Specious Bank Proposals from the White House

January 22, 2010

“Desperation is sometimes as powerful an inspirer as genius.”

-Benjamin Disraeli Dear Partners, We are busy putting the final touches on our 2009 wrap-up report to Partners and have been distracted this week by the antics out of Washington. The 2009 Review Report will be published next week. Meanwhile, this week should have been a great week for our fund. Our financials all reported great earnings recovery trends and many on Wall Street started to finally agree with us that credit costs have peaked (credit has turned). The cherry atop the earnings sundae should have been the out-of-touch progressive agenda in Washington taking a body blow in Massachusetts with the election of a fiscal conservative who disfavors unfair government taxing of bankers that have repaid TARP e.g. Instead, the markets are reeling and the country’s premiere financial firm’s are seeing their share prices distorted by a panic-stricken “buyer’s strike” following the suspicious timing of the specious new bank reforms from the White House. We all know the President badly needs a victory, but this is his “Hail Mary” pass? We have seen a 17% year-to-date gain in the hedge fund erode by about one-third since the Obama administration’s Malakoff cocktail press conference. First, let’s go over the fundamental facts:

• Bringing parts of Glass-Steagall back would do nothing to prevent future financial crises like the one our country has endured. Rumors are circulating that the President chose to ignore his economics team in favor of his political strategy team on this issue.

• Almost all the firms that blew up in the housing crisis would not have been

averted by Glass-Steagall – they were home builders; mortgage companies;

investment banks; government sponsored enterprises; insurance companies; savings and loans; and mostly small community banks.

• TARP worked “magnificently” as Warren Buffett said two days ago in lauding

Chairman Bernanke.

• The TARP losses that Mr. Obama’s “banker’s tax” is supposed to recover are virtually 100% General Motors, Chrysler and GMAC, none of which are banks and the likelihood of repayment seems quite a stretch.

• Yet, the “banker’s tax” targets JP Morgan, Goldman Sachs, Wells Fargo et al,

which all repaid TARP profitably for the taxpayer. So, the “banker’s tax” is an overt lie. If one wishes to “soft speak’ the term to avert offending anyone, it’s a non sequitur. If this is still too harsh, we apologize profusely and gladly would supply the term - “ruse” if this helps to soften the truth.

• Stranger still is Mr. Obama’s sudden interest and discovery that proprietary

trading, private equity firms and hedge funds caused the housing crisis and must be fixed before Fannie Mae. Very odd conclusion. Prohibiting or limiting these valuable sources of capital would certainly be harmful to the liquidity necessary in our capital markets and this ultimately would damage our economy’s recovery prospects. Long-term, such prohibitions make our most important financial institutions far less competitive on the world stage! Who thinks that this helps anyone?

So, what’s up? Even the most veneer review of the facts suggests none of this makes fundamental sense. Did something happen on the way to the Forum?

• The progressive tax and spend agenda has either been defeated or been minimized at every turn, in large part, due to the fiscal conservative populism that has swept the nation beginning last summer, largely over health care reform.

• The progressive agenda suffered significant losses in both Virginia and New

Jersey in November and it was massacred in Massachusetts this week. • Their agenda is lost – healthcare reform; global warming payola; union (card

check) pay-offs and other nefarious slights-of-hand (and big cash movements we might add). Even the Cornhusker Kick-back is suddenly jeopardized. But wait – what about financial reform?

• The White House’s apparent response to the Boston Massacre was to accept

defeat on all other reform. So, all the President’s men (well, some of them) were mustered and the politicos hatched a plan for recovery (Not an economic plan, but a POLITICAL one). This plan MUST “capture Tea Party populism” the President demanded and simultaneously “trap” the fiscal conservatives by pitting

their free market capitalism ideals against the one and only major flaw in the Tea Party movement – Tea Partiers appear to hate big business almost as much as they despise big government.

“Scott Brown is just like me” – Barack Obama

• Voilá! Ignore your economics team and pull the ancient formaldehyde preserved

Paul Volker and his antiquated ‘70’s style Glass-Steagall type reforms off the shelf, dust them off and sell them to the Tea Partiers as a way to “punish” big banks under the auspices that it also can reduce systematic risk in the economy – “Hurrah…we’re back!” Volcker’s plans, while stale, are workable if executed pragmatically, but he’s a mere “prop” in a political gambit. Make no mistake.

The new progressive, anti-bank strategy will backfire and we believe bank stocks will return to leadership stocks very soon…

• The voter post mortem from Massachusetts suggests that two things cost Mr. Obama “Mr. Kennedy’s” seat in the Senate – (i) the administrations’ soft stance on the terrorists and (ii) the excessive spending of his progressive government.

• Distaste for “Wall Street” was NOT the cause of the Boston Massacre anymore

than prop desks caused people to buy too much house or speculators to juggle three condos and foolish people to lend to them.

• While many regular folks across America may not like individuals that make

more money than they do…those folks are smart and they do understand that some jobs just pay more.

• The public wants banks regulated but not dismantled and they do not believe

“Wall Street” is refusing to lend to them either. After-all, they can walk into their local community bank and test this theory out and most have…

• The counter evidence against Mr. Obama’s proposal is powerful and irrefutable

on the merits – large banks have repaid TARP and Detroit has not. Detroit is Mr. Obama’s “baby”. “Wall Street” was the Fed’s problem and ….like the Fed, was a profitable venture for taxpayers! Chairman Bernanke saved us from a Depression. Just ask Warren Buffett.

• The “banker’s tax” is wildly unpopular among the public as most Americans have

a material distaste for unfair taxation. Just ask King George. Scott Brown said he disfavors the “banker’s tax” flat out and he partially campaigned on it. While we have yet to discover exactly who Mr. Brown is, we are quite sure he’s not just like Mr. Obama as the President has asserted. And we certainly don’t think the people see them in the same light either.

• Finally, the current financial reform bills in the House and Senate are very

different, quite convoluted and clearly contradictory on several fronts. For

example, some want to “End the Fed” while others in Congress wish to expand it. Mr. Obama further complicates the matter via his “timely” new round of added proposals this week thus causing further splintering throughout the Congress.

• Yesterday, republicans questioned Obama’s “add-on proposals” and even House

Finance Chairman Barney Frank (D-MA) announced his own reservations on the timing of such proposals and their impact on the economy. He appeared in our estimation to be “chapped” that he wasn’t consulted first. Senate Finance Committee member Dick Shelby (R-AL) said he first would demand hearings on the new proposals if they were to be considered at all. So, financial reform getting through the Congress will be sausage grinding that may make health care reform look legible and the folks at Jimmy Dean wince.

Our conclusion is that this will backfire on Mr. Obama and blow over quickly. A mere excuse to take some chips off the table in a market that has made a good move. One buys this Obama swoon in bank stocks! This is perhaps your last chance at an “Obama discount.” It’s his last salvo. One deals with “populism” by ignoring the proposals that have no fundamental merit as the people eventually will figure out the facts. For example – “we need health care reform because we have an emergency where millions of Americans are not insured”. That didn’t work very well. So, how will “Wall Street must pay (even though they already have paid us back)” work with the populace? It will NOT sell. Buy the big, diversified and well capitalized banks. This may be the last great entry point of the crisis.

Regards,

Michael P. Durante Managing Partner