July 23, 2011
David Kotok


202-224-3121 is the telephone number for the US Capitol. No typo this time: I just tested the number and left a message for a Member of Congress.

The message is simple. Dear Congressman/woman: if the United States defaults, the personal and institutional responsibility for the fallout is squarely on you. If the House and the Senate reconcile and pass a debt ceiling bill and send it to the President, then, and only then, is there a transfer of responsibility to the White House.

“Directly Linked Aaa credits have been placed on review for possible downgrade, affecting more than 7000 ratings,” said Moody’s. “Indirectly linked Aaa credits” will be assigned “into one of two categories, according to the degree of their vulnerability to the credit of the U.S. government.”

America’s full faith and credit is on negative review by Moody’s, Fitch and S&P. Independent rater Egan-Jones has already downgraded the US credit.

At Cumberland we have not downgraded the US. It has the absolute capacity to pay every obligation it owes. It has a $15-trillion economy, an operating legal structure, a liquid capital market, functioning courts which enforce claims, and it has its own central bank. The US dollar is the reserve currency of the world.

At Cumberland, we do not issue specific political ratings. If we did, the US Congress would get an F. It is an absolute failure. There is no limit to the opprobrium, scorn, ridicule, criticism, and disdain that can be heaped on them as a collective. But a collective is a composite of individuals. Many of these individuals are intransigent, uncompromising, blundering, idiotic fools. Listen to their statements and watch their actions. And we, my fellow citizens, elect them. We then go on about our regular business and are passive. What does that make us?

Their telephone number is 202-224-3121. Give the switchboard the name of the Congressman or Senator. Leave an unambiguous message.

Some of the directly linked bonds on the credit agency watch list are: pre-refunded Munis secured by escrows of treasury securities; Federal Home Loan Bank credits; Fannie Mae, Freddie Mac, and Ginnie Mae credits; many state housing finance-agency bonds; HUD-sourced credits; and debt linked to US government leases. There are over 7000 credits on the direct-linked list. They measure in the trillions of dollars. There are many more on the indirect-linked list.

In addition, the US government makes transfer payments to Social Security recipients, veterans, the disabled, and many others. It funds the deficiency balances of the unemployment trust funds among the 50 states. It is the back-stop guarantor of the FDIC, which is the insurance agency for bank deposits in the United States.

I will stop the list here. If you are still with me, dear reader, you know where this is going: 202-224-3121.

Cumberland’s investment view is based upon a no-default scenario. We believe the best assurance that there will be no default is in the hands of the citizens of US. Watch their anger if they do not get paid by their government. The Gang of 535 consists of 435 House Members and 100 Senators. They will feel this wrath. They know it. That is why we believe there will be no default.

But we are not complacent. There is uncertainty. A fear premium is in the marketplace. In our view, this provides the investor with opportunity.

The no-default scenario is playing out in Europe. It will play out here, too. The most impacted sector is the financials. My friend Dick Bove at Rochdale Research has made the case for undervalued banks. He is correct. There are many banks trading their shares at half of their book value, and that is after the book value has been hit by substantial loan-loss reserves.

This is not just about banks. The entire financial sector is cheap. It has been beaten up by regulatory issues, specifically by Dodd-Frank and indirectly by thousands of bureaucrats at the federal and state level. And it depends on the US government to maintain its Aaa credit rating and avoid default.

At Cumberland, we have taken the financial sector to an overweight position. We do this right in the heat of the battle. Financials are about 15% of the weight in the S&P 500 index. Our collective weight is 21%. Our specific ETF choices are XLF, KRE, and ICF. We hold them in our US exchange-traded fund portfolios. We also have exposure in our global portfolios. More details can be found in this week’s Barron’s in the column on ETFs written by Murray Coleman.

No American default is our assumption. If we are wrong, if the US defaults, if the political system fails, then the markets will experience a horrible shock. The unthinkable will have occurred. We do not expect it. We believe Winston Churchill characterized the US well when he said, “You can always count on Americans to do the right thing after they’ve tried everything else.”

We are off to the GIC conference in Jackson Hole next week. Last count, there are 30-40 open seats left for those who may want to join the meeting and are wondering if there is space. Registration and conference agenda may be found at www.interdependence.org. Talk about timing for a meeting to discuss Fed policy, the economic outlook, and sovereign debt. Whoodahthunkit when we planned this date a year ago!

Thanks for your patience, dear readers. 202-224-3121. Churchill also said, “Courage is what it takes to stand up and speak; courage is also what it takes to sit down and listen.” 202-224-3121.


David R. Kotok, Chairman and Chief Investment Officer

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