Illinois Has No Political Will; Fiscally and Ethically Bankrupt

Moody's downgraded the State of Illinois credit rating for its General Obligation bonds from AA3 to A1 citing the State's continued inability over years to confront mounting debt with a balanced budget as required by Illinois Constitution.  This is one in a series of debt downgrades which will undoubtedly continue.  Moody's observed that Illinois is making only stop gap steps by borrowing against the tobacco settlement funds, an economically questionable tax amnesty program, and dependence on Federal stimulus funds which are running out.  Moody's also stated the economic recovery in Illinois will lag the Nation.  The Illinois political leadership in the House, Senate, and Executive has failed to solve large unfunded pension liabilities, exceptional retiree health benefits, and a chronic disparity between revenue and spending.  Moody's commented that the larger the deferral of action lasts the harder implementation of a solution will become.  Conservatively, the FY 2010 budget deficit will be approximately $13 billion, although I have long maintained it may be closer to $15 billion after all non-recurring funds are considered.  Illinois is fiscally bankrupt.

The primary response of the State of Illinois to the budget problems has been to not pay its bills to vendors, universities, local government, private social service agencies, and school systems.  Some have not been paid for over a year.  In fact, there are at least $5 billion in unpaid bills, which is twice the amount one year ago and almost ten (10) times the amount of unpaid bills in 2008 ($512 million).

The primary and absolute cause of this fiasco is the failure of the Democrat and Republican elected representatives and senators to work together and perform their governmental duties in the best interest of the people rather than political posturing and partisan combativeness aimed at no results.  Results, decisive political leadership, would require acceptance of votes.

The Governor submitted a budget which attempted to show the value of a 1% income tax increase for education with significant education cuts if not passed, examples of what 10% agency cuts might mean, and more borrowing to make pension fund payments as well as massive fund sweeps of dedicated funds.  All of this was artfully constructed for political effect, but in no way adequate in resolving the debt problems of Illinois government.  A prior proposal for a 2% income tax increase to a flat 5% was never seriously considered in 2009.  The Republican party has been adamant that operational cuts must be made but have failed to provide concrete cuts for consideration.  The opposing candidate for Governor has proposed, in the past, across the board 10% cuts but has equivocated recently as it is widely acknowledged such cuts would not be enough to solve the debt problem and could be destructive of the services government is expected to provide its citizens.  The current Governor has spoken of making cuts and cost savings but they have yet to materialize beyond words.

One bill passed in 2010 would raise judicial retirement ages from 55 to 67 after January 1 and reduce annual pensions from 85% of ending salary to 60% of social security wage base.  This is a significant cut, yet, the General Assembly was unable to make other pension reforms or increase retiree health premiums to levels still below the private sector.  The president of the Illinois Judges Association objected to the pension changes for judges appointed after January 1, 2011 and said judges need to provide for their families and educate their children.  Does this logically mean other, average, people do not need to provide for their families and educate their children?  The annual pension of a current associate judge making $165,588 would be $140,750.  If appointed after January 1, 2011 the annual pension at current salaries would drop to $64,080.  The average State employee (the regular joe --- not the special, politically connected elite) pension is approximately $20,000 according to AFSCME. 

Democrats control both houses of the General Assembly but refuse to take action by their majority only.  Republicans demand cuts but refuse to be associated with cuts affecting public services.  There have been demands for a forensic audit despite the estimate of a cost in excess of $60 million and the existence of State Auditor reports on all State agencies, departments, and boards.

Illinois pension systems are the most under funded state pensions in the United States in excess of 50% (almost 60%)  under funded.

Over 3000 State employees are exempt from the civil service and there has been an absolute refusal to assure these employees positions are evaluated for cost effectiveness and individual performance as any competent organization would do annually.

The sad fact is that, after so many years of incompetent and corrupt political administration have transpired, the debt problem cannot be resolved by cost savings, efficiencies, and spending cuts alone but also require tax increases.  This creates a situation which is unpalatable to both political parties as well as unions, local governments, public employees, retirees, and diverse public interest groups of all political spectrums.


Some civic organizations have proposed radically differing proposals.  The Center for Tax and Budget Accountability traditionally proposed a wide adoption of service taxes, because Illinois is a State which taxes few services, despite the disposable income regressive nature of sales and service taxes, but this year embraced a variety of income and sales taxes combined with some tax relief for lower income groups proposals.  The Illinois Policy Institute saw the solution in significant public sector labor and wage cuts and freezing spending for coming years.  The Civic Federation has consistently advocated the need for an income tax and significant pension system reform as well as full funding as well as detailing other budget proposals.
During the Democrat primary there was a good debate on flat rate income tax and a progressive income tax, but unfortunately most of it revolved around exemptions and taxing the "rich".  However, a progressive income tax would require a Constitutional amendment, which would mean a new Constitutional convention which would open up a wide variety of political controversies.  The flat rate increase was hobbled by high personal exemptions, an assumption of a four person family size, and no consideration of the regressive nature of sales taxes on disposable income.  Neither proposal would have generated enough money to solve pension funding or cover current spending.  When it comes to actual per capita taxation, Illinois is relatively low ranked compared to other states.

Illinois tax revenue is decreasing at serious levels during this period of financial crisis and fragile economic recovery.  Sales tax revenue alone is down $494 million for the year and all revenue is down $1.456 billion through May.

The budget as passed by the General Assembly is acknowledged to not be in balance.  Consequently, it is unconstitutional.  It does give the Governor authority to transfer funds, not restricted by Federal or State mandates, within the budget. 

And all of the politicians and the candidates want to wait until after the election.  Whoever wins will still face the same bureaucracy and fiscal problems.  How do you get qualified veterans hired with their legal preferences much less other qualified management personnel if all state job opening descriptions contain a requirement for specific knowledge and experience in specific department and program rules and regulations and statutes?  This limits hires to current state employees or the politically connected who get to bypass the process.  How can needed cuts be done if every special interest group with enough political campaign contribution clout and/or voting voices dissuade what needs to be professionally and reasonably done?

What needs to be done is obvious to any trained professional.  1) Make cuts based on top down evaluation of program spending and revenue efficiencies provided by an intergovernmental team which is independent of any department working out of the Governor's Office.  2) Make efficiency cuts based on cost savings and target possibilities to increase current revenue programs, such as uncollected or unenforced fines.  3) Professionally evaluate all exempt personnel and positions for competence, organizational necessity, and cost effectiveness.  4) Implement all State Auditor report recommendations and findings in past department, board, and agency audits and terminate those people who cannot get it done.  5)  Make a choice as to what programs are economically and socially safety net and growth necessary and which are not and prioritize each category and the programs within each category.  6) Increase the flat rate individual income tax to 5.5% from 3% with 1/2 percent directly deposited in the pension funds for an increase of $5.7 billion in general revenue and $1.425 billion for pensions; leave the personal exemptions unchanged but provide a sales tax credit for the 40 % lowest taxpayers.  7) Increase the corporate flat tax rate from 7.3% to 8.5% (same as Indiana) with 1/2% directly deposited in the pension funds.  8) Reform pension and retiree health benefits and ages consistent with actuarial needs and private sector costs; create a two tier system for current participants and new hires after reforms.  9) Create the necessary changes and review process to properly terminated or demote and reassign any civil service or union employee for documented inadequate job performance in an expeditious time frame.  10)  Reform legislative and elected official pensions to eliminate double dipping and limit pension amounts to no more than 60% of final social security wage base with service years prorated to state employee vesting period (if full vesting is 30 years for state employee and elected official has ten years in any state government elected office that would equal 1/3 of the 60 of final social security wage base as a pension).  11) Create a luxury sales/service tax which applies to luxury items starting at specified dollar amounts for each type of item adjusted for CPI (inflation) but not declining.

No wonder politicians prefer handpicked "experts" to professionals.  The ethical pursuit of serving the best interests of the people is obviously not as rewarding as not getting things done right or not done at all.

Print Page

Leftovers -- Radio Show 5/8/2010

On the 4th of May the stock market went into correction and this meant, if you listen to me, you would have been out of individual stocks and ETFs (which were not part of a well diversified portfolio or fully hedged portfolio) by the end of May 5th.  This would have meant that the wild flash decline and subsequent recovery would not have affected your positions, because all 8% stop-loss or stop-loss limit orders would have been executed by the end of 5 May or sold manually.  The wild crash and recovery on 6 May is from unknown causes but appears to have resulted from several factors starting with a NYSE slow down in trading which caused orders to be sent for execution to electronic markets, a large S&P 500 mini sell order, and algorithmic computer trading programs kicking in and/or defaulting to 1 penny prices as the result of electronic market, with no market makers, sell volume.  Tupperware, which had been a subject of a listener question a few weeks ago, fell 14.8% for the week.

NYSE subsequently decided to cancel orders executed within an approximate 20 minute time period on 6 May if the price was substantially below the immediately prior market prices.

Monthly Jobs report showed an increase of 290,000 jobs minus 66,000 Census temporary jobs equals an increase of 224,000.  Official unemployment increased to 9.9% from 9.7%.  Official discouraged workers is 17.1%, but, if you use the 1994 calculation, discouraged workers are approximately 22%.

U.S. retailer sales were weaker than expected up only .5% at stores open at least a year which was far below the 1.5% expected.  Even discount stores saw a decline in sales.  This continues to show the recovery is too dependent on consumer spending and consumers are not spending with continuing long term high unemployment.

The number of people working part time for economic reasons was unchanged at 9.2 million.  The Employed to population ratio went up to 58.8% from 58.6%.

Tom Duy in his Fed Watch blog said that the inventory drain has become apparent and prices are edging up again.  He doubts that consumer spending can be sustained, because it has been heavily supported by falling savings rate, while income growth less transfer payments remains stagnant.  We have growth but it is growth which leaves the economy limping along and heavily dependent on policies which stimulate consumer spending.  He stated the opinion that outsourcing over the last twenty years has left the U.S. structurally dependent on trade deficits.  Inflationary growth continues in China and other Asian countries like South Korea and Indonesia, while the U.S. needs to decrease imports.  With the Fed is keeping interest rates low , there is not sufficient growth to alleviate unemployment.  He sees a declining value of the dollar as necessary to spur exports, but I have to disagree, because increased exports would require competitive products being sent to countries that are decreasing exports.  I do not see that happening.  A stronger dollar would bring foreign money into the U.S. as a safe haven for investment and would provide more buying power for U. S. businesses abroad..He also cannot understand that the eurozone countries will not benefit from euro devaluation, because the current account balances of each country are not fiscally adjusted within the eurozone.  Rather than internal devaluation (cut wages, raise taxes) those eurozone coutnries with current account balance deficits need targeted investment to stimulate growth and adjust nominal wages and labor units.

The Pragmatic Capitalist noted that the rise in the Libor parallels the spike in Greek sovereign CDS.  It is happening because banks are starting to not trust each other.  It is apparent that the Libor is reacting to counterparty risk.

China raised required bank reserves 50 basis points to 17% for big lenders and the banks were told to reign in credit issuance.  The central bank is stepping up its open market operations in the attempt to drain liquidity.  It wants to reduce new lending this year by 22%.

It appears the bailout of Greece by the EMU and the IMF will encompass approximately 110-115 billion euro available over three years with 80 billion from EMU and 30 billion from the IMF.  The Greek parliament passed an austerity package needed to receive the bailout and Germany approved their first year payment of funds for the bailout.  The money will be in the form of loans at approximately 5%, which is high.  The ECB suspended its minimum credit rating threshhold on sovereign debt to allow Greece to participate in ECB lending programs, even if their debt is further downgraded.  Trichet, the ECB chairman, said Greece is a special case and he is confidant Greece will do what it must do.  French President Sarkozy said the EU needs a mechanism in place to defend the euro.  Germany reiterated there needs to be more rigorous enforcement of the deficit limitation rules and a closer monitoring of sovereign government finances by the EU.  Germany sees speculation against the euro and a repetition of the 1931 currency crisis in its insistence on deficit reduction rather than targeted investment to spur growth in those euro countries with current account balance deficits, because they have non-competitive exchange rates and there is no method for fiscal adjustment within the eurozone.

Hussman sees the Greek problem as a violation of transversality in which there needs to be a well defined  present value of debt in order to credibly pay off debt.  Greece has insufficient economic growth; it is accruing high interest rates payable in a currency it cannot devalue.  Without transversality, the price of a security can be anything the investors like.  Transversality forces the price of an asset to be equal to the discounted cash flow value. He thinks the Maastricht Treaty would have to be changed to allow for larger budget deficits to achieve anything from the bailout other than short term results.  He believes the budget discipline imposed upon Greece will be hostile to GDP and tax revenues making it more difficult for the bailout to succeed.

Martin Wolf, in "A bailout for Greece is just the beginning" published in Financial Times (copy the title and Google search to get past the Financial Times paywall), thinks the 110 billion euro bailout will be enough to take Greece out of the debt market for two years only.  The agreement specifically prohibits any debt restructuring.  The plan sets 2014 as the year in which deficit will be less than 3%.  To get to that Greece will have to endure a cumulative decline in GDP of at least 8%.  He believes Greece may be unable to avoid debt restructuring.  "Given the huge fiscal retrenchment now planned and the absence of exchange rate or monetary policy offsets, Greece is likely to find itself in a prolonged slump."  While Greece needs to fiscally adjust nominal wages, the debt burden will actually become worse.  In his opinion more money will be needed is restructuring is ruled out.  In my opinion, the bailout should be closer to 140 billion euro and Greece should be allowed to restructure debt by extending the maturity dates of all debt by five years.  Wolf sees the bailout as rescuing European banks and not Greece.  Wolf believes the eurozone must either allow sovereign default or create a true fiscal union and funds sufficient to provide fiscal adjustment when needed.

The eurozone has a single central bank tied to disparate national fiscal policies and there is no mechanism within the EU to respond to fiscal adjustment needs of individual countries.  There are no EU taxes, no EU distributed spending, and no EU bonds or debt.  Some would like a common tax policy and EU review of sovereign budgets.  I believe there should be a Euro bond and, rather than being tax based, guaranteed by the sovereign nations of the eurozone combined with a Fiscal Adjustment Fund to respond to the special needs of individual countries in need of GDP growth and fiscal adjustment of nominal wages and labor units or in need of more internal consumption like Germany.

Spain sold 3.09 billion euro of 5 year bonds with a yield of 3.6% up from 2.8% from the issue sold in March.  The bid-to-cover was 2.4 up from 1.5.  The spread between Spanish bonds and German bonds has grown from 80 basis points to 160 basis points in two weeks.

Bullard, the St. Louis Fed President, said a sovereign default in Europe could threaten the continuing recovery in the U.S.  However, Greece cannot default without totally withdrawing from the EU, which would be a potentially greater bombshell than default in my opinion.  Rather than a debt crisis, this is, in my opinion, a credit crisis and the risk is that interbank lending may become frozen in Europe and create a global crisis.

Nomi Prins had an excellent article on how proposed financial reforms are basically not touching hedge funds, private equity and trading abuses of banks, and the lack of proper risk management in the financial banking system.

The Consumer Metrics Institute had an very good article on how the collection and time period of GDP numbers are ancient history by the time the quarter of record is completed and shifts of just two weeks in either direction could have profound effects using their sampling during Q4 2009 and actual Q4 2009 results.  In their opinion demand side numbers are continuing to contract indicating a possible double dip.

Roubini had a strange fear inspiring article in which he fears U.S. debt will result in either inflation or default, but it is not true, in my opinion, that debt equals inflation.  Inflation expectations are high and may be growing although we are presently in a deflationary situation.  However, in my opinion, there is the risk of inflation as the Fed exits from its $2.3 trillion balance sheet by selling mortgage backed assets after all liquidity programs have ceased.  It has tried very hard to increase U.S. banks capital ratios and liquidity at the expense of long term continued high unemployment.  This will be a very difficult balancing and timing act that may go in spurts as the Fed adjusts to market response.  As long as the Fed continues low rates, it cannot begin an exit and sell assets.  I think Bill Mitchell would agree with me.

Bank analyst Meredith Whitney is steadfast in her opinion there will be a double dip in housing and that banks are "under-reserved".

AIG Q1 profit was $1.21 per share or $1.45 billion net.  Just one week ago it drew down another $2.2 billion from the New York Fed loan facility for a total net loan of $21.6 billion plua $5.8 billion in interest and fees.

According to the Fed, banks have tightened credit card terms and loan standards for small businesses which is tightening credit and restraining the economy, although consumer and business demand for laons has declined.

Consumer spending is up as savings is going down.  Savings are being spent.  U. S. personal income was up .3% in March, but spending was up .6%.  This is not sustainable without jobs and income growth.

ISM U.S. service sector index was flat at 55.4 for April and march; employment was down to 49.5 from 49.8.

ISM manufacturing index was up to 60.4 from 59.6; new orders were up to 65.7 from 61.5; inventory was down to 49.4 from 55.3; production was up to 66.9 from 61.1; customer inventory was down to 33.0 from 39.0; prices were up to 78.0 from 75.0.

U.S. factory orders were up 1.3% in March and February was revised up to 1.3% from .6%.

GM sales were up 6.4% April vs year ago.
Ford  was up 24.7%.
Toyota was up 24.4%.
Hyundai was up 30%.
Chrysler was up 25%.

According to a Hewitt study, retirees will need 15.7 times final annual salary with 4.7 times coming from Social Security and only 18% will have that.  On average workers accumulate 13.3 times annual salary leaving 2.4 times as a shortage.  Defined Benefit participants are likely to have 74% of needs.

Consumer borrowing was up 1% annualized for March ($1.95 billion).

Canada's finance minister, Jim Flaherty, said high unemployment and fears of a renewed credit crunch could harm economic recovery and there is need to be cautious.

German retail sales were down 2.4% in March but up 2.7% vs year ago.

Producer prices in the eurozone were up .6% in March and up .9% vs year ago.

Brazil's industrial output was up 2.8% in March.

China's National Bureau of Statistics sees 9% growth and a 4% increase in consumer prices.

Indian consumer prices are projected to rise 7.5%.

Australian retail sales were up .3% in March (expected .8%) after dropping 1.2% in February.

German industrial output was up 4% in March for its biggest gain in ten months.

The Federal reserve FOMC policy makers have agreed to sell some of its $1.1 trillion MBS assets but remain divided on timing and extent as too soon and/or too much too fast will hurt recovery.

Australia increase interest rates by 25 basis points to 4.5% for the sixth time in seven months.

Moody's placed Portugal on review pending a credit downgrade.

ECB held its interest rate to 1%.

Spanish GDP was up .1% in Q1 (first in six quarters) and it is seen as exit from recession by some.  I prefer to see two successive quarters and, if Spain adopts a EU austerity program, it will go back into recession.

Vanguard ETFs are now commission free at Vanguard.

GMAC changed its name to Ally Financial.  2010 Q1 profit is $162 million vs <$675 million> year ago.  Its troubled mortgage unit --- Residential Capital --- had a $110 million profit.

Two money losing airlines (United and Continental) will merge.

Pending U.S. existing home sales were up 5.3% in March and February was revised up to 8.3%.

U.S. personal bankruptcies were up 15% in April.

Freddie Mac Q1 was <$6.7 billion> and wants another $10.6 billion from the U. S. Treasury.



Print Page

Leftovers -- Radio Show 5/1/2010

During this show we discussed a customer's encounter with Chase personal bankers in Texas, when Chase refused to allow the individual to transfer more than $2000 per day from her Texas unemployment Chase debit card (she had allowed the balance to grow unused as she used savings) amounts to her community bank account and insisted she should open a Chase account.  The personal bankers also made a variety of other claims including that, if she transferred her retirement account to Chase, she could get 30% yields, which was an amounted repeated several times without any reference to time period.  To make such a yield statement is a securities violation.  The woman was very impressed with the extreme pressure she was put under as a small, unemployed.

The Fed Open Market Committee April meeting press release stated household spending remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit but they see improvement.  Employers remain reluctant to add to payrolls.  With substantial resource slack (interpret that as high unemployment) continuing to restrain cost pressures, inflation is likely to remain subdued.  With low rates of resource utilization and stable inflation expectations, the economic conditions warrant exceptionally low levels of the federal funds rate for an extended period.   In Fed speak, "extended period" equals at least six months.  Hoenig was the lone dissenting vote and voiced the belief that continued expression of exceptionally low levels of the federal funds rate for an extended period was not warranted and would lead to a build-up of future imbalances and increase risks of longer run macroeconomic and financial stability, while limiting the Fed's flexibility in raising rates modestly.

U.S. Q1 GDP is estimated to have grown 3.2% annualized.  This is not large enough to sustain a recovery.  In past recoveries, GDP growth rates of 7% or more for several quarters were not unusual.  Of the 3.2%, 1.7% was from slower inventory reduction (it comprised 4.4% of the Q4 5.6%) and 1.6%was from sales which is an anemic number..  Personal consumption expenditures were up 3.6%.  Weekly unemployment insurance claims remain elevated well above 400,000 indicating more jobs are still being lost than created.

John Hussman's weekly commentary noted the price-to-normalized earnings multiple of 19.1 exceeded the peaks of August 1987 and December 1973 and the only market valuation exceeding the current level was 20.1 just prior to the 1929 crash.  Still market valuations have never been used as an indicator of near-term market fluctuations.  He then discussed two looking forward models of a typical post-war recession or a period of credit strains.  The current situation has attributes of both.  Any increase in credit strain could consequently move markets negatively with the most damaging declines occurring when reality departs materially from expectations.  These two data sets have distinct differences in how the market responds to valuations and market action with "post-war" being positive and "credit strains" being negative.  He still finds the market overvalued and overbought with no reprieve in interest pressures.

Following up on a prior week question regarding owning individual bonds, I stressed that owning individual bonds with concentrated risk exposure just like owning stocks is usually not advisable for the common investor.  Additionally, they are not as liquid as other investments and, if you have an emergency and you have to sell them before they have matured, you may have to sell them at a steep loss, depending on the maturity of the bond at the time.  You probably could not build a large enough portfolio of different company and municipal/state bonds to offset default exposure. The credit risks associated with municipal bonds are particularly hard for a common investor to determine. You have to buy them and sell them through a bond sales person.  Bonds could have call options which reduce the yield which could have been realized if held to maturity.  You could buy Treasury bonds directly from the government,  You could also buy iBonds which have a fixed interest rate and an inflation rate with the fixed rate set every May and November for the life of the iBond while the inflation rate changes every May and November.  The May 2010 iBond has a fixed rate of .20% and a current inflation rate of .77%.  Most common investors are better off with well managed mutual fund bond funds or selected ETFs or ETNs.  There is also the possibility of exchanged traded bonds (just like stocks) in face values of $25 to $100 with no minimum purchase.

FDIC is concerned that if derivatives trading is removed from banks in the financial reform bill that the trading activity will end up in unregulated entities.

Bullard, St. Louis Fed President, said the Senate financial reform bill would result in "blatant politicization" of the central bank and questioned the proposed system to wind down biggest banks.  He opposes an audit of the Fed.  He thinks a consumer protection agency within the Fed blurs responsibilities and would prefer it be either completely under Fed control or spun off independently.  The biggest banks are too complex to put through a resolution process.  I have long maintained that if there was another financial crisis like 2008, systemically dangerous, without respect to size, financial institutions might have to be resolved in parallel by stripping toxic assets from balance sheets as well as some being singularly resolved by liquidation or reorganization.  I have also long argued that the Consumer Financial Protection Agency should be independent.  It was placed within the Fed to insure it does not do anything which upsets the financial system.

Former Fed governor Mishkin said controlling $1 trillion in mortgages was a huge difficulty for the Fed which acted in bravery to prevent depression but now is faced with cleaning up the mess.  The top priority of the Fed should be selling these mortgaged backed assets.  In my opinion, there is a relatively large discussion within the Fed with substantial disagreement about when they can start selling assets, particularly since the Fed is just ceasing its special liquidity programs.  I have been particularly concerned that the Fed has shown no interest in how monetary policy is affecting jobs and high unemployment.  Lacker, Richmond Fed President, said low rates are appropriate while economic slack is taken up in coming years.  Again, in my opinion, the concern is increasing the liquidity and capital ratios of the banks while it is ok for unemployment to be continued in order to keep inflation down.

The Fed this week authorized offering term deposits for lenders who are eligible to collect earnings on their balances at the Fed's Reserve Banks to drain liquidity as a prudent plan with no near-term implications.

The TARP Special Inspector General, Barofsky, indicated their may be possible criminal charges with respect to the SEC, Treasury, and New York Fed (from when Geithner was the Fed President) cover-up of AIG counterparty payments and has fought several attempts by Treasury to reduce his authority and overview.

I indicated that if a EU/IMF bailout of Greece was not agreed upon by Monday, it would hit the fan and the market ride could get wild.  It would increase credit pressures not just on Portugal but also Spain, which has a much larger economy.  If it gets to Spain, it could very well go global given German banks heavy exposure to Spain and weak regional saving banks (caja) with substantial real estate mortgages on their balance sheets.  The emphasis on deficit cuts will be counter productive as it will put Greece in recession with deflation and possible price inflation from tax hikes resulting in years of stagnate growth.  The emphasis should be on efficiency cuts and increased targeted investment to increase domestic consumption of domestic products and to increase price competitive exports.

Greek bond yields continued to rise, bank stocks are falling, and there is a growing fear of contagion within Europe.  Some in Greece are calling for EU common budget  policy to help create a fiscal policy which addresses the weaknesses of the euro exposed by the Greek crisis.  The IMF indicated the final package may be as high as 120 billion euro.  Key to any bailout is agreement by Germany in which many Germans blame speculators and Greek fiscal incompetence rather than this being the ultimate result of Germany's refusal to allow current account balance inequalities and exchange rates to be resolved when the euro was created, because it was to its benefit and economic advantage over the other EMU countries.  This helped create a pseudo gold currency which did not provide for any fiscal adjustment between countries while depriving member countries of any monetary policy to help adjust individual member country's economy.

S&P cut Greek bonds to junk and Portugal to A-.  On Monday, trading pressure on Greek bonds had pushed yield on ten year to 6.2%, 2 year to 12%, and the spread between Greek and German bonds were at 5.63%.  By Wednesday, 2 year Greek bonds had passed 23% yield.  Greece banned short selling for net two months.  Spain's credit rating was cut one notch to AA with negative outlook.  By Thursday, 2 year Greek bonds were down to 13% and 10 year to 9.4% with prospect of bailout.  The Greek bailout may be 120 billion euro over 3 years with drastic austerity cuts and tax hikes.  Greece warned that default was not option, but many commentators keep wanting to bet on it.  I have questioned why a restructuring of debt is not done by increasing maturity dates by five years.  One Greek economist proposed a similar process this week. This would avoid a haircut and default.  Default is not possible unless Greece withdraws completely from the EU and that is not going to happen even if Germany would try to kick them out.

Rogoff stated his opinion that if Greece gets a bailout than at least one other country will get one within one to two years.  He is overly optimistic, because the austerity measures he has endorsed as necessary to cut debt will drive other countries into recession and stagnate European growth as well as run the risk of significantly aggravating citizens within those countries to the point of social action.  Portugal credit swaps hit a record 318 basis points as it suffers from contagion pressure on bonds.  Portugal's problem is not necessary public sector debt which is on a par with France but it has an economy which is not growing.

IRS guidance has been provided in Notice 2010-38 on tax-free health insurance for children under the age of 27 years.  Detailed regulations have not yet been issued providing guidance on how employer health plans can avoid penalties for providing health coverage deemed unaffordable to lower paid employees.

Spanish unemployment is at 20.1%

South Korean GDP is up 1.8% Q1 and 7.8% vs a year ago.

IBM will buy $8 billion of its shares in second buyback.  Is IBM upbeat or does it not have better options for its cash?

Caterpillar earnings were up and beat expectations but sales were down everywhere except in the AsianPacific.

Ford beat Q1 earnings expectations with $2.1 billion revenue, which was up 15%, and pretax profit of  46 cents per share vs <75 cents> last year.  However, Ford shareholders do not believe it can continue and the stock went down 6% the same day.

HP will buy Palm for 41.2 billion.

Russia's central bank cut interest rate 25 basis points to a record low 8% as the recovery remains unstable.

Brazil's central bank hiked interest rate 75 basis points to 9.5% to curb inflation fears; it was the first hike in two years.

Eurozone inflation is up 1.5% April vs year ago (1.4% in March).

Japan's unemployment is up .1% to 5%.

Chicago Fed National Activity Index is up to <.07> from <.44>.

U.S. Treasury Auctions:

5 year TIPS, $11 billion, yield .55% (high), bid-to-cover 3.21, foreign 23.1%, direct 13.0%.
2 Year Treasury, $44 billion, yield 1.024%, bid-to-cover 3.05, foreign 31.04%, direct 21.4%.
5 year Treasury, $42 billion, yield 2.54%, bid-to-cover 2,75, foreign 48.9%, direct 24.3%.
7 year Treasury, $32 billion, yield 3.21%, bid-to-cover 2,82, foreign 59.5%, direct 12.2%.  The 7 year was a strong auction.


Print Page

Financial Reform in an Age of Unavoidable Corruption

While we have been covering financial reform news on the Radio Show and have written about how it is being gutted and sterilized by lobbyists and the financial sector in Corporate Socialism vs Regulatory Reform and  Dysfunctional Governance, we have come to realize there is no hope, because the banker's lobbyists have ravaged the bill creating a watered down, pro financial sector business as usual, anti-American public/consumer protection, and keep everything confusing rather than transparent morass which sets the stage for the next financial crisis.  We have also commented here and here as well as in several other posts.

It appears the U. S. Senate will vote in the next few days on their version.  With respect to fiduciary duty in providing financial advice, they are going to let the SEC study the issue, although there are amendments (again) to provide exemptions to stock brokers and insurance agents, which may or may not get included.  I have made my self clear on this subject.  What is most disturbing is that it is illegal in the United Kingdom, Australia, and Canada to provide financial advice and sell financial products, because they are fiduciarily incompatible activities.  In the United States, even the "reformers" of the financial planning groups ardently defend the "unavoidable" conflicts of interest of sales people giving financial advice as necessary.  The world is leaving the United States behind in its own boiling stew.

If you want well-balanced but detailed analysis of the financial reform bills and issues, you should visit the blog Rortybomb.  You can also get well balanced viewpoints by doing a search for "financial reform" in the blog search boxes of naked capitalism and Economist's View.  It is always best to be well informed --- even if it makes you outraged.

Print Page

Goldman Sachs Fraud & CDOs

I have covered on the Radio Show the on-going subject of SEC civil accusations and Justice Department criminal investigations into Goldman Sachs accusations that it misled investors with respect to the Abacus collateralized debt obligations that it helped bundle, sell, and then shorted them, because they were designed to fail.  I have not written about it, because I do not like just repeating what others have to say.

If you want to get a good, in depth feel for what Goldman Sachs is accused of doing and how it conducts business, Felix Salmon has done extensive posts on the subject.  If you go to his blog and type in "Goldman Sachs fraud" in the blog search box, you will find a list of articles.  You can also search for "Abacus".  You could also search the blog naked capitalism for the same subjects plus "Magnetar", which is a Chicago hedge fund that managed to sell investments which dramatically and consistently tanked.

If you want to understand how CDOs work and how they were used and how their sale may have been misleading in how they were packaged and sold in the Abacus offering, you should use the blog search at interfluidity, which describes these CDOs in technical detail.


Print Page

Leftovers --- Radio Show 4/24/2010

Seven banks failed, all in Illinois, including Broadway Bank owned by the Giannoulias family and in which the U.S. Senatorial candidate Alex Giannoulias was a former officer.  It will cost the FDIC $394.3 million and does not affect the family's holding company.  The unofficial problem bank list at www.calculateddriskblog.com is up to 694.

We followed up on a question about Tupperware stock from some weeks ago, because it reported earnings which were up 69% and sales up 20%.  We reiterated that has mixed fundamental and technical information; that it had gone through its buy point on April 5th and immediately fallen back.  On last Monday it went through its 50 day line and came back above during the trading day establishing a secondary buy point as low as $47.08, if one wanted to take the risk by buying 25-50% of planned investment and waiting until next day to see how it performed before investing more if it went up.  With its earnings report it did go through its primary buy point of $50.73.  This stock has shown weakness and low volume.  As with all individual stock purchases, an 8% stop loss order should always be placed to limit losses.  If one had done proper research and looked at similar market sector groups, one might have found BTH, Blyth, which broke out on April 5th and proceeded to go up 88%.

Vanguard Total Stock Market Index mutual fund has long term results and short term risks.  As we explained in prior weeks, it might have a place in a well diversified portfolio with a horizon of 8-10 years, but should not be owned by someone whose investment time horizon cannot absorb and recoup the short term losses as it follows the market down as it did in 2008.  A less expensive alternative would be the Vanguard ETF (VTI) with a cost of only 9 basis points.

We urged the caller from the prior week to determine what percentage of the total retirement portfolio was put into individual Ford bonds (the comment by the caller was we now own a lot of Ford bonds).  This would be key in determining if it was inappropriate.  The spouse had followed a stock broker adviser to another brokerage and the stock broker redid the spouse's retirement account.  Individual bonds constitute all at risk investment just like individual stock.  Individual company bonds are generally not appropriate for the common investor as they may difficult to sell, may have maturity problems with respect to the actual premium/discount investment returns, and require more analysis with respect to risk.  I urged them f they were listening to go back to the stock broker and ask for a complete accounting of all commissions and fees received by the stock broker.  While I said I have no problem with Ford bonds, one should remember that two years ago Lehman was too big to fail and no portfolio should have a significant exposure to one company.

We also commented on the Malcolm Berko newspaper column in which a local individual had asked for help in making selections in their Bunn-o-Matic 401(k) program, because J. P Morgan, which administers the plan said they could not provide advice.  Rather than help he went into a tirade on how awful the choices were and that the choices were only J. P Morgan mutual funds and how he could get no information from Bunn-o-Matic or J. P. Morgan.  He did not help the individual and his advice to complain to the employer is not useful.  J.P. Morgan cannot give advice to the participant because their client is the employer.  The fact that the employer chose a plan which lacks proper diversified choices from a variety of fund families based on performance and expenses speaks to the plan administrator being chosen because somebody knew somebody rather than due diligence and duty to the retirement plan participants.

I help retirement plan participants make the best choices available to them based on their individual retirement needs with in their retirement plan offerings all the time.  It is often not very pleasant given very poor choices or choices from only one mutual fund company.  It is also not unusual to see only choices from one company, including tailored sub accounts with additional management expenses in a variable annuity retirement vehicle.

The March 26.9% increase in new housing sales is an aberration due to the tax credit which expires at the end of April.  We will see a similar aberration in April.  Schiller indicated the housing recovery could be on shaky ground and we may be at risk to another bubble.

I followed up on reports and speculation that some funds, such as IAU, which are supposed to hold physical gold, may be holding paper from banks (fractional reserves) rather than physical gold consistent with shareholder purchases.  One person had gone to ScttiaMocatta, which holds some of the IAU gold and only about 19.5% (all of the gold in the vault) of what was supposed to be there for IAU.  Some are asking if this means they are keeping only enough on hand to meet daily redemptions and is this only one-tenth or one-hundredth of what is supposed to be physically held.  Others are also speculating about whether there is enough physical gold and silver to cover physical demand.

We talked about how preferred stock has the worst of two worlds in that to a common equity holder it is fixed obligation and, hence, looks like some kind of debt, while to a bondholder or a bank or some other creditor it looks like equity, because they lie between bondholders and common shareholders.  You do not have the contractual claim of a bondholder and you do not have any way to grow as you would with common stock.  They are inherently flawed securities with the worst of both worlds.  You have credit risk (is the yield worth the risk?) and extension risk (will they ever be redeemed, will they just sit there at a very low nominal rate of return?).  As interest rates go up, the value of any preferred stock is going to go down.  Investors often do not consider that inflation my erase yield over time.  It could potentially destroy a whole lot of value in your portfolio over time.

John Hussman in his weekly commentary talked about how delinquent mortgages are 21.3% higher than the same period last year.  February's foreclosure rate of 3.31% was a 51.1% increase over a year ago.  In January distressed sales accounted for 29% percent of all sales.  He also dissected bank earnings reports to show that those favorable earnings reports do not reflect discretionary charges and the bank earnings have been boosted by reduced loss provisions (about $1 billion for Bank of America alone) while actual charge offs are increasing.  He believes investors should not be surprised by another wave of credit strains.  The stock market remains strenuously over bought and over valued.

Besides the Goldman Sachs dubious derivatives being investigated, there is also a Chicago company called Megnetar which put together a variety of deal of which 96% were in default by the end of 2008.  Of interest is the way in which Magnetar took these CDOs to an industrial level and the involvement of Rahm Emmanuel.
Yves Smith of naked capitalism has written extensively about Magnetar.  It is an example of hedge fund excess.

The SEC has issued subpoenas to Goldman Sachs, Credit Suisse, Citigroup, Bank of America/Merrill Lynch, Deutsche Bank, UBS, Morgan Stanley, and Barclays Capital seeking information about the sale and marketing of CDOs.

The Countrywide grand jury continues after two years.

The U. S. Senate has finally discovered that the ratings agencies were besieged with conflicts of interest in their "issuer pay" business model.  We have been talking about this buy the rating conflict for over two years.

According to a Quinnipac University poll, 60% of Americans favor raising taxes on those who make more than $250,000 and 64% of those who make over $250,000 agree.  Since 1960, the top 1% pay 50% less taxes while the middle class are paying the same percentage in taxes and the top 400 households pay 2/3rds less taxes.  The tax cuts for the top 400 households cost the United States $48 billion in 2007, $700 billion as the result of the Bush tax cuts, and if the those tax cuts were retain another $826 billion over the next ten years.  Those tax cuts for the wealthiest families all contributed to the growth in the national debt.

The health care tax credit is available for small businesses with 25 FTE or less.  They are not limited to 25 employees but to the equivalent of 25 full time employees and the average salary must be no more than $50,000.  The full amount of the credit is only available to employers with 10 or less FTE with an average salary of less than $25,000.  To be eligible the employer must make a non-elective contribution on behalf of each employee for qualifying health insurance in an amount equal to not less than 50% of the premium cost of the qualifying health plan.  The credit is equal to the applicable percentage of the small business employer's contribution to the health insurance premium for each employee.

Moody's cut Greek credit rating one notch to A3.  Weber, president of the German central bank, indicated Greece will need more aid and disparaged Greek citizens for not caring or appreciating the seriousness of the debt problem.  Evidently, Weber is under the false impression that citizens exist to support government rather than government exists to support individual liberties.  In that Greece will need more than 45 billion euro over three years, Weber is correct that it should be closer to 115 billion euro.  I would go so far as to say it should be 140 billion euro over three years.  Some discussion has also broached the subject of any EU loans have some type of super senior status to other creditors.  There have been public comments that the EU loans should be given in tranches and tied to deficit goals.

The basic problem with the proposed bailout is that it concentrates on deficit reduction and has no program for structural reforms to increase economic growth.  These structural reforms are not only necessary in Greece but they are necessary in the structure of the euro, current account balances, and fiscal flexibility of the EU to the fiscal policy needs of any member nation.  In the meantime, the perception this is a short term solution means Greek bond spreads continue to increase.  Taxes will be raised and wages cut, which will only aggravate the economic situation putting Greece into long term recession and deflation with the possibility of price inflation.

The external deficits, loss of competitiveness, and anemic economic growth aggravated by the appreciation of the euro from 2002 to 2008 has only intensified the "original sin" of the euro which failed to address the divergent nominal labor units and wages of each eurozone country.  These eurozone countries no longer have the foreign currency reserves needed to prevent the equivalent of a bank run on its short term liabilities and the ECB does not have the authority to act as a lender of last resort as a central bank of a country with its own currency would have.  Despite continued arguments that Greece would be better off defaulting or must eventually default, default is not an option as it would require a complete withdrawal not just from the eurozone but from the European Union.  This European debt crisis is actually a credit crisis in which the structural weaknesses of the euro are being exploited by speculators and a crisis in confidence inflated, because no eurozone country, unlike any country with its own currency, can exert monetary policy and each has relinquished full fiscal policy options under the Stability and Growth pact. 

Mary Schapiro of the SEC continues to talk reform but always within the constraints of the investment community she sees as her true constituents.  Her failure to recognize the need to serve the American public and defend the public against fraud and the risky self-serving conduct of investment managers and investment advisers, puts her at odds with Sheila Bair of the FDIC and Elizabeth Warren of the TARP Congressional Oversight Committee.

Many investors are confused by or do not understand bond fund duration.  Bond funds do not always respond predictably to Treasury market shifts, because duration, or interest rate duration, works best for bonds which are similar.  The further away you get from investment grade bonds, the typical duration calculation begins to lose its predictive value as the gauge of how bonds will improve in relation to Treasuries.  Rather than gain or loss, the spread duration will describe how much a bond's price will move if there is a change in the gap between its yield  and a comparable Treasury..  This is yet another reason why common individual investors need to be wary of investing in bonds and have trouble evaluating bond funds.  Duration is an estimate and normal conditions do not always prevail.  Portfolio durations are just a weighted average of the durations of its underlying bonds and funds with the same duration average could perform very differently.  You need to read the fine print and figure out what it holds.

Greece sold 1.95 billion euro of 3 month bills at 3.65%, which was twice the January auction rate of 1.67%.

India raised its interest rate for the second straight month.

The Bank of Canada removed its pledge to keep interest rates low until the second half of 2010.

The Bank of Japan rebuffed government calls to target 1-2% inflation saying inflation short term focus on prices could lead to excessively low interest rates and fuel a credit bubble.

US consumer prices were up 3.4% in March vs year ago with higher energy prices.

Chrysler has lost $4 billion since bankruptcy in June 2009.  It has a Q1 loss of $197 million (improvement) with a "operating" profit of $143 million.  Q1 sales were $9.7 billion.  Fiat thinks combining its auto unit with Chrysler will save $4.9 billion over four years.

On Thursday, the market bull/bear contrarian index went over bull exceed bear by 35.9%.  The last time it was over 35% was January 13th just prior to the 9% Nasdaq correction.

French consumer spending on manufactured goods was up 1.2% in March.

UK March inflation was 3.4%

UK GDP Q1 2010 grew only .2% (expected .4%) and now expect 1-1.5% for year if the stimulus is maintained as the recovery is "fragile" according to the Chancellor of the Exchequer.

Canadian annual inflation rate slowed to 1.4% in March from 1.6%.  Retail sales up .5% in February, but economists expected 1%.

US wholesale prices were up .7% in March (expected .4%) with 70% of increase due to 2.4% jump in consumer foods.  Gas was up 2.1%.

US existing home sales were up 6.8% in March with 8 months of inventory left.  New home sales were up 26.9% in March, which is an aberration due to the tax credit.  New home inventory was down to 6.7 months from 8.6 months.

 US durable goods total orders were down 1.3% in March (67.1% drop in non-defense aircraft).  Excluding cars and aircraft, orders were up 2.8%.  Non-defense capital goods orders were up 4%.  Inventories were up for the fourth month.

US producer prices finished goods were up 6.6% annualized in March unadjusted.  Adjusted March total was down .8% and finished goods were down 3.4%.

According to Moody's, CRE (commercial real estate) prices are down 2.6% in February.

Vehicle miles driven in February were down 2.9% (6.3 billion miles) vs year ago and 2010 YTD is down 2.3%.

GM repaid US and Canadian loans of $8.1 billion implying they use profits when in fact they used TARP money held in reserve.  The US and Canada continue to own Chrysler.

AIG is "considering" if it should take action against Goldman Sachs for $2 billion CDO insurance loss.

FASB "may" review repo 105 and 108 guidelines, which have been used by banks to hide debt and loss reserves as quarterly reporting dates approach and then put them back on their books after reporting financial data.

Wells Fargo profits fell to 45 cents per share from 56 cents year ago on 25% decline in mortgage originations.

Proctor & Gamble dividend increased 9.5% to 48.18 cents per share.

Evans (President of Chicago Fed) said the Fed will keep near zero interest rate for quite some time --- at least six months.  He sees high unemployment keeping policy accommodative and there is a need to keep an eye on price stability.  In my opinion high unemployment is being used to keep inflation down while the Fed is focused on increasing the capital ratios and liquidity of banks, which are allowed to keep toxic assets on their balance sheets at fraudulent values by special legal dispensation.

As many as 6 members of the Fed FOMC (open market committee that sets rate and policy) favor selling some of the Fed's mortgage backed assets if the economy keeps improving.




Print Page

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.



Print Page