Friday, May 7, 2010

Leftovers --- Radio Show 4/17/2010

We clarified for listeners who have complained about the national deficit that 2/3rds of corporations operating in the United States pay no income tax.  In 2009, GE paid no income tax.  Warren Buffett pays a smaller percentage of his income in taxes than his secretary does.  There is extensive economic literature on national deficit spending and how it is a question of efficiently targeted spending to develop economic growth and decrease unemployment.  A national government has a societal balance sheet in which when
         private spending goes up                     public spending goes down
         private spending contracts                   public spending goes up
The question then becomes is the public spending efficient in targeting economic growth and employment.  National governments with their own currency should not be confused with regional (states) and local governments which cannot deficit spend and maintain credit rating.

On April 14, these Proshares ETFs did a 1:5 reverse split:  DUG, EEV, FXP, GLL, SMN, SRS, URE and these did a 1:10 reverse split: UYG and ZSL.

UBS launched a new  ETN to track 25 infrastructure master limited partnerships, MLPI, which derive their revenue from the transportation and storage of oil and gas which is generally viewed as more stable  with steady cash flows,  the current yield is approximately 7%.  Owning an ETN rather than the actual master limited partnership means that the investor would get a 1099 form from the ETN rather than a K-1 partnership statement.  This means the ETN would be suitable for a tax deferred account.

Powershares has a closed-end fund income ETF, PCEF, which provides diversification and income enhancement in one trade.  It currently has a yield of approximately 8.3%.  The underlying holdings of PCEF will make distributions of ordinary income, dividends, long and short term capital gains, and return of capital which will passed on to investors via distributions..

We covered a long list of fraudulent securities activity including SEC filing civil criminal fraud charges against Goldman Sachs on one of their Abacus funds for failure to disclose they would profit from the failure of the investment upon which investors lost $1 billion.  The SEC knew Stanford was running a Ponzi scheme as early as 1997 and did nothing.  The SEC is examining the public statements of GE during the financial crisis for accurate representation.

A Goldman Sachs international real estate fund has losses of 98%.  A Morgan Stanley real estate fund has losses of 67% or $5.4 billion.

A J. P. Morgan Chase executive was asked during testimony before a Congressional committee who mortgage borrowers could turn to if his bank's employee's were not helping them and he replied they could come to him.  As he was leaving, fifty such borrowers approached him and he pulled his coat over his head and ran for it.

Health insurers are changing their accounting methods to book administrative costs as medical costs to evade the new health insurance regulations.  Investment banks are creating new financial structures in which deferred tax assets (including pension liabilities) could be turned into cash or an equivalent valid for capital purposes to  get around the new regulatory capital rules.

AIG continues to protest pay restrictions and has defied the government by paying two executives more than allowed.

While the SEC has accused Morgan Keegan & Co. of fraudulently overvaluing subprime mortgages, their auditor PricewaterhouseCoopers LLP still maintains there was nothing wrong with the fund's numbers and have not withdrawn its audit reports for fiscal 2007, since they can no longer assert "a high level of assurance".

One cause for Citigroup's problems in 2008 was it had to buy back $25 billion of CDOs it had bundled and sold, because they also sold liquidity puts requiring them to buy the assets back at face value if credit markets froze.  They did not even include the puts on their balance sheet as they regarded the transactions as low risk.  The OCC regulators were not allowed to examine these puts, because they were created by Citi's non-deposit investment banking unit.  This is being cited as a breakdown in both risk management and internal reporting.

A report prepared by inspector generals for the Treasury Department and the FDIC documents that the FDIC and OTS feuded over whether Washington Mutual should be put under enforcement action for capital deficiencies with OTS always insisting it was not necessary and the FDIC not taking action earlier prior to July 2008 when there was $5 billion capital need problem.  Washington Mutual was OTS largest institution it regulated and did not want to lose control of it.

China announced higher mortgage rates and down payment ratios for second homes on April 15 after another record jump in property prices (11.7%) in March.  Down payments must be at least 50% (up from 40%) and mortgage rates cannot be lower than 110% of benchmark rates.

Intel earnings exceeded expectations, but the more detailed information shows their PC Client Group revenue was flat, Data Center Group revenue was down 8%, Other Intel Architecture group revenue down 9%, and Intel Atom microprocessor and chipset revenue down 19%.

The CFTC is having a hearing on naked short selling and a whistle blower disclosed that JP Morgan, acting as an agent in both the US (safeguards and limits on naked shorts) and London (cash only) for the Federal Reserve to halt the rise of gold and silver against the US dollar, makes money no matter how the market moves.  Another individual testified that the selling in London was leveraged in that for every one hundred clients it could only redeem gold for one client at any one time.  Since there is supposed to have been physical gold purchased, this amounts to fraud.  However, in the United States, in a New Orleans trial, the players have filed a motion claiming immunity because they were acting in partnership with Treasury and the Federal Reserve.

The Federal Reserve anecdotal Beige Report was proclaimed by the media as expressing economic improvement when in fact it said "Overall economic activity increased somewhat ...". I t went on to say labor markets remained weak, consumer spending increased, business services were mixed, bank lending activity was mixed, credit standards remained generally unchanged and credit quality for many small firms continued to decline.

Tom Duy's Fed Watch said we are stuck in the middle and trend growth is just not good enough.

John Hussman said "The real concern from my perspective remains the potential for a second wave of delinquencies beginning in data as of the first quarter of 2010 and extending well into 2011. While we've seen some suggestions that many Alt-A and Option-ARM loans have already been modified, the premise of this argument is problematic since it is also true that about three-quarters of modified mortgages go on to default a second time, and few of these modifications result in substantial alterations in principal or interest payments beyond 12 months.
"In short, my impression is that investors are deluding themselves about the solvency of the banking system. People learned in the 1930's that when you don't require the reported value of assets to have a clear and tangible link to the value that the assets would have in liquidation, bad things happen. Yet this is what regulatory and accounting rules are allowing for the banking system at present. While I do believe that bank depositors are safe to the extent of FDIC guarantees, my impression is that the banking system is still quietly insolvent."

Tom Duy in another Fed Watch said to look for the following factors if the recovery is beginning to derail: 1) renewed surge of foreclosures, 2) waning fiscal stimulus, 3) energy price shock, and 4) an external bogeyman ( a foreign collapse which ripples globally).

In the last 11 recessions since World War II have been preceded by a sharp increase in the price of crude oil.  The number of vehicle miles driven, which is available form the U. S. Department of Transportation, continues to fall and is also worth watching.

Bank of America, JP Morgan Chase, and Wells Fargo may have put aside $30 billion in reserves to cover possible losses on home equity, which is an amount almost equal to estimates of their 2010 profits.

Matthew Richardson and Nouriel Roubini have proposed a systemic risk tax be assessed on banks based on risky activities and debt.

There is tentative talk the EMU and IMF will provide 45 billion euro loan to Greece with 30 billion from the EMU members and it is looking more likely Greece will have to take them up on the offer, although it appears it is not enough money.  Such a small amount would create what Marshall Auerback has called a Maginot Line and fail.  He sees the actual current crisis as the result of the ECB blocking a basic repo function: "But the decision a few months ago by the European Central Bank to block a basic “repo” function — namely, the purchases of a number of European commercial banks of Greek government debt and exchanging this debt via repos with the ECB for German and French government paper is what appears to have initially triggered the Greek crisis and raised issues of Athens’s potential insolvency."  He also blames Germany's fear of inflation and Germany does not see it will ultimately be the victim of its own reluctance to do what is necessary within the EMU, because Germany "doesn’t see the risk that the collapse of aggregate demand within the European Monetary Union will ultimately lead to a collapse in Germany’s export sector (a large chunk of which is the product of intra-European trade), and the corresponding extension of the “PIIGS” disease of slow growth and high unemployment to the heartland of the euro zone."  Gonzalo Lira has perceptively called the euro a very complex fixed rate exchange system, which is normally called a currency peg, but he also implies that the single most important problem of the EMU is that member nations were allowed to continue issuing their own debt which would mean the "nations" should disappear.  The EMU problem is structural, as we have said in the past, in which member countries do not have any monetary policy and limited fiscal policy to address their national economy.  Felix Salmon thinks the best case scenario would be for Greece to restructure its debt with a 25% haircut.  There has been some talk that the EU may consider creating a Euro bond, as I have proposed in the past, to fund a permanent action fund.

The Baseline Scenario sees Portugal as the next problem, because it is the smallest, but I think Spain is the weakest link with the much larger economy, regional banking system, very high (near 20%) unemployment, and burst real estate bubble that would imperil German and other European and  global banks with Spanish exposure.

Later in the week there was a 61 billion euro (at 5%) rescue plan announced as available for Greece, but many perceive these plans as attempts to provide confidence to the market rather than actually designed to solve the problem, although Greece did successfully sale 2.1 billion euro of debt after the announcement.  Many people, such as Munchau in his article "A Greek bail-out at last but no real solution", continue to believe Greece will eventually have to default without considering that Greece would have to completely withdraw from the European Union in order to leave the euro and that would ripple globally through the stock markets in ways we would not want to see or experience.  Others, such as Daniel Gros in his article "Only Athens can rescue Greece", still perceive this credit crisis as a solely Greek problem rather than a structural problem of the euro itself.

While ROTH conversions of traditional IRA accounts is popular among sales people, it is not always proper for many individuals and is often done wrong by many individuals and advisers.  When after-tax contributions are mixed with tax deferred contribution in the same IRA, it is a mistake to not identify the different amounts and convert them separately and properly identified. This is often overlooked by the individual and/or the adviser who should know better.  Another common mistake is it is not all or nothing; you can make a partial conversion which should be determined by doing the math on what is needed at what time in retirement and what the tax bracket in retirement is likely to be.  Additionally, the incrementally effective tax liability of the 3.8% Medicare tax, AMT, estate tax, and port mortem distribution need to be considered in deciding if a ROTH conversion is appropriate and beneficial.  Often the offset value of the IRD deduction is overstated; because the IRD deduction for beneficiaries of a traditional IRA will generally be recovered over multiple decades with minimum distributions which decreases the overall net present value of the IRD deduction.  Be careful of advisers who are also salesmen, because they have chosen to give advice while maintaining self-serving conflicts of interest.

Fisher (Dallas Fed President) said the Fed is done pumping money into markets and has clearly indicated it will not print money to fund deficit and some Fed officials regret buying $300 billion in longer term Treasuries, because it suggested Fed was willing to fund the deficit.  .I have stated on several occasions in the past that the Fed buying long term Treasuries was questionable.

Aetna has been suspended from Medicare enrollment based on their changes to Part D coverage.

The IRS has released payroll tax exemption form for the HIRE Act.

Alcoa earnings met expectations but sales disappointed.

Lasker (Richmond Fed President) and Fisher (Dallas) both indicated unemployment unlikely to improve this year.

March foreclosures were up 19% from February and Q1 2010 was up 7% from the prior quarter.

Capital One credit card defaults were up to 10.87% March from 10.19%, but charge offs were down 2,1% from 2,5%.  Other banks were reporting charge offs only.

The NFIB small business index was down 1.2% in March to 86.8 and that is considered a negative sign.

The US trade gap was up $39.7 billion in February with imports up 1.7% and exports up .2%.  Imports from China were down 7.2%.

US retail sales were up 1.6% in March and 7.6% vs year ago.

US industrial production was up one-tenth of a percent in March, 7.8% for Q1, output was up .9% in March, and capacity utilization was up .2% to 73.2, which is 7.4 below the average.

China's Q1 GDP vs year ago was up 11.9%, which is the largest in three years and consumer prices were up 2.4% March vs year ago (February was 2.7%).

Eurozone production was up .9% in Q1.

UK exports were up 9.5% February, which is their biggest increase in seven years.

The Bank of Japan is expected to revise its inflation forecast to show deflation with consumer prices expected to stop falling beginning in April 2011, which is a year earlier that previously projected.

Some Japanese lawmakers are trying to interfere in monetary policy in an attempt to make the yen weaker.

South Korea said economic uncertainties are high while inflation risks are low.

Singapore's economy expanded 32.1% from the prior quarter and the government responded by aggressively tightening its monetary policy by allowing the Singapore dollar to appreciate to a five month high.

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