Monday, April 5, 2010

Leftovers --- Radio Show 3/27/2010

We went through a list of what is in the new Health Reform Bill, detailed that what some business are reporting as an immediate expense to income is actually the repeal of a deduction for employee medical benefits for which they have also been receiving a subsidy, and we discussed that children with pre-existing conditions may not be covered until 2014 as the result of the actual language in the legislation.  This bill is still being analyzed by experts and the analyses are not all in agreement.  We did not get around to Marshall Auerback's article explaining how this health reform is actually a status quo entrenchment of the private insurers, who will profit immensely.  He also maintains that deficit hysteria also drove the legislation to put revenue before expenses, which is backwards, and left the insurance companies uncontrolled.  Cutting costs would not be as profitable.  These are positions I have long maintained and voiced time and again.

Just as Bill Gross of PIMCO was saying bonds have seen their bet days, we saw the 10-year US swap spread turn negative for the first time on record.  This means the Treasury yield is higher than the swap rate, which is typically greater given the floating payment are based on interest rates that contain credit risk.  The 30-year swap spread turned negative for the first time in August 2008.  There is rising demand for higher-yielding assets such as corporate and emerging market securities.  Debt issued by financial firms is swapped from fixed-rate into floating-rate payments, which trigger receiving in swaps, which causes the spread to narrow.

John Hussman in his weekly commentary railed against the FASB continuing to allow banks too much discretion in valuing assets and this risks creating zombie banks as the gap between stated assets and actual probability of cash flow from those assets grows.  He indicated "... the ability to obscure valuations appears to be a primary reason for the growing gap between delinquencies and foreclosures ...".  This is consistent with my repeated observations and warnings that the bank balance sheets are fraudulent and cannot be relied upon.  Hussman elaborates that we should not be relying upon any foreclosure data, because the minor resets in the later part of 2009 will not be appearing until March-April at which time we should be looking for any spike in 30-day delinquencies.  If one seeks to accept greater risk than there needs to be better clarity and better valuation upon there can be reliance.

We talked again about the proposed rules to require investment advice to retirement plan participants to be conflict free, which means that most of the financial services current players would not be able to provide that advice, leaving only impartial fee-only, conflict free financial advisers like myself.  Unfortunately, employers have shown no concern or interest in these new proposed rules and the mandatory consequences.

J. P. Morgan, Lehman, UBS, Bank of America, Bear Stearns, Societe Generale, two of General Electric's financial companies, and Salomon Smith Barney, which was a part of Citigroup, have all been charged by the US Justice Department  for being involved in a conspiracy to pay below market interest rates to US state and local governments on investments.

The Federal Home Loan Bank of San Francisco has filed suit in the Superior Court of California against nine securities dealers in order to rescind its purchases of 134 securities in 113 securitization trusts amounting to more than $19.1 billion alleging the dealers made untrue and misleading statements about the characteristics of the mortgage loans underlying the securities.

Retiring Fed Vice Chairman Kohn said that US policy makers were complacent about complex financial instruments and they did not know as much as they thought they did.  In separate comments he outlined four homework assignments for monetary policymakers: 1) evaluate implications of changing character of financial markets in designing liquidity tools to be used when panic-driven runs threatened financial stability; 2) improve our understanding of the effects of the large-scale purchases of various types of securities and the massive increase in bank reserves; 3) should central banks use adjusting level of short-term interest rates in order to rein in asset prices that appear to moving away from sustainable values (asset bubbles) while maintaining objectives of full employment and price stability; and 4) should central banks adjust their inflation targets to reduce the probability of reaching zero interest rates.

Yellen, San Francisco Fed president, said the housing market seems to have stalled, unemployment will be 9.25% at the end of this year and 8% by the end of 2011, and interest rates will need to remain low.

The Economics of Contempt blog argued that clearinghouses for derivatives will not work , because it is too burdensome to provide the documentation of collateral behind the securities and would disrupt the liquidity of the market.  In my opinion transparent markets where transactions are recorded and tracked are necessary if we are to determine risk management concerns and I question why any security should be sold if it cannot document collateral.

Germany continued a hard line against developing a plan to assist Greece within the European Union and keeps insisting the Stability and Growth Pact be rigidly interpreted even if this means the debt crisis inflames Spain, Portugal, and Ireland.  Germany risks damaging the European Union, which provided it with favorable current trade balance exchanges in the euro, in its pursuit of its own national interests at the expense of other EU member states.  In Spain, the problems exposed by the bursting of the housing bubble are piling up and the government appears to not have the determination to accept the political consequences of EU austerity imposed plans, which means the more serious financial condition of Spain's regional banks and their heavy exposure to construction and housing loans is not getting the crucial attention it needs.

Speculation that the US Treasury will classify China as a currency manipulator in its semi-annual report on April 15th appears to be political jockeying and China warned against such a sanction and said it will probably report a trade deficit in March.  Fan Gang, the only academic member of the People's Bank of China, contended that a rise in the yuan is not a solution for the problems of the United States and a stronger yuan could actually push up inflation in the US.  China will weigh all of the external and internal possibilities and sees a primary concern as the need to reduce income inequality between rural and urban workers.

China and Germany have become the two surplus trade countries driving the global economy and both may have to come to the realization that helping their trading partners may be in their best interests.

We have talked and published at length on the spending and real estate bubbles in China.  If those bubbles exist and they burst, the effect will be felt around the world and will have severe economic consequences for every nation.

While many have called for the appreciation of the yuan, including Paul Krugman who sees no danger in a trade war, others disagree and think a revaluation of the Chinese currency would actually cut global economic growth by 1.5%.  Exports are an essential 1/3 of China's economy and if it well to revalue the yuan and continue exporting to the US at higher prices and lower profits than inflation in the US could be pushed up.  All countries need to export, but not all countries can compete and the marketplace is not a level playing field.  Attempts to create global reforms effecting current trade balances could end up creating the same problems in the European Union.

One of the reasons the current financial crisis spread so far so fast, besides the proliferation of derivatives, may have been the increasing worldwide reliance on wholesale funding to supplement demand deposits..  When those sources dry up, the banks become even more vulnerable.  Wholesale funding includes Federal funds, public funds (sate and local), Federal Home Loan Bank advances, Fed primary credit program, foreign deposits, and brokered deposits obtained through the internet or CD listing services.  This only emphasizes the need to assess the safety of the sources of bank funds as part of prudent risk management.

Fitch downgraded Portugal's sovereign debt one notch to AA- and cited budget underperformance, although Portugal is taking positive steps.  The downgrade wasmuch anticipated is not considered significant with Fitch already in the middle of S&P and Moody's.  In fact, the premium Portugal pays on bonds actually fell compared to the German bund.

US Treasury auctions:
2 year treasury, $43.5 billion, yield 1.0%, bid-to-cover 3.025%, foreign 34.78%, direct 13.8%.
5 year treasury, $42 billion, yield 2.605% (10 bops higher), bid-to-cover 2.55, foreign 39.6%, direct 27.1%.  This was a weak auction which drove US CDS wider (more risky) than Europe CDS.
7 year Treasury, $32 billion, yield 3.374%, bid-to-cover 2.61, foreign 41.9%, direct 8.1%.  This was a weak auction also.


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