Merrill Lynch job cuts... 150 banks with bad loans... Biggest home price drop on record... The government's scheme for making value investors rich... Value investors bullish on financial stocks... Taiwan's new president...

Rumors are swirling that Merrill Lynch will be the next bank to announce layoffs. Inside sources say Merrill will cut 10%-15% of its investment banking division, roughly 300 bankers. The same sources say Merrill is also preparing for another write-down – up to $8 billion.

In the waiting area of the local airport this morning, I was talking with a friend, who is an accounting professor. He has heard as many as 50,000 people in the New York financial community could lose their jobs before it's all over. That sounded high to me. But even if it's only partially true, could it be anything but good? Aren't most of them just croupiers, shuffling assets from here to there for the purpose of shaving off fees?

The March 18 issue of American Banker has an interesting two-page spread: a massive list of the 150 banks and thrifts with the highest ratios of nonperforming loans and leases as a percent of gross loans and leases. The list is predominately small institutions, many with less than $100 million in assets. South Central State Bank of Campbell, Nebraska, with just $80 million in assets, tops the list with 50.52% of its gross loans and leases – nearly $31 million worth – reported as nonperforming.

Subprime losses are hitting China... Bank of China, the country's flagship foreign exchange lender, said it held about $5 billion in subprime securities at the end of 2007. The bank booked a $1.3 billion provision to cover losses. 

All these write-downs make me wonder... what were the securities really worth to begin with? If they were rated AAA and yielded 5% at the time of inception, should they have been rated B- and priced to yield 15%? And if cash recoveries reflect what the yield should have been, instead of what it originally was... then what? 

Home prices in 20 metropolitan areas fell 10.7% since January 2007, the biggest drop on record. The S&P/Case-Shiller home-price index has now fallen for 13 consecutive months. The only city to escape the fall was Charlotte, North Carolina. The huge drop in prices caused a 2.9% bump in home sales – the first month-over-month rise since July.

When defaults rise, mortgage-servicing costs go up. That's why billionaire private-equity investor Wilbur Ross bought H&R Block's mortgage-servicing platform for $1.1 billion. Ross calls it "an attractive business" and says he'll "continue to seek acquisitions of prime, alt-A and subprime servicing." Ross's Option One acquisition will be combined with the servicing unit he bought from American Home. Option One and American Home service a combined $95 billion worth of mortgages. Ross likes to take his creations public. Who knows? You may yet get the chance to buy a piece of Ross' new venture.

In its latest effort to fix the housing market, the Fed is giving regional banks the authority to boost their mortgage-backed securities (MBS) holdings by $100 billion. The Federal Home Loan Banks can now buy MBS worth up to 600% of their capital for two years. The move should inject up to $168 billion of liquidity into the MBS market.
Rate cuts and "liquidity injections" all have the same ultimate effect. They provide the excess funds with which future investment mistakes will be made. The federal government is like a massive machine for transferring wealth from momentum buyers to value buyers.

These days, value buyers, like Rich Pzena, Wally Weitz, and Tom Gayner, are all buying financial stocks. Rich Pzena: Fannie and Freddie, Citigroup, and Morgan Stanley. Wally Weitz: Fannie Mae, Dividend Grabber pick Redwood Trust, and Extreme Value pick American Express. Tom Gayner: title insurers LandAmerica and Fidelity National, Bank of America, and AIG.

Maybe it's time to buy commercial real estate debt, too...

Top-quality commercial real estate debt is priced at levels implying default rates of 80% to 100%. But according to the Wall Street Journal, commercial real estate debt default rates have never exceeded 31% in even their worst years. The reason for the huge mispricing... panicking banks and brokerage firms had to hedge their commercial real estate loans by selling CMBX indexes, which are baskets of credit-default swaps on commercial real estate debt. Then, noticing the trend, hedge funds piled into the trade for a quick profit. A portfolio manager at OppenheimerFunds said, "The implied losses are so severe that under any reasonable scenario you can't justify these levels."

Like we said yesterday, at some point, all the bad news gets priced in. And it looks like we're nearing that point with commercial real estate debt. When Bear Stearns collapsed, and Standard & Poor's placed Goldman Sachs and Lehman Brothers on negative watch, the price on these credit default swaps didn't budge.

At least one insider is bullish on a beaten-down financial, according to 10-Q detective. "H&R Block Chairman Richard Breeden spent almost $50 million to increase his holdings in the tax preparation company by 40 percent. From Tuesday through Thursday, Chairman Breeden purchased 2.4 million shares for $47.8 million, at an average of $19.82 a share." That's despite new allegations of discriminatory loan practices. Breeden's firm now owns 2.6% of H&R Block. 

New highs: Chunghwa Telecom (CHT), Wal-Mart (WMT), Health Care REIT (HCN), Ventas (VTR).

When you read my comments (below) and get offended, e-mail your invective to feedback@stansberryresearch.com.

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Ferris comment: The policy dates back at least as far as the work of advertising genius Claude C. Hopkins (1866-1932), much admired by David Ogilvy, who in turn was much admired by our parent company's founder, Bill Bonner, who lives not far from Ogilvy's former estate in southern France. Hopkins believed in offering a free sample when a product was strong enough to speak for itself. Our money-back guarantee is similar to a free sample, since you can get all your money back, even after getting full use of the product for a few months.

"Someday you're gonna be right on this commodities thing (...I hesitate to bring up your last call on natural gas). But giving yourself 10 years to be right about financials over commodities is being pretty generous with the clock. Given that gold has already risen for seven years now, I don't know how you can lose that one. OK, a one-year estimate on a blow-off for commodities is a little more even-handed challenge... but you're going against Jim Rogers, T Boone Pickens, Peak Oil, the Iraq war, tax rebate checks, major mining CEOs, The 'deficits don't matter' presidency, campaign promises for universal healthcare, the growth of China and India, and every central banker ever to dawn a three-piece suit... and the Freakin' Mogambu Guru. Are you saying, 'It just seems like things can't get any better for gold and silver... so they won't.' Is that your point? Well, I'll give you credit... that's the best argument I've heard yet. (But I'll still only believe it when I see it...)" – Paid-up subscriber Steve Colton

Ferris comment: Rising oil and gold prices has made too many commodity bulls happy for too long. It has given them the luster of financial acumen and provided timid sideliners with the "confirmation" they require to go long. So, starting about now, I would expect the long commodities trade to be a disappointing one for enough time to make people doubt it. And we can rest assured that over the long term, commodity prices will do what they've always done: Fall in real terms. All the commodity shortage arguments have always ended up being wrong. Basic economics says that'll continue forever.

"The professional and semi-professional investment community is subject to the same politics as any other business. If your customer is a union pension fund, you don't knock the union.

"Perhaps you can enlighten me as to why the following questions are never asked about the poor 'Mom & Pops' that Wal-Mart runs out of business:

"The Wal-Mart haters would have you believe that the Mom & Pops were paying union scale and had better benefits than Exxon. I agree with Joe, the only reason you see such Wal-Mart bashing is because they are nonunion and unions support a lot of politicians and investment professionals." – Paid-up subscriber Mark

Ferris comment: That's right. Wal-Mart offers much more value to many more employees than the mom-and-pop shops it replaces. When mom-and-pops open up, they don't get 25,000 people showing up to fill out applications for 300 jobs. Wal-Mart does. When people say Wal-Mart destroys the environment, property values, or the prospects of working people, I chuckle. You could only make those accusations in a state of pure ignorance of the facts and numbers to the contrary. (I suppose you could also make them if you're OK with lying through your teeth.) 

Regards,

Dan Ferris
Medford, Oregon
March 25, 2008                                                                                             

The Election is Over... And Taiwan is Ready to Soar
By Ian Davis

The opposition has won.

This Saturday, Ma Ying-jeou, of Taiwan's opposition Nationalist Party, took over the reins from incumbent Chen Shui-bian of the Democratic Progressive Party.

This is good news for Taiwan's economy...

Under President Shui-bian, Taiwan's ties to China were strained. In his quest to make Taiwan its own independent state, Shui-bian used some unconventional methods to crusade against China. For example, he removed the word "China" from the names of many Taiwanese companies. He also applied for his country to join the United Nations under the name "Taiwan" instead of the island's official name, "The Republic of China."

Taiwan's two largest trading partners are the U.S. and China... So between its strained relationship with China and the U.S.'s sluggish economy, the island nation's economic outlook suffered last year. As a result, investors abandoned Taiwan, and its stocks underperformed other emerging markets throughout the year.

The Taiwan Fund (TWN) was down 4.3% in 2007, compared to a gain of 31.6% for the iShares MSCI Emerging Markets Index (EEM).

Taiwan Stocks Soar Leading Up To Election

I believe Taiwan will continue to outperform other emerging markets throughout the year. Here's why...

Taiwan is a developed nation on China's doorstep... And with the election of Ma Ying-jeou, it's improving its relationship with China. Some of Ying-jeou's plans include creating a "common market" – like the European Union's – with China and ending a decades-old ban on direct flights and shipping between the two countries. As one UBS research analyst put it, "Ma's plan to improve relations with mainland China will cut political risk, luring about $50 billion into Taiwan's markets in the next few months."

Even if the U.S. economy continues to weaken, exports to China will take the place of many American ones.

Taiwan is also fairly cheap. The Datastream Taiwan index has a P/E of 15.3, which is well below the Datastream China index's P/E of 28.5 (and the Datastream U.S. Index's P/E of 17).

Now that the uncertainty of the election is behind them, Taiwanese stocks are rallying.

However, with the enormous gains that have taken place in the last couple of months, I would wait to buy any Taiwanese stocks. Whenever a stock spikes, some short-term traders just take their money and run. Taiwanese stocks likely will experience some short-term profit taking in the near future. Once the fund corrects and then resumes its rally, it'll be time to consider buying.

Until next time...

Good investing,

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