Most people, and rightfully so, are stock market shy, especially in bank stocks. The beating has been unmerciful and over done. So let’s make some money on bank bonds.

Bonds are of a higher order than stocks. When there was a threat of a problem in the banks, the stocks dropped as much a 90% in months. Not the bonds. They dropped a fraction compared to the stocks and then rebounded to near PAR or higher and still paid interest to their holders.

By law, all bond issuers, banks, manufacturers, all of them, have to pay interest and their principle at maturity. Stocks have no legal backing requiring them to do anything even similar.

Bank bonds are so cheap right now, that it’s child’s play to pick big current yields, 8% and 9% and capital gains in excess of 20% and 30%, in less than 36 months!

Here’s one example.

Citigroup. I know, you don’t have to say it, C has had a tough time, but it isn’t going anywhere between now and Oct 2010. If we were talking about 10 or 15 years, I might agree with the critics, but not 18 months. Worst-case scenario is it is broken up and sold, or sold whole. In either case the bondholders still get paid.

Here’s how one bond return breaks down. It’s a 7.25% coupon, for sale at 76.5, or $765 per bond. It is rated A- and it is a firm rating, no downgrade is expected in the future. That’s a current yield of 9.47%.

Here’s how the return calculation looks: it has a yield to maturity of 27.34, but its total return, money in/money out, is four interest payments equaling $145, plus capital gains of $235.  When you divide by your cost of $765, you get a total return of 49.67% in approximately 18 months, giving you an annual average return of 33.11%.

Don’t feel like being that adventurous? Here’s a softer play.

Bank of America has been described by some of the best minds in the business as being poised to make huge returns in the next few years. Everything is in place, including their buy of Merrill Lynch.

Its stock almost doubled just on the news of Citigroup’s performance in the first two months of 2009.

Here’s a bond to look at BAC, 7.4% coupon maturing 1/15/11, selling for 88.5, or $885 and rated A-.

Here’s a maturity of less than two years, an A- rating, that has a yield to maturity of 15% and a total return of 29.71% ((2 x 74) + 115 / 885 = 29.71%) Current yield, (coupon divided by price) 8.36%.

If you’re willing to go out a little further than two years the gains are even bigger.

In this market, you need all the tools you can get to make it out alive. Look at the Bond Trader; we’ve been doing trades like this since last September, without a single loss.

Source: Hit the Banks for 33% Plus Annually

A GM bailout would cost $200 billion, say the papers. Uh oh…that’s more than the feds have on hand. And right behind GM are cities, states, colleges…all with their hands out…

Yes, they are all of “vital national importance.” We can’t let them fail, can we?

Of course, it’s all nonsense. Automakers…governments…they go broke from time to time; it’s no big deal. And colleges…who needs them? You can get a much better education just keeping your eyes open. Right now, Mr Market’s Advanced Seminar on Economic Corrections is delivering one helluva lesson. Of course, the tuition is very expensive…

Stocks are down so much that dividend yields are beginning to look respectable again – averaging about 3.8%. For the first time in 50 years, you can get more yield from a stock than from a 10-year US Treasury bond. You remember, stocks were supposed to pay lower dividends because stockholders are supposed to earn capital gains as well as dividends. The combination of capital gains and dividends gives investors a total return greater than bonds; this is the “risk premium” that you get to compensate you for periods when stocks go down. What happened to the risk premium? Here it is!

When is the risk premium at its lowest? At the very moment when investors believe it is highest. That is, at the end of the ‘90s, investors came to believe that they couldn’t go wrong with stocks. They were so sure that stocks were the way to go that they willingly bought stocks that paid little or nothing in dividends. They thought the price of the stock would go up; so they didn’t need dividends.

But stocks have gone nowhere since the mid-‘90s. Now, investors want dividends.

Meanwhile, to those who have been given the most Mr Market takes the most back. No country got as much out of the credit expansion as Britain. Its leading industry – finance – was in high cotton for the last decade. Gone were the conservative old bankers with their derby hats and pin striped suits. The new breed of go-go moneymen in the City wore fancy Italian suits and came up with plenty of fancy investments too.
But just as the bankers were fashion victims, so were their clients.

Poor RAB Capital, for example. The hedge fund manager is traded in London. It’s seen its funds under management fall by 70%…and its share price is down 92%.

The pound is down 25% against the dollar over the last 90 days. Housing is down about as much as in the US. “Help wanted,” signs are disappearing from shop windows. And suddenly you can get a table at a good restaurant without a reservation.

But that’s the trouble with a downturn. Just when other people can’t afford to eat at fancy restaurants – neither can you!

“Everybody’s got to cut back,” we told the family again on Saturday. “This is a global financial crisis. We don’t know how long it will last or how bad it will get. But we’re saving every possible penny – just in case.”

This is what economists call the “propensity to save.” It’s what happens in a serious downturn. But the propensity to save is not necessary shared by all the members of the family alike. Edward, 15, put his finger on what economists call the “paradox of thrift:”

“Hey, Dad, but if we all stop spending…nobody will have any money, will they? Besides, you said you’d get me a new skateboard for my birthday.”

Edward is more civic minded than his father.

High rates of saving causes a recession to turn exceptionally nasty. People cut back…and all of a sudden…the cutbacks are magnified by millions of little decisions all up and down the economic ladder. The rich cancel their restaurant reservations…the poor buy a little less meat. But one man’s expense is another’s revenue. Pretty soon, money is getting tight throughout the whole system. That said, the man whose financial advisor tells him to keep spending in order to help the economy has a fool for a counselor. The smart thing to do is to cut back; let someone else go broke.

*** We are so happy to see Thomas L. Friedman back in the pages of the International Herald Tribune…and back in form too!

The NY Times columnist is always entertaining…and helpful. Unwittingly, of course, the only way possible for Friedman. What makes him entertaining is that he is perpetually in a state of emergency…and irrepressible alarm…that causes him to run around wildly and crash into things.

Remember the terrorism scare of the early 2000s? Friedman was right at the front of it…howling at the mob to mobilize…urging them to panic. Otherwise, the terrorists were going to blow up every public building and underwear store in Christendom. More recently, there was his fright about rising oil prices. Once again, we had to “do something!” He called for a massive, nationwide campaign, “similar to the Manhattan project,” in order to save America from the oil exporters.

Now, it’s the financial crisis that has the man in a sweat. What a delight to have his views on the financial world! He is such a shallow thinker that his errors are always right on the surface. It is reassuring too; if Freidman agreed with our position, we’d have to rethink it.

“If you are going to fight a global financial panic like this, you have to go at it with overwhelming force,” writes Freidman. How does he know that? How many of these things has he seen? Well, none. No one ever has…which he admits a few lines earlier.
But ignorance never stops Freidman. He may not know where the enemy is…but he gives the order anyway: “Charge!”

“This is no time for half-measures,” he continues. How does he know what is a half-measure and what is a full measure? And what about no measure at all? Again, he doesn’t explain. But this is no time for thinking – it’s once again, into the breach! What we need now is “an overwhelming stimulus that gets people shopping again. And an over-whelming recapitalization of the banking system that gets it lending again.”

“Go shopping,” he summarizes.

Anyone with half a brain knows that it was too much shopping and too much lending that got the US into this jamb. But that disqualifies Friedman right there. Not that he isn’t a smart fellow; but he’s determined not to let thinking get in his way. He’s smart enough to know that once you start thinking about things, they always turn out to be more complicated and nuanced than you had hoped.

But if you concern yourself only with appearances, you don’t have to worry about it. What do people in a healthy economy do? They go shopping. What do banks in a healthy economy do? They lend money. So, hey, this is easy. If banks would just lend and consumers would just buy things – we’d have a healthy economy, no?

Another charming feature of Friedman’s pensée is his willingness to chuck principles, rules and dignity whenever they get in the way. Dismissing the question of why the taxpayer should pay for Wall Street’s mistakes, he writes: “…fairness is not on the menu anymore. …we need to throw everything we can at this problem…”

And now we turn our attention to the White House. George W. Bush is said to be not merely a lame duck president…but a dead duck too. He cost Republicans a victory, say pundits: he ruined the country…he destroyed the empire…he wrecked the economy. Today, you could accuse the man of sorcery or child molesting and half the nation would believe you.

Before we come to our revisionist look at the man, we repeat our advice. Just this weekend, Barack Obama pledged to put an end to Bush’s disgraceful torture policy. Dubyah should watch his back and avoid foreign travel; otherwise he’s likely to arrested and slapped with a human rights violation. After all, most of the world would like to see him do the perp walk. Besides, he deserves it.

But here at the Daily Reckoning we always take the side of the underdog and the lost cause. Poor George is both. So, when we read the text of his speech last week in New York, we found it to our liking. Here is a man who has had some sort of brain operation or brain washing, we decided. They severed the connections, making it possible for him to think one thing and so something entirely different.

“History has shown that the great threat to economic prosperity is not too little government involvement in the market. It is too much government involvement in the market. … And the surest path to…growth is free markets and free people.

“Capitalism is not perfect. But it is by far the most efficient and just way of structuring an economy. Capitalism offers people the freedom to choose where they work and what they do, the opportunity to buy or sell products they want and the dignity that comes form profiting from their talent and hard work…

“The record is unmistakable: if you seek economic growth, social justice and human dignity, the free market system is the way to go.”

These insights are, to our mind, correct. But the US government with George W. Bush at the controls hardly favored free-market capitalism. Instead, the Bush administration presided over a “mixed economy” – both “innocent fraud,” as John K. Galbraith described the free-market’s excesses, and the government’s armed robbery.

… 36% of GDP was spent by government…and more than half of all eligible voters depended for their livelihoods – in whole or part – on government checks

…federally–chartered mortgage lenders – Fannie and Freddie – helped stimulate a huge bubble in the housing market

…the US government’s central bank – the Federal Reserve – led by Mr Bush’s appointee, Alan Greenspan, practically single-handedly caused a huge bubble in finance, credit, speculation and consumer spending

…when the bubble inevitably burst, Mr Bush’s own Treasury Secretary (recently one of the Wall Street bankers who had most benefited from the financial bubble) rushed in to use government money (aka taxpayers’ money) to buy up Wall Street’s mistakes…

…then, the feds partially nationalized the nations leading banks…

…and further lowered the cost of credit, in order to try to blow the bubble up again…

…and now, the US, along with the world’s other leading governments, is pledging to give the world what it least needs – more regulation!

Source: Mr Market’s Advanced Seminar on Economic Corrections