States...or at least the Lower 48. Today, a bit
more grist for the housing-bubble mill.

- Mortgage applications have tumbled for five straight weeks.
What's more, Market tracker DataQuick reports that March
sales in the San Francisco Bay Area were down 15% from a year
ago. Numerous other markets are also reporting double-digit
sales declines. Is the weakness in SF a harbinger of national
trends? Will the epicenter of the boom become ground zero of
the bust? Certainly, the VC market - an emblematic feature of
the California economy - is looking very bust-like.

- Venture capitalists, on average, saw a drop in their
returns for the eighth straight quarter, with back-to-back
losses of 20 percent or more the past two years. Oh well, the
VC funds are likely to bounce back over time...There will
always be another once-in-a-lifetime stock market mania.

- [Editor's note: Ironically, the drop in interest in VC
funds makes now a great time to fund companies at the private
placement level...that is, if you have the capital. If you're
interested in reviewing a list of private placement deals
being presented to members of Agora's Supper Club, please
send an e-mail to club director Vickie Beard: VBeard@agora-
inc.com ]

------------

Bill Bonner back in Paris...

*** We came upon this on Richard Russell's excellent Dow
Theory Letters website (www.dowtheoryletters.com). It
reminded us how long, hard and frustrating the path to a bear
market bottom can be. The numbers show the progress of the
Japanese stock market from its high in 1989 to its low of
last week.

12/25/1989 38,916
9/25/1990 20,984 -46.08%
4/19/1991 26,542 +26.49%
8/10/1992 14,820 -44.16%
8/30/1993 21,116 +42.48%
8/29/1994 20,658 -2.17%
6/12/1995 14,703 -28.83%
6/17/1996 22,531 +53.24%
12/22/1997 14,803 -34.30%
10/5/1998 12,879 -13.00%
7/12/1999 18,248 +41.69%
4/10/2000 20,434 +11.98%
3/12/2001 12,232 -40.14%
9/17/2001 9,554 -21.89%
5/20/2002 11,976 + 25.35%
4/21/2003 7,699 -35.71%

Readers will note that the Nikkei Dow rallied more than 25%
on 5 separate occasions...while still continuing its death
march. Despite the rallies, over a 14-year period Japanese
stocks lost 80% of their value.

Why did it take so long?

Japan's government and central bank fought the correction at
every step of the way. The Bank of Japan lowered interest
rates - down to zero, where they've been for the last 5
years. And the Japanese government did just what the Bush
Administration is doing: increase public spending.
(For one egregious example, see:
"Carving Up The Home Security Pie"
http://www.dailyreckoning.com/body_headline.cfm?id=3130 )

In fact, the Japanese increased government spending so much
that Japan now has the highest public debt in the developed
world.

If Japan is the trendsetter we think it is, American
investors can look forward to a long, hard slog. And in the
year 2013, they can expect the Dow to be trading around 2500.

By then, people will have stopped paying attention to the
Dow. Instead, they will probably keep an eye on the Chinese
stock market or the price of gold, for they will have
concluded years ago that U.S. stocks are not a suitable place
to put money because, they will say to one another,"In the
long run, stocks always go down."

In Japan, at the peak of the bubble, the average fellow had
50% of his assets in stocks; now, he has less than 10%.

Americans had more than 50% of their money in stocks in the
late '90s. Now, the figure is less than 40%...and probably
headed much lower.

But there is one major difference between the U.S. and Japan.
The Japanese never saved less than 10% of their incomes (in
the U.S., savings rates fell near zero) and never had to rely
on foreigners to finance their economy.

*** House prices in the UK are beginning to fall, says the
Financial Times.

*** At last, we are enjoying a gray, rainy day in Paris.

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The Daily Reckoning PRESENTS: Faith may be the key to eternal
salvation, but in the here and now, faith is often the ticket
to financial damnation...especially on Wall Street.


BLIND FAITH
By Eric J. Fry

"Faith is the assurance of things hoped for, the conviction
of things not seen," the writer of Hebrews reminds us. Today,
investors pay more than 30 times estimated earnings for the
S&P 500 - an act of faith of Biblical proportions.

Today's stock buyers"hope for" a second-half recovery that
will drive a robust earnings recovery, and they rely on the
conviction that paying 30 times earnings for stocks will
prove to be a rewarding proposition. We do not share the
hopes or convictions of the bulls.

The recent rally on Wall Street has been a classic triumph of
faith over fact...of hope over substance. No stock better
exemplifies misguided faith at work than Dow component
General Motors. GM's frightening investment profile should
inspire far more fear than greed. And yet, the automaker's
shares have rallied a sparkling 18% since early March,
contributing handsomely to the Dow's 1,000-point rally over
the same time frame.

Apogee Research took a peek under the hood of this struggling
automaker early last month and recommended that subscribers
sell the stock short. Mr. Market had other ideas. The stock
rallied sharply over the ensuing weeks, eventually hitting
Apogee's stop-loss limit and forcing the research firm to
advise exiting the trade...for now.

For the time being, the bulls are"right" about GM; their
faith is serving them well. By contrast, Apogee's well-
reasoned, skeptical analysis of the automaker has produced
little more than weeping and gnashing of teeth, thus far.

What do the bulls know - or what do they think they know? Are
the automaker's operations firing on all eight? Hardly. GM's
"earnings growth" relies upon one lone cylinder: its credit
operations...and that cylinder, too, is beginning to sputter.
Meanwhile, GM's mounting pension and benefit obligation is an
ominous drag on shareholder equity.

Most folks think of GM as a car company. But it's really a
finance company in disguise. Of GM's three primary
businesses, only GMAC - also known as the Financial and
Insurance Operations unit (FIO) - has been the consistent
leader in providing net income. As we noted in the Daily
Reckoning last week,"Of the $1 billion that the company
earned during the [first] quarter, $700 million came from its
finance unit. Meanwhile, profits at the automotive division
tumbled 16%. Hmmm...some banks give away toasters to attract
new customers. General Motors, apparently, gives away cars."

GMAC's contribution to overall net income has nearly doubled
since 1996 - from about 16% of net in 1996 to about 31% in
2002. But recent trends suggest that GM's shining star may be
losing its lustre. Credit quality has deteriorated markedly
over the past year, while less-reliable mortgage banking
income has become increasingly important to the operations of
GMAC. The percentage of GMAC's net income that comes from
mortgage operations rocketed 64% higher in 2002, which means
that mortgage lending contributed a whopping 29% of the
entire company's net income. Not bad for a car company!
What's more, this surprising trend accelerated in the first
quarter of this year, when mortgage lending kicked in a
breathtaking 38% of GM's overall net income.

Clearly, GM's booming mortgage banking business is masking
the difficulties plaguing its auto operations. The buyer of
GM shares must believe that the mortgage boom will hang on
long enough for GM's struggling auto operations to produce a
"hoped for" turnaround. Unfortunately, there are already some
troubling clouds gathering on GMAC's credit-quality horizon.
The provision for credit losses as a percentage of finance
revenues has doubled over the past three years.

Meanwhile, charge-offs are accelerating. The $1.395 billion
in credit charge-offs for 2002 is 160% higher than the $532
million in 1999, even though the $27 billion of FIO revenues
in 2002 were only 32% higher than the $20.45 billion booked
in 1999. In other words, change-offs are growing five times
faster than revenues!

Another challenge for GMAC arises from its lowered credit
rating, which S&P downgraded last October to triple-B from
triple-B-plus. Although the rating is still in the
investment-grade category, the downgrade has increased the
cost of financing GMAC's credit operations, thereby squeezing
its interest margin. The impact of the credit downgrade on
GMAC's operations is described in GMAC's 2002 10-K as having
"increased the Company's unsecured borrowing spreads to
unprecedented levels".

Meanwhile, GM's operating margin has been contracting, due in
large part to the company's aggressive sales incentive
programs - 0% financing seems to be"standard equipment" on
most new car models rolling out of Detroit these days. GM
expects to continue its aggressive sales incentive program,
according to CEO Richard Wagoner."We'd obviously like to
scale back on the incentives somewhat, because, frankly, it
would help our bottom line," Wagoner candidly admitted
earlier this year,"but when we've tried to do that over the
past 12-18 months, we've found that the market shrinks and we
lose share. And so we've actually decided we're going to stay
aggressive in the marketplace."

Last, but certainly not least, GM's pension and benefits
obligation is an ominous drag on shareholder equity. All
told, GM's underfunded pension and other post-retirement and
employee (OPEB) benefit obligation increased a whopping 27.6%
last year, to $76.8 billion from $60.2 billion at year-end
2001.

For perspective, the shortfall is nearly 20 times GM's
average annual net income of $3.9 billion for the past seven
years. The rapidly worsening pension and OPEB underfunding
led GM to take a $13.6 billion charge to shareholders' equity
last year, which amounts to a staggering 70% bite out of the
$19.7 billion in such equity listed as of Dec. 31, 2001. Last
year's charge came on top of a $9.5 billion charge to
shareholder equity that GM took in 2001. Because of the
torturous complexity of the Financial Accounting Standards
Board (FASB) rules that govern a company's accounting for
pension and OPEB obligations, both charges bypassed the
income statement and were charged directly to shareholder
equity. As a result, many shareholders probably didn't
realize the sheer enormity of the combined $23.1 billion
charge, which decimated book value from more than $30 billion
in 2000 to only about $7 billion at year-end 2002.

In effect, GM is selling the family silver to satisfy retiree
benefits.

The growth in the OPEB obligation is being driven by
escalating health care costs, which is more than a little
ominous given the seeming intractability of these continually
rising costs. The ever-increasing cost of providing health
care, especially for the vast family of company retirees, is
an obvious worry for GM's management, and it related as much
in the September 2002 edition of GM Encore, a publication
directed specifically at the retired employees."GM spends
$1.3 billion a year on prescriptions," the magazine said,
"while annual costs are increasing 15% to 20%."

We can't help but note the incongruity of a company telling
its retiree base that prescription drug costs are increasing
at a 15% to 20% clip, while continuing to estimate far lower
growth in its own OPEB obligation. In calculating its OPEB
obligation, GM assumes only a 7.2% increase in health care
costs for 2003, less than half the rate of increase in
prescription drug costs that it laid out to retirees. Of
course, while GM is cautious in not overestimating the rate
of increase in health care costs, it throws caution to the
wind when it comes to estimating future returns on pension
assets.

Like other members of the S&P 500, GM has used a more than
generous 10% expected rate of return on its assets. (GM will
moderate its expected rate of return for 2003 to...9%.) Such
exceedingly optimistic assumptions served to increase GM's
operating income line by $8.7 billion in 2001 and $8.1
billion in 2002, even though the pension assets actually
showed losses of $5.3 billion in 2001 and $5.4 billion in
2002.

How does GM get away with this sleight of hand? you may
wonder.

Simple.

It's all perfectly legit under generally accepted accounting
principles. GAAP rules allow a company to book its expected
return on pension assets, instead of its actual return, as
part of its operating earnings.

Even more worrisome than GM's questionably favorable
assumptions about future health care costs and asset returns,
we think, is that most of the benefits are payable to people
who no longer work for GM. The projected obligation is
calculated on the costs for current employees as well as on
the increasing costs for current retirees, who account for
about two-thirds of the people covered by the OPEB
obligation. According to GM's 2000-2001"Corporate
Responsibility and Sustainability Report," the company is
"the largest private purchaser of health care in the United
States and in 2001 provided health care coverage to 1.2
million employees, retirees and their dependents at a cost of
$4.2 billion".

Given that GM's current employee head count is 349,000 (down
from 362,000 in 2001), it doesn't take a mathematical genius
to figure out that health-care coverage for 1.2 million means
that a substantial portion of the costs are attributable to
GM's aging retiree base. As of September 2001, GM's hourly
employee pension plan had more than 520,000 participants, and
its salaried employee pension plan supported 199,392, for a
total of nearly 720,000 beneficiaries, both working and
retired, or more than double the 349,000 people working at GM
as of last December 31.

Unfortunately, there is probably little that GM could do to
trim benefits for the current population of retirees. As
Robert S. Miller, Bethlehem Steel's chairman and chief
executive officer, told Bloomberg News:"I hope other
companies are ready for this, because many of them, including
some automakers, aren't going to be able to outrun their
pension liabilities. At some point, the great sucking sound
of pension and health-care liabilities just overwhelms your
ability to raise capital or invest in new plants and
equipment."

Over time - a very long time - GM may be able to overcome its
myriad difficulties. But success is far from assured. We
suspect that investors will require the faith of Moses and
the patience of Job to reap a long-term profit from GM
shares.


Regards,

Eric Fry
for The Daily Reckoning