Saturday, April 24, 2010

Leftovers -- Radio Show 4/10/2010

We talked about how banks appear to be masking risk levels as major US banks have lowered debt levels before reporting earnings in the last five quarters.  18 banks, including Goldman Sachs, J. P. Morgan Chase, Bank of America, and Citigroup, understated debt levels used to fund securities trades by lowering them an average 42% at the end of each period and increasing the debt levels in the middle of each successive quarter.  The question is what are they doing which is producing a similar result just as Lehman used the Repo 105.

We discussed how oil production is up in all oil producing countries despite an oversupply glut.  While it may be based on speculation of impending growth, it could potentially hamper any recovery as unemployment remains at 9.7% officially and will remain high for a very long time and gasoline prices have a tendency to strangle growth as every one cent increase in the price of gasoline takes out $1.5 billion from consumer pockets annually.

We noted that three banks in Puerto Rico holding almost 25% of the assets of the island are in trouble and the remaining healthy banks do not have the ability to acquire these banks,  Since mainland banks have abandoned Puerto Rico, the FDIC may not be taking action, because it cannot find buyers and it cannot absorb losses from the resolution of these banks.

For over twenty years, investors have been told that over 90% of portfolio returns is from diversification.  This is a common myth as the actual study only wrote about variation of returns and not returns based on performance.  A new study published in March/April 2010 shows about 75% of a typical fund's variation comes from general market movement and the rest from specific asset allocation and active management.  The old study incorrectly ascribed all 100% of return variation to asset allocation, when the variation actually comes from stock selection and general market movements.  This just another example of the common investing myths that permeate financial planning and investment advice, such as 4% withdrawals, 60/40 to 40/60 equity/bond portfolios, and "market efficiency" in Modern Portfolio Theory and Capital Asset Pricing Model -- all of which do not work.  Even William Sharpe is now attempting to develop asset allocation based on market movements.

John Hussman continues to see the market as over bought and overvalued as well as over bullish with hostile yield conditions.  Historically, this means a continued tendency of the market to achieve successive but slight marginal new highs.  Unfortunately, this skew in the market also has a remaining probability of vertical drops well over 10%.  He believes one should be in a defensive stance.  He notes that mortgage delinquency rates remain at record highs while foreclosures have lagged creating a shadow inventory.  He finds the implied return for the S&P 500 over the next ten years to be 5.7%.  He think any credit hiccup could cause a market reversal.

While the Federal Home Loan Banks financial statements are showing $1.9 billion profits, but $8.8 billion in mortgage portfolio paper losses which are not expected to recover in the foreseeable  future are not included, because the FASB changed the accounting rules over a year ago.  All 12 banks reported $42.8 billion total capital or 4.2% of assets while the government gave them credit for $60.2 billion in regulatory (primarily imaginary) capital.

Pragmatic Capitalist posted on "The Enron Banking System" in which he attributed the financial crisis to profitable excess risk taking and called for drawing the line between banks and risk taking firms.  He said banks should be more like utilities and less like hedge funds, banks should not exact onerous fees on the public or engage in a business model which drives customers into debt, and banks should be true lending institutions devoid of non-banking activities such as hedge funds, CDS, off balance sheet financing, and trading.  Banks should be oriented towards productive economic growth.

Rick Bookstaber posted on the current dangers in the municipal bond market.  He sees leverage and complexity problems with unreliable credit ratings, general obligation bonds actually being residual claims as revenue streams have been sold off, and the potential for default which could cascade.

In a Washington's Blog post on rental prices, he noted that it may take until 2014 for unemployment to decline to 5% and unemployment is a primary cause of foreclosures.  He also noted that the rich have become richer as the middle class continues to disappear into the poor.  The rich tend not to rent.  The foreclosed tend to seek shelter with family or friends.

Greek citizens and companies have started moving money from Greek banks to foreign banks with more the 3 billion euro leaving the country in February.  There are also pressures from increasing bond spreads.  These are symptomatic of a lack of participant confidence.

Hoenig, Kansas City Fed President, that a long period of low rates builds bubbles and the Fed could, in his opinion, raise interest rates to 1%, leaving them at historically low levels but sending a signal that easy money policies are pulling back.  This caused a noticeable negative market reaction on the 7th.  Bernanke said it is too early to raise rates with weak housing, low loans to small business, and unemployment. Lacker, Richmond Fed President, said he is becoming less comfortable with low interest rates and sees the recovery as sustainable and unlikely to double dip.

The Obama Administration is calling for limitations on GRATs, by not allowing zero value for estate purposes, and calling for a ten year term on GRATs.  This could make them far less beneficial.  A GRAT is a trust to which an individual has transferred assets in return for an annuity in order for the assets to pass to a beneficiary free of gift taxes after the term of the trust ends which is normally two to three years.  If the grantor dies before the term is up, the entire asset is put back into the estate.  If the value has to be at least 10%, this could cause the potential losses to the donor to outweigh the benefits.

A recent Transamerica Retirement Study found 71% of workers surveyed had access to company 401(k) retirement plans and 77% of those contribute to the plan with 41% saving more than $50,000 and 29% more than $100,000.  30% of those surveyed were not offered a plan at work and only 22% had saved more than $50,000 and 18% had saved more than $100,000.

The EU agreed on an unspecified rescue plan for Greece in the form of loans, perhaps at approximately 5%.  Fitch downgraded Greece's credit rating two notches.  Trichet, ECB chairman, said Greece is not at the point where it needs a financial bailout and default is not an issue.  However, the ECB did extend looser collateral rules and will continue to accept lesser rated debt, as low as BBB-, as security in lending operations but will apply new risk buffers on riskier assets in the form of risk margins known as haircuts.  Government bonds ar not affected.  Here are some key political risks to watch in Greece with respect to deficit cuts, public opposition, social unrest, and bond and CDS markets.

There is growing expectation the Chinese yuan will be allowed to appreciate, but the Chinese government, while it is exploring just such options, is resistant to external pressures to do what they may have to do in order to control inflation and a potential real estate bubble internally.  Western commentators keep calling for appreciation of the yuan and some think it is imminent, but I have been maintaining it will be done slowly and in steps to allow appreciation of perhaps 2-4% after other monetary policies have been engaged.  Contrary to some commentators, the appreciation of the yuan will not have many benefits to the United States and could cause prices, including oil, to rise with jobs going to other Asian countries.

In 2008, US births were down 2%.

Of privately held financial wealth in the US, as of 2007, the top 1% of the population hold 42.7%, the next 19% of the population hold 50.3%, and the remaining 80% hold 7%.  Only 31.6% of the population own more than $10,000 in stock.  70% of white families wealth is in their principal residence compared to 95% of blacks and 96% of Hispanics ("Wealth, Income, and Power" by William Dormhoff -- University of California - Santa Cruz).

Kocherlakota, Minneapolis Fed President, said Fed should start selling small (non-trivial) amounts of MBS each month to normalize the Fed B/S.  He also said there cannot be a sustainable recovery until housing starts pickup dramatically.  Paul Volcker said the US may need a VAT (national sales tax) on energy or carbon to control the deficit.

It is a tax fact that 47% of all US households will pay no income taxes for 2009.

A senior vice-president of Bank of America at a building industry conference in Irvine, California said Bank of America will increase its foreclosures from 7500/month to 45.000/month by December.  That is a 600% increase.

Not counting 2009, 1.2 million households have been lost in this financial crisis through 2008.

Office vacancy rate is at a 16 year high.

Pending home sales were up 8.2% in February.

ISM non-manufacturing index is up to 55.4 in March from 53.0.

US wholesale inventory is up .6% in February; sales up .8%; inventory sales ratio still 1.2 months.  January sales were revised down to .9% from 1.2%.

Treasury will sale $142 billion in bills this coming week plus $8 billion in TIPS, $40 billion in 3 year, $21 billion in 10 years, and $13 billion in 30 year.

Brazil's inflation is projected at 5.18% for 2010.

Chile's February economic activity index was up 2.7% vs year ago, but it may contract ifor March post earthquake and then pick up with construction.

Australia raised interest rates 25 basis points for the 5th time in 7 months to 4,25%.

US consumer credit fell $11.5 billion in February.

Germany's trade surplus jumped 39% to $16.3 billion as exports rose 5.1% to $94.9 billion and imports rose .2%.

Bulgaria delayed plans to adopt the euro with a budget deficit higher than EU target 3% of GDP.

GM lost $4.3 billion in the 2nd half of 2009, but says it will pay off government loans by June of this year.

Poland's central bank sold zlotys to curb a rise in its currency and to bolster exports and the economy.

Despite the EU imposed austerity program, Spain is attempting government programs to create jobs (over 20% unemployed) and to offer loans to small businesses.

Bank of England held their interest rate  at .5 % for the 13th monthand made no increase in asset buying.

The ECB kept their interest rate at 1%.  Trichet said recovery will be no better than moderate or uneven this year with no inflationary pressures medium term.

US Treasury Auctions:
9 year 9 months TIPS, $8 Billion. yield 1.709%, bid to cover 3.469, foreign 37.5%, direct 7.51% (small direct).
3 year Treasury, $40 billion, yield 1.776%, bid to cover 3.10, foreign 52,25%, direct 10,75%.
10 year Treasury, $21 billion, yield 3.9%, bid to cover 3.73, foreign 43.11%, Direct 16.32% (strong demand, biog direct).
30 year Treasury, $13 billion, yield 4.770%, bid to cover2.73, foreign 36.85%, direct 24.48% (better than expected, huge direct).


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