The madness continues... Buy now, only 3% down... Sell your home without moving... Where did the Americans go?... Speculators bet oil will decline... Tweedy, Browne says buy financials... When to buy gold...

Sometimes it's hard to decide which headline is the most ludicrous...

"Buy GM," Barron's exclaims. "No other car company is running down the green highway as fast as GM." I've never seen a "green highway." But I have seen GM's balance sheet. The article neglects to mention one supremely important fact to equity buyers: The company is extremely unlikely to ever earn enough selling cars to cover the interest on its more than $30 billion in debt. Of course, General Motors buys lots of advertising from Dow Jones. Maybe someone "forgot" to look at the balance sheet.

"Fannie Mae Drops Policy Over Down Payments," says the Wall Street Journal. "Fannie Mae confirmed it is scrapping a policy that required higher down payments on home mortgages in areas where house prices are falling." Hmmm... I only know a little bit about Fannie Mae's business, but what I know scares me to death. Fannie directly owns around $723 billion worth of mortgages, including many of very dubious value, such as $215 billion of "interest-only" loans, $268 billion of mortgages with loan-to-value ratios in excess of 90%, and another $25.2 billion of subprime residential mortgage-backed securities (RMBS) – better known on Wall Street as "toxic waste." It holds these assets with only $43 billion of core equity – a little more than 16 times leverage. Thus, a 7% decline in the average value of its mortgage assets (a $50 billion loss) would wipe out shareholders. That's about 10% of the risky paper it owns... an amount that's almost certain to be lost.

And that's not the real problem. The real problem is, off-balance sheet, Fannie provides a principal guarantee to another $2.25 trillion (yes, trillion) worth of mortgage securities. These securities make up a large chunk of the reserves of the world's financial institutions. But... damn the torpedoes. Who cares about risk? Americans always pay their mortgages. Real estate prices always go up. Starting today, borrowers will only have to put 3% down to qualify for a Fannie Mae guaranteed loan.

"Pinched Out Consumers Scramble for Cash," says the Wall Street Journal. With regulators moving to shut down payday lenders and other high-interest rate loans (nevermind the 21% rate on most credit cards), where will the lumps get the cash they need? By selling the remaining equity in their homes! A San Francisco real estate investment company, Rex & Co., launched a new product last year – the "REX Agreement" – that invests in your house without you having to move out. The catch? The price, of course. Rex pays 13% of the value of your home for 50% of any future price appreciation.

Why would you agree to this deal? Well, you might logically do it if you're convinced the price of your home will decline in the future. But most people take the contract because they can't afford to live in their big houses anymore. A Rex & Co. client Tom Terrill explains to the Journal: "I needed to do something to get more cash or reduce my living expenses or live in a very, very much downsized home..."

What, we wondered, happened to the America we knew and were taught to respect growing up – the country built on hard work, savings, independence, self-reliance and liberty. Where have all of those Americans gone? And who are all of these people who so foolishly believe they can live on credit (or the government) forever?

Hedge-fund managers and speculators have reduced bullish oil bets by 80% since last July as crude prices top $135 a barrel. Net long positions fell to 25,867 contracts on the New York Mercantile Exchange in May from a record 127,491 on July 31, 2007.

Value mutual-fund manager Tweedy, Browne reminds us why holding through turbulent periods, and sometimes adding to troubled positions, is the best strategy...

As a group, [financial stocks] are down approximately 34% from their highs in the face of large and serious markdowns, which for many has caused considerable damage to their balance sheets. One must tread cautiously here, but there are some very good companies that we feel are "being thrown out with the bathwater," companies such as Lloyds TSB, American Express, AIG and U.S. Bancorporation. While the past performance of any stock or industry sector is not necessarily indicative of future returns in general, or our Funds in particular, over the last 18 years, there have been four times when financial stocks corrected by as much as 30% or more. Yet over this entire period, a buy and hold investor would have made a cumulative return of 339% or roughly 8.40% per year on average. If you include estimated dividends during this period, your return would have been approximately 10% to 11% annualized. Not bad for such a turbulent period.

In this case, one explanation for the seemingly market-beating result is simple: paper money. In an inflationary environment, banks need not suffer for their foolish lending. The Federal Reserve is always available to print more money, washing away the past losses. Profitability of the banking sector is assured only via a money cartel that steals efficiently from the rest of the economy.

The news keeps getting worse for automakers... Toyota, the world's largest car company, is considering downgrading its U.S. sales forecast for pickup trucks and other big vehicles. GM's U.S. market share is expected to fall below 20% this month, its lowest in history. And Ford will start producing the Fiesta, a compact car available outside the U.S., in its Mexican truck-manufacturing plants. Also Cerberus, the private-equity firm, sold "significantly" more than half of its equity in Chrysler, which it bought last year. 

And Barron's says buy GM...

While high gas prices are killing car sales, they're lining the pockets of Middle Eastern princes and Russian oligarchs and sparking demand for gas-guzzling private jets. The new oil-rich have driven demand for jets so high, there is now a five-year waiting list. And the impatient millionaires are paying up to a 10% premium for immediate delivery of used jets.

New highs: Valhi (VHI), Potlatch (PCH), Sabine Royalty Trust (SBR).

We're back from Nicaragua, and we don't have any more tropical storms to disrupt our communications. Let us know what you're thinking... feedback@stansberryresearch.com.

"Goldsmith's, 'My dog ate my homework!' excuse... Powers out?!?!? Sounds like the excuse (we ran out of gas) I gave the father of my girlfriend in high school after bringing her home an hour and a half late one Saturday night. (The view from where we were parked was also too pretty to be tied to a schedule that required us to be somewhere at a certain time). Thank God WE didn't have cell phones back then!!!" – Paid-up subscriber John Guhn

"I have been following your reports from various central american countries with a lot of interest. A former school mate of mine has traveled extensively throughout central and south america and he rates Panama and Uruguay the best and the cheapest places to live. He said that the cheapest and most beautiful beaches he found were in Uruguay. What is your take on Panama and Uruguay?" – Paid-up subscriber Joe Olympia

Porter comment: Uruguay is the finest country in Central or South America, in my view. It is in an entirely different league than Panama. In fact, only Chile and Argentina compare to Uruguay in terms of quality of life. And Uruguay is still very cheap (as is Argentina).

"$900 an ounce gold is only 10% higher than it was in 1979. Has inflation really been that low over nearly a 30-year time frame or is gold only a barometer of inflation when S&A gurus says it is?" –Paid-up subscriber Bill G

Regards,

Porter Stansberry
Baltimore, MD
June 2, 2008

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