In a note to file under the “Playing for Time” theme, the Curious Capitalist notes:

First American CoreLogic has taken a look at the effect of the government’s efforts to drive down mortgage interest rates, which, among other things, makes for easier refinancing. According to the loan analytics company, in the first half of 2009, refinancing homeowners set themselves up to save some $11.5 billion over the next five years. The typical person who refinanced was able to drop his monthly payment by $120 a month, a reduction of 10.5%… The value of mortgage originations hit $664 billion in the second quarter, and 69% of that was refinancing (by contrast, 37% of origination activity was made up of refis in the last quarter of 2o08). Fair or not, the government’s plan at least worked.

After Buffett’s investments in a handful of major railroads – Union Pacific (UNP), Norfolk Southern (NSC), and most notably Burlington Northern Santa Fe (BNI) – the industry garnered plenty of attention. The attractive industry dynamics and a myopic focus on the major players makes me interested in the small number of publicly traded regional railroads – among them Kansas City Southern (KSU) and Genesee & Wyoming (GWR).

Why railroads? Foremost, it’s an industry with significant tangible barriers to entry, and it provides a vital economic service. Although fixed asset investment is substantial, I also believe that the general consensus underestimates the variability of the typical railroad’s cost structure – yes, there’s operating leverage there, but there is also room to reduce headcount as unit volumes decline. Below is a graph of quarter-over-quarter revenue growth compared to QoQ operating expense growth for two major carriers (Norfolk Southern and CSX), one larger regional (Kansas City Southern) and the short-line amalgamation G&W.

I go to school just outside Boston and my family lives near Philadelphia, so I do a fair amount of travel between the two cities. Lately, I’ve noticed one bothersome change – the amount of traffic created by construction projects has greatly increased the length of the drive. Given the poor shape most state budgets are in, and the emphasis on infrastructure spending in spending stimulus funds, my intuition says that the stimulus funds are financing this construction, which is in turn causing traffic.

Now, my trips are done later at night – I usually work during the day, have dinner, and pack before getting on the road. I’m usually traveling between 8 p.m. and midnight, since it fits my schedule and will theoretically minimize rush hour traffic issues. The favored time to do this roadwork, however, is overnight, when it impacts fewer people than during the day. As much as I don’t like that, at least there’s some forethought there.

One phrase I keep coming back to is “playing for time” – I see it as a good description of the strategy (or lackthereof) underlying most of the economic policy decisions that emanate from Washington.

What areas are being targeted, and how is it being accomplished?

Last week, I noted that Primus (PRS) announced a fairly significant “credit mitigation” transaction, which clipped the tail risk on about $1.2 billion in notional CDS. Because Primus discloses such events and credit losses as they occur, and the company not writing new CDS business, non-GAAP earnings aren’t really a surprise – economic results of $47.5 million came from CDS premiums (no credit events in Q2) and a repurchase of debt at a large discount.

The most interesting development is that Primus is now using its float – over $730 million at quarter’s end – to invest in investment grade corporates. On the conference call, CFO Richard Claiden said that $20 million of holding company capital was now allocated this way, and subsequently Primus Financial has started doing the same. In the second quarter, Primus’ interest income from short-duration risk-free assets was a mere 0.61%. With the iShares iBoxx Investment Grade Corporate Bond ETF (LQD) yielding 5.59%, there’s plenty of room for improvement in the yield on that capital (which is about 5.6x Primus’ current market cap). My valuation model ballparks a 100 basis point improvement in yield over the duration of Primus’ current swap portfolio as being worth 58 cents per share in terminal value. There’s value to be captured here, and investing in investment grade corporates is a natural way to leverage Primus’ credit evaluation abilities.

Primus Guaranty (PRS) announced the other day that it entered into a significant credit mitigation deal with one of its counterparties, reworking $1.2 billion in notional value of credit default swaps. According to the press release, $40 million in notional exposure written on a monoline insurer was terminated for $15 million, or 37.5 cents on the dollar. The other billion-plus is being moved to a subsidiary of Primus Financial capitalized with $36 million, which is the maximum exposure (plus future premiums on those swaps) that can be lost.

Working backwards, ring-fencing certain swaps clips the tail risk existing in the portfolio at about 3.1% – a fairly high level that’s about 50% above what I’ve modeled previously. From the press release, my assumption is that the counterparty is willing to do this to minimize credit/counterparty risk related to Primus; it’s not collateral per se, but it functions in the same way.

This isn’t going to be a typical book review, because my thoughts on the book can be summed up in a concise manner, and I think the real story is much more relevant in regards to current events.

Goldman Sachs: The Culture of Success is written by a former Vice-President at the company, detailing the path taken to the firm’s 1999 IPO. It’s a fairly involved historical work that covers major events and people that made Goldman what it was at the time it went public (the book was published in early 2000, so no vampire squid references). My two complaints:

If you needed something to temper the bullishness that’s gripped the markets, here it is. Wallboard maker USG reported second quarter earnings Thursday. From the conference call:

Looking ahead at the remainder of 2009 and into next year, we are not expecting much improvement in our markets. More specifically, we are planning for low levels of residential construction, though some stabilization seems on the horizon, a continuing slowdown in repair and remodel and a fairly significant drop in new non-residential construction.

This is a long overdue follow-up to a previous post on whether or not the ratings agencies are good candidates to be sold short. CalPERS is suing Moody’s (MCO), S&P, and Fitch, saying that their ratings “proved to be wildly inaccurate and unreasonably high.”

Hindsight is 20/20. Are the ratings agencies legally liable for misjudging the risks to instruments they rated? After all, the lawsuit documents say that CalPERS relied on the “AAA/Aaa” ratings given to the SIVs they purchased. The ratings agencies have the special privilege of a protected franchise, but if CalPERS is truthful that it only invested in SIVs because of the rating, it should have been damn sure that the ratings were appropriate.

One prominent argument used by critics of the government’s actions since September 2008 has been that various programs – TARP, TLGP, etc. – have been used to avoid the reckoning needed to clear bad debts out of the system.

For a time, any new risks that emerged were dealt with through creative application of the rules (as with many “bank holding companies”) or, when that failed, by simply creating a new lending facility.

When Fed Chairman Ben Bernanke coined the term “green shoots” of recovery during his 60 Minutes interview, it became entwined with the improbable – both in terms of timing and magnitude – rally taking place in the stock market. The S&P 500 went from a low of 666 to peak over 950, and green shoots abounded. Prices have slid back since then, because the perception of green shoots hasn’t matched with the reality of nobody involved in business seeing the same thing.

On DailyFinance, I devote time to tracking what influential people in business and finance are saying about the markets, and I haven’t heard any of the outright optimism that a 40% rally is predicated off of. Warren Buffett said that the economy is still in shambles, Mohamed El-Erian of PIMCO said that low interest rates will be necessary “for a long time” to heal the economy, and American Express CEO Ken Chenault hoped for growth resuming in the second half of 2010. Elsewhere, the KB Homes (KBH) conference call and other data showed no bottom is in for housing, and the Homebuilders ETF (XHB) is down more than 20% from its recent highs.

I’m going to interrupt the regularly scheduled program to briefly tackle one of my side interests in finance – options theory – having been inspired by this article from Bloomberg on options trading volumes. From the article:

Average daily trading increased 24 percent to 15.7 million contracts in May, the biggest jump in seven months, as investors boosted the use of equity derivatives, Options Clearing data show. Volume had slowed last year after professional investors such as hedge funds sold positions to pay back clients. Forced sales and the highest prices on record cut trading by 7 percent in December from a year before. November volume fell 21 percent.

Today, I’m going to try to tie together three distinct threads into something I’ve been debating for about a year now – the savings rate, consumer discretionary stocks (i.e. “retail”), and the economic foundations of America. Please bear with me – I’ll start with something from my colleague Peter Cohan, who was writing about the savings rate hitting a 50+ year high. From “Fiscal prudence is great for consumers. But is it bad for stocks?”:

If investors think that all this saving will eventually lead to mounds of dry powder to be invested in stocks, then now could be a fine time to invest in stocks. But if consumers stop borrowing and keep saving, it could be years before consumer spending increases lead to economic growth…

I covered earnings for Accenture (ACN) over at AOL Money + Finance, and want to use this opportunity to dive more into the conference call and prospects for the stock. First, the numbers were pretty strong, with the main drag being currency-related.

From the earnings write-up (“Accenture shares rise on earnings beat”):

From a fundamental standpoint, I see two major reasons to establish a short position:

• High Valuation
• Bad Business Model

Granted, both have difficulties associated with them – but just as with going long, basing something solely on valuation carries much more risk of a long period of adverse price changes. A deeply flawed business model (usually coupled with less-than favorable industry economics) is something to fall back on, whereas the action based only on valuation requires the ability to hold the bet to term.

This week, I started working with AOL Money & Finance writing on two of their sites – DailyFinance and BloggingStocks. I’m looking forward to working with the talented and enthusiastic team there to produce great content, and to take advantage of the opportunities that the backing of a large platform offers.

A recent article on the increasing public pressure on Citigroup (C) CEO Vikram Pandit grew out of a conversation I had with Tom Brown, whom I’m greatly indebted to for the perspectives he has given me across a number of areas. Pandit, he said, would be the only large bank CEO replaced this year – this was shortly before the news broke about how heavily the Fed and Treasury leaned on Bank of America’s (BAC) Ken Lewis to save Merrill Lynch. In a small bit of irony, I found an article written by Tom Brown in 2005 urging the break-up of Citigroup via a note in BusinessWeek Online written by Amey Stone; Amey is now my boss.

A few days ago, I reviewed Chris Mayer’s book, “Invest Like a Dealmaker.”

One very brief section of the book that I enjoyed, but did not mention in my review, came back to me upon reading news that Apple (AAPL) once again cut the price of the iPhone – essentially, that some industries offer inherently poor returns. Citing a presentation from J. Carlo Cannell of Tonga Partners, Mayer writes:

I read Christopher Mayer’s “Invest Like a Dealmaker: Secrets from a Former Banking Insider” during my vacation.

How does Mayer define a “dealmaker?” From the book:

When I was in New York City last week, I had the chance to meet a number of people in the finance and asset management fields. One discussion I had with a pair of value-oriented investors ties in closely with recent news that Google (GOOG) Almost Bought a Paper. As CEO Eric Schmidt told the Financial Times:

FT: Would you ever consider buying a newspaper; they’re cheap right now?

A while back, I looked at the non-financial components of the Dow Industrials to ascertain whether or not basic business models were solid. The strong ROAs earned by most firms, coupled with moderate leverage, show why many are regarded as best-of-breed.

Today, we’re taking a look at the other side of that – is the business model of banks as used in the past broken, or merely undergoing a correction?