The Illinois pension bond auction to fund the State of Illinois' current pension systems contribution was moderately successful attracting a bid-to-cover of 1.65 from 128 bidders bidding $6.1 billion for $3.7 billion. The 2014 bonds had a spread of 280 basis points above comparable Treasuries, while the 2019 bonds had a spread of 240 basis points over comparable Treasuries. The high yield for the 2019 bonds was 5.877%. This was 179 basis points more than Phillip Morris corporate debt. Only twenty percent of bids were from foreign investors who should have seen this offering as an attractive high yield diversification from European debt.
This bond issuance had been delayed to let the market digest Governor Quinn's proposed budget. As we have previously written, Illinois has serious deficit, revenue, unfunded pensions, budgeting, and credibility problems. During the week the bond spreads over Treasuries narrowed down from 300 basis points to market whisper spreads to finally settle five basis points each below what the State expected. Given that Illinois' credit default swaps are higher than California, the large spreads and high yields are to be expected, however, the State tries to portray the average yield of 5.56% as "good".
Unfortunately, this was a necessary restructuring of debt to make this fiscal year's pension contribution, although the SEC is investigating how the pension contributions were calculated and disclosed to investors.
Print Page
Saturday, February 26, 2011
Tuesday, February 22, 2011
Michael Pettis on China's Growth
In Michael Pettis' private newsletter "China Financial Markets" published on February 21, from which I am only allowed to quote, he discussed corruption in China's high speed rail lines which he basically sees a typical fraudulent behavior manifested towards the top of a market.
"But in so doing it is also organized to exacerbate underlying imbalances and ultimately to increase the cost of the adjustment. This means that if we are nearing the end of the growth model’s life (in the next year or two if there is a strong consensus at the top, or in the next three to four years if there is a difficult leadership transition), the adjustment will not occur as a crisis but rather as a long and sharp slowdown in economic growth."
In January, the inflation rate came in at 4.9% versus the same period last year, which was lower than the market expected. However, the CPI basket was revised at the same time, bringing down what would have been 5.1% to 4.9%, by lowering the weighting of food prices by 2.21% and increasing the weighting of the housing sector by 4.22%. Pettis sees this as convenient timing but not sinister. Even so, the month-to-month increase suggest just under 13% annual inflation. He believes the central bank's fifth 50 basis points increase will help temporarily, but "... most Chinese growth is the result of overheated investment, and removing the sources of overheating without eliminating growth is going to prove impossible. I have been making the same argument for at least two or three years, and so far we have seen how Beijing veers between stomping on the gas when the economy slows precipitously and stomping on the brakes when it then grows too quickly. I don’t believe anything has changed."
Most interestingly, bank deposits were down in January for the first time since January 2002 and he quotes Credit Suisse as stating that it was corporate deposits that went backwards and not household deposits as would have been expected near the Chinese New Year, which would indicate it is not seasonal and may be of concern. Pettis, on the continued tightness in the interbank market, said "So why did corporate deposits drop? My guess is that large businesses may be finding it much more profitable to lend money to other businesses, especially those who don’t have easy access to bank credit, than to deposit cash in the bank at such negative real rates. Both the Credit Suisse report and an email I got last month from a friend of mine at Bank of China suggests that there may be an increase in intercompany lending, and to me this would be a very plausible consequence of negative real deposit rates."
He sees the Japanese concept of zaiteku (raising capital for securities investment, real estate, etc.), which cause increased speculation rather than business operations to build in the late 1980's leading to a subsequent painful contraction, as taking hold in China. "From the Japanese experience (and many others) it is clear that when SOEs and large businesses find it profitable to speculate on asset markets, intermediate loans, or otherwise earn financial profits, they usually do, in which case we need to worry about three things. First, financial transactions – especially when they largely replicate risks that are being taken already within the financial system – increase systemic risk even as they disguise risk-taking. A problem in the financial markets is reinforced by a drop in corporate profitability tied to financial speculation, which then reinforces the problems in the financial markets.
"Second, Chinese banks already do a bad enough job of assessing credit (why not, when most credit risk is socialized?), and it is hard for me to believe that we are going to see much better credit risk management from corporate treasurers, and even harder not to wonder if guanxi will play an important role in this whole process. Third, the more lending occurs away from the purview of the PBoC and the CBRC, the less control and oversight monetary authorities will have over the financial system...
"On the one hand overinvestment, excess liquidity and credit expansion, off-balance sheet activities, and zaiteku are generating huge growth and, along with it, huge risks, while on the other the PBoC and the CBRC are doing what they can to monitor, manage, and limit risks in the banking system. I wonder if they can pull it off."
With respect to the problem of hot money flowing into China, Pettis suspects foreign direct investment (FDI) may be including a lot of disguised hot money inflows. He agrees with Deputy Finance Minister Zhu that the United States' QE2 does cause an explosion of liquidity growth in developing countries if those countries intervene in their currencies; if there is no intervention there is no liquidity growth. The State Administration of Foreign Exchange (SAFE) report said hot money inflows have been negligible. "It turns out, according to most interpretations of the SAFE report, that the speculators creating the hot-money inflows are not the much-vilified foreign hedge funds – surprise, surprise – but Chinese businessmen bringing money into the country in dribs and drabs."
Print Page
Sunday, February 20, 2011
Are Illinois Bonds Worth the Price?
In January of this year, the SEC announced it had started an investigation in September 2010 of claims made by the State of Illinois relative to the accounting of actuarial future savings from last year's two tier pension reform creating different retirement ages and new contribution rates and pensions for employee's hired after January 1, 2011. We have previously commented on this accounting grey area in which all current employees, not just new hires, appear to be used to estimate future savings which are then considered a current contribution by the State reducing its actual monetary legally required annual contribution to the pension systems.
During the week of 2/21/2011, Illinois intends to sell $3.7 billion in general obligation bonds to fund the State of Illinois' annual contribution to the Illinois pension funds. The official statement (prospectus) of the bond issuance clearly refers to the SEC investigation and the actuarial and accounting issues involved (page 53 of the document or Adobe page 84), including the divergence of what is allowed under Illinois law and what is prescribed in GASB 25 as amended. The actuarial method used and the possible inclusion of all current employees in the calculation are not considered appropriate or proper by most actuaries, as detailed in a New York Times article, "The Illusion of Pension Savings".. This Asset Smoothing Method, as used by Illinois, also does not keep the ending period open but closes it at 2045, which Illinois admits will fail if any legislatively mandated annual ramped (increasing yearly to 2045) pension system payments are not made.
This $3.7 billion general obligation bond issuance is to make this fiscal years annual payment, because the State of Illinois does not have the money to make its annual contributions. Although the State has just passed a tax increase, there was no provision for restricted pension funding and it has not been in effect long enough to bring in new revenue. Pension contributions by the State must be made from general revenue. Credit default swaps for Illinois are still higher than California, but have been falling since the tax increase. However, the market (New York Times: "Illinois Pension Bonds to Test Investors' Faith") appears prepared to require a higher yield than expected.
This $3.7 billion is part of a fiscal deficit of at least $15 billion for FY 2011. Another part of the deficit is $8.75 billion owed Illinois vendors in unpaid bills for goods and services. A bill presently before the Illinois Senate would authorize a bond issuance for $8.75 billion to pay vendors and is being pushed heavily by Governor Quinn. The administration calls it debt restructuring, which is technically correct, but the opposition party calls it paying bill with a credit card. Given that the tax increase has not had time to provide revenue to address the deficit, the choice is either let Illinois vendors/businesses go out of business and/or layoff employees or pay the vendors and Illinois businesses alive and healthier. While Governor Quinn's administration has been exceedingly slow, for whatever reasons, to make transparent, documentable spending cuts to create efficiencies, it is well known that spending cuts cannot solve the deficit, because the people are unwilling to accept the loss of services or tax breaks they personally enjoy and expect. To turn different groups of people against each other to deprive the other group of their services or tax breaks and paint groups of people as undesirable is divisive political manipulation which is inconsistent with a republican democracy and cannot be tolerated in a free society.
The $3.7 billion pension bonds will be snapped up, primarily by foreign investors seeking high yields and diversification from the high yields of European countries. However, the State of Illinois cannot continue to fund pension annual contributions with debt. There needs to be a restricted revenue source which cannot be diverted. This needs to be the last time bonds are used to make annual pension contributions.
The $8.75 billion bond authorization to pay vendor bills is necessary to keep Illinois business and employees at work. This should be a one time debt restructuring, but Illinois has a horrible record for not taking action on a bipartisan basis to fund the services and necessary economic safety nets the people demand and expect.
Print Page
During the week of 2/21/2011, Illinois intends to sell $3.7 billion in general obligation bonds to fund the State of Illinois' annual contribution to the Illinois pension funds. The official statement (prospectus) of the bond issuance clearly refers to the SEC investigation and the actuarial and accounting issues involved (page 53 of the document or Adobe page 84), including the divergence of what is allowed under Illinois law and what is prescribed in GASB 25 as amended. The actuarial method used and the possible inclusion of all current employees in the calculation are not considered appropriate or proper by most actuaries, as detailed in a New York Times article, "The Illusion of Pension Savings".. This Asset Smoothing Method, as used by Illinois, also does not keep the ending period open but closes it at 2045, which Illinois admits will fail if any legislatively mandated annual ramped (increasing yearly to 2045) pension system payments are not made.
This $3.7 billion general obligation bond issuance is to make this fiscal years annual payment, because the State of Illinois does not have the money to make its annual contributions. Although the State has just passed a tax increase, there was no provision for restricted pension funding and it has not been in effect long enough to bring in new revenue. Pension contributions by the State must be made from general revenue. Credit default swaps for Illinois are still higher than California, but have been falling since the tax increase. However, the market (New York Times: "Illinois Pension Bonds to Test Investors' Faith") appears prepared to require a higher yield than expected.
This $3.7 billion is part of a fiscal deficit of at least $15 billion for FY 2011. Another part of the deficit is $8.75 billion owed Illinois vendors in unpaid bills for goods and services. A bill presently before the Illinois Senate would authorize a bond issuance for $8.75 billion to pay vendors and is being pushed heavily by Governor Quinn. The administration calls it debt restructuring, which is technically correct, but the opposition party calls it paying bill with a credit card. Given that the tax increase has not had time to provide revenue to address the deficit, the choice is either let Illinois vendors/businesses go out of business and/or layoff employees or pay the vendors and Illinois businesses alive and healthier. While Governor Quinn's administration has been exceedingly slow, for whatever reasons, to make transparent, documentable spending cuts to create efficiencies, it is well known that spending cuts cannot solve the deficit, because the people are unwilling to accept the loss of services or tax breaks they personally enjoy and expect. To turn different groups of people against each other to deprive the other group of their services or tax breaks and paint groups of people as undesirable is divisive political manipulation which is inconsistent with a republican democracy and cannot be tolerated in a free society.
The $3.7 billion pension bonds will be snapped up, primarily by foreign investors seeking high yields and diversification from the high yields of European countries. However, the State of Illinois cannot continue to fund pension annual contributions with debt. There needs to be a restricted revenue source which cannot be diverted. This needs to be the last time bonds are used to make annual pension contributions.
The $8.75 billion bond authorization to pay vendor bills is necessary to keep Illinois business and employees at work. This should be a one time debt restructuring, but Illinois has a horrible record for not taking action on a bipartisan basis to fund the services and necessary economic safety nets the people demand and expect.
Print Page
Monday, January 17, 2011
Is Illinois the State Most Likely to Default?
At the end of December, credit default swaps for the State of Illinois had reached a five month high and were more expensive than those of California, indicating Illinois was the State most likely to default. Actually, this was nothing new as Illinois has had the most expensive credit default swaps since early July 2010. Bill Gross of PIMCO said he would not buy Illinois bonds.
The budget problems in Illinois are not new and have grown from root causes starting in the second term of Governor Edgar. I have talked and written about this for over a year and been adamant fiscal year budget deficits would be close to $15 billion; I have reviewed budget proposals from different sources and made several suggestions towards a rational budget solution; and I have particularly stressed the immense problem of pension underfunding, of which no budget solution can omit, here, here, here, and here.
During the election both candidates made statements about the budget problem, which I did not take as reliable. One would cut government by 10% across the board and the other wanted to increase the 3% income tax to 4% with the extra 1% going to education. Neither of these would come close to solving the budget problems. The tax increase was not high enough and the spending cut was not practical much less sufficiently deep. Both were good attempts to frame the question and promote public discussion but I do not know that I would have used them in a campaign where they could be mistaken as promises. When, during the campaign, Governor Quinn's Budget Director said there would be an increase to a 5% income tax after the election, it did not surprise me. Yet, the New Year dawned and the State had done very little with days left in the Legislative Session. In 2010, it had passed a two tier pension system for State employees and then certain municipal employees. While I have never been fond of a two tier pension system, I supported its creation as economically necessary. Still, there was over $8 billion in unpaid vendor bills and disbursements, no payment to the pension funds of $3.7 billion for FY 2011 (which are among the most under funded in the nation), a looming Fiscal Year 2011 budget deficit of $15 billion, an end of a national economic stimulus to the States which was too little, an end to the Build America Bond program which put even more pressure on municipal bonds and state and municipal funding, and the prospect in Fiscal Year 2012 the State will have to start paying back interest on loans from the Federal government for unemployment insurance. Less money would be available going forward, future interest payment were increasing for the coming fiscal year, and debt costs for Illinois on any new bond placements were going up on Illinois' deteriorating credit condition.
Consequently, even the preliminary movement towards a partial budget solution moved the credit default swap prices down a little and, while Illinois's historical use of borrowing can be troublesome if it does not come with sustainable economic growth, the more rational recognition that default is not very likely (the Bond Girl links within this link are particularly good). The public discussion has never been well served by a shallow public understanding of the role of government spending in growing income and employment in the private sector. This had been preceded by the Governor talking about the need for bonds to pay the FY pension funding, which he never got. No pension funding. Then, the Legislature put forward an increase to 5.25%, with .25% to go towards an annual property tax rebate of $325 per home owner, which would have been a much larger rebate than more than 80% of homeowner's currently receive. I t would have also increase cigarette taxes $1 per pack and raise $377 million annually going to education, although economic studies have shown that such a tax decreases overall sales taxes collected adjusted for inflation and population growth. The corporate tax would go up to 8.4% (it may have been only 8% as there was confusion in this number in printed reports). That proposal had replaced an old proposal for 5% individual income tax and expansion of service taxes (which I have always opposed as regressive --- I prefer looking at luxury taxes, but nobody has done a study --- although Illinois does not tax as many services as some other states). It was immediately criticized as a huge 75% tax increase and little discussion of how to otherwise solve the budget problem. In the end, the Legislature did not provide any borrowing for unpaid bills or pension funding, but it did approve an individual income tax rte of 5% and a corporate tax rate of 7% for the next four years only and a 2% spending increase annual cap with reversion to old tax rates if violated. This immediately drew criticism from individuals and business owners as well as comments from the Governors of neighboring states inviting businesses to migrate despite their tax rates being similar or more. In fact, tax rates are hard to compare with other states, because they involve income tax, sales tax, services tax, property tax, and other taxes. Some income taxes are flat and some progressive. Some have different taxes on the municipal level or income tax on the county as well as state level. Governor Quinn's message in signing the bill listed savings implemented by his administration which are not significant in demonstrating competent efficiency effort and some of which may not be independently verifiable.
The deficit hawk, which was predictable, and deficit dove, however well intentioned but too general, reaction was not helpful in promoting what is needed in Illinois and what will work and what will not work in Illinois.
The bottom line is very stark and difficult. Using information (read it all) from the Institute of Government and Public Affairs, if the deficit were to be attacked through individual and corporate income tax rate increases, the individual tax rate would have to be 7.1% and 11.3% for corporations with each !% increase from 3% and 4.8% generating $2.5 to 3 billion annually. Borrowing by itself will increase expenses and the problem. To attack the problem with spending cuts, all government spending by the Legislature, Judicial, and all Constitutional officers would have to be cut by 26% or more. Such spending cuts would be disastrous with respect to employment (thousands of state jobs would be lost) and to essential government services (this includes economic safety net service unless you believe children and adults deserve to suffer and die) serving the general welfare of all citizens of the State. The people would not accept such cuts nor should they.
This means, besides the tax increases, Illinois needs to rationally cuts spending to create efficiency (not just cuts to make cuts) and needs to borrow prudently at reasonable interest rates and yields. The exempt and double exempt personnel positions (some of these people go back to at least the Ryan administration) need to be professionally evaluated for economic efficiency and competency. Yet, Governor Quinn has removed only two high profile people and given preferential treatment to others, who would have been fired in the private sector, because they apparently know people. Governor Quinn's people have demonstrated they prefer politics to properly managing state government. Spending increase by 3.4% annually, but the spending cap in the new law is 2%. This means at least 1.4% will have to be cut annually on top of efficiency cuts as soon as possible. This requires professional management.
Political management is not competent professional management. Paying vendors will provide growth and employment, but under this budget law it will require borrowing. No one is going to be happy with what has to be done and promote an economy which provides growth. No one is going to be happy with the factual fiscal situation and options unless government takes the necessary actions to provide the services for which government exists and the people demand for all citizens without respect to income level.
The economic issues have been confused by partisan public positioning which has not been focused on getting things done for the people. The state is not economically bankrupt, but it has a serious solvency problem. It can be solved. In fact, the U.S. Bankruptcy Code allows municipalities and counties to declare bankruptcy but not states. Political ideology has used differing economic theories to avoid dealing with the factual situation in the public arena. Cutting by itself will alienate the people who expect government to provide services to all segments of society. Political management will alienate people who expect government to provide services to all citizens and not just benefit an elite. We need to work together.
Print Page
The budget problems in Illinois are not new and have grown from root causes starting in the second term of Governor Edgar. I have talked and written about this for over a year and been adamant fiscal year budget deficits would be close to $15 billion; I have reviewed budget proposals from different sources and made several suggestions towards a rational budget solution; and I have particularly stressed the immense problem of pension underfunding, of which no budget solution can omit, here, here, here, and here.
During the election both candidates made statements about the budget problem, which I did not take as reliable. One would cut government by 10% across the board and the other wanted to increase the 3% income tax to 4% with the extra 1% going to education. Neither of these would come close to solving the budget problems. The tax increase was not high enough and the spending cut was not practical much less sufficiently deep. Both were good attempts to frame the question and promote public discussion but I do not know that I would have used them in a campaign where they could be mistaken as promises. When, during the campaign, Governor Quinn's Budget Director said there would be an increase to a 5% income tax after the election, it did not surprise me. Yet, the New Year dawned and the State had done very little with days left in the Legislative Session. In 2010, it had passed a two tier pension system for State employees and then certain municipal employees. While I have never been fond of a two tier pension system, I supported its creation as economically necessary. Still, there was over $8 billion in unpaid vendor bills and disbursements, no payment to the pension funds of $3.7 billion for FY 2011 (which are among the most under funded in the nation), a looming Fiscal Year 2011 budget deficit of $15 billion, an end of a national economic stimulus to the States which was too little, an end to the Build America Bond program which put even more pressure on municipal bonds and state and municipal funding, and the prospect in Fiscal Year 2012 the State will have to start paying back interest on loans from the Federal government for unemployment insurance. Less money would be available going forward, future interest payment were increasing for the coming fiscal year, and debt costs for Illinois on any new bond placements were going up on Illinois' deteriorating credit condition.
Consequently, even the preliminary movement towards a partial budget solution moved the credit default swap prices down a little and, while Illinois's historical use of borrowing can be troublesome if it does not come with sustainable economic growth, the more rational recognition that default is not very likely (the Bond Girl links within this link are particularly good). The public discussion has never been well served by a shallow public understanding of the role of government spending in growing income and employment in the private sector. This had been preceded by the Governor talking about the need for bonds to pay the FY pension funding, which he never got. No pension funding. Then, the Legislature put forward an increase to 5.25%, with .25% to go towards an annual property tax rebate of $325 per home owner, which would have been a much larger rebate than more than 80% of homeowner's currently receive. I t would have also increase cigarette taxes $1 per pack and raise $377 million annually going to education, although economic studies have shown that such a tax decreases overall sales taxes collected adjusted for inflation and population growth. The corporate tax would go up to 8.4% (it may have been only 8% as there was confusion in this number in printed reports). That proposal had replaced an old proposal for 5% individual income tax and expansion of service taxes (which I have always opposed as regressive --- I prefer looking at luxury taxes, but nobody has done a study --- although Illinois does not tax as many services as some other states). It was immediately criticized as a huge 75% tax increase and little discussion of how to otherwise solve the budget problem. In the end, the Legislature did not provide any borrowing for unpaid bills or pension funding, but it did approve an individual income tax rte of 5% and a corporate tax rate of 7% for the next four years only and a 2% spending increase annual cap with reversion to old tax rates if violated. This immediately drew criticism from individuals and business owners as well as comments from the Governors of neighboring states inviting businesses to migrate despite their tax rates being similar or more. In fact, tax rates are hard to compare with other states, because they involve income tax, sales tax, services tax, property tax, and other taxes. Some income taxes are flat and some progressive. Some have different taxes on the municipal level or income tax on the county as well as state level. Governor Quinn's message in signing the bill listed savings implemented by his administration which are not significant in demonstrating competent efficiency effort and some of which may not be independently verifiable.
The deficit hawk, which was predictable, and deficit dove, however well intentioned but too general, reaction was not helpful in promoting what is needed in Illinois and what will work and what will not work in Illinois.
The bottom line is very stark and difficult. Using information (read it all) from the Institute of Government and Public Affairs, if the deficit were to be attacked through individual and corporate income tax rate increases, the individual tax rate would have to be 7.1% and 11.3% for corporations with each !% increase from 3% and 4.8% generating $2.5 to 3 billion annually. Borrowing by itself will increase expenses and the problem. To attack the problem with spending cuts, all government spending by the Legislature, Judicial, and all Constitutional officers would have to be cut by 26% or more. Such spending cuts would be disastrous with respect to employment (thousands of state jobs would be lost) and to essential government services (this includes economic safety net service unless you believe children and adults deserve to suffer and die) serving the general welfare of all citizens of the State. The people would not accept such cuts nor should they.
This means, besides the tax increases, Illinois needs to rationally cuts spending to create efficiency (not just cuts to make cuts) and needs to borrow prudently at reasonable interest rates and yields. The exempt and double exempt personnel positions (some of these people go back to at least the Ryan administration) need to be professionally evaluated for economic efficiency and competency. Yet, Governor Quinn has removed only two high profile people and given preferential treatment to others, who would have been fired in the private sector, because they apparently know people. Governor Quinn's people have demonstrated they prefer politics to properly managing state government. Spending increase by 3.4% annually, but the spending cap in the new law is 2%. This means at least 1.4% will have to be cut annually on top of efficiency cuts as soon as possible. This requires professional management.
Political management is not competent professional management. Paying vendors will provide growth and employment, but under this budget law it will require borrowing. No one is going to be happy with what has to be done and promote an economy which provides growth. No one is going to be happy with the factual fiscal situation and options unless government takes the necessary actions to provide the services for which government exists and the people demand for all citizens without respect to income level.
The economic issues have been confused by partisan public positioning which has not been focused on getting things done for the people. The state is not economically bankrupt, but it has a serious solvency problem. It can be solved. In fact, the U.S. Bankruptcy Code allows municipalities and counties to declare bankruptcy but not states. Political ideology has used differing economic theories to avoid dealing with the factual situation in the public arena. Cutting by itself will alienate the people who expect government to provide services to all segments of society. Political management will alienate people who expect government to provide services to all citizens and not just benefit an elite. We need to work together.
Print Page
Saturday, January 8, 2011
Economy & Market Week Ended 12/18/2010
In this commentary we look at the tax cut (again, we had a detailed in analysis in our prior commentary) and possible challenges for Social Security, the continuing problems of unemployment and deleveraging, whether growing income inequality precedes financial crises, the Fed, inflation, the failure of HAMP, the foreclosure mess and other bank issues, attempts to skirt around financial reform, some possible concerns in Canada, the continuing problems of the eurozone and what some people want to do about them, Ireland, the problems in Spain, Germany's troublesome positions and reasoning, China's importance, and market conditions (warnings?) as well as U.S. and international data.
Inflation (CPI) in the United States for the month of November came in at 1.14% (1.17% in October). If the 1990's calculation was used it would be approximately 4.3%; if the 1980's calculation was used it would be approximately 8.8%. From October to November it rose 0.04% but December may show a larger increase as December 2009 was <.18%> and may also be affected by QE2.
As we have mentioned, the new tax cut bill does nothing for those who have been unemployed for longer than 99 weeks and they will slide off into uncounted anonymous limbo. Here are the unemployment figures by state. Illinois has 9.6% unemployment.
The deleveraging process has been a subject of interest for some time and I have often commented on it. The sad fact is that the develeraging process by consumers is being driven by debt default just as I have written in the past that business deleveraging is fueled by write-offs of bad loans and asset values.
1.6 million Americans have put off retirement to continue working as the result of falling asset prices.
The cut in the payroll tax is being seen by some Republicans as a means to change Social Security, which has been a concern to many economists as the result of the President's Deficit Commission Report, despite it not receiving the necessary 14 votes to be recommended to Congress. It is interesting to note that one of the 11 votes for the Deficit Commission Report was Illinois Senator Dick Durbin who said "It is just a step forward in the debate." Considering how close Dick is to President Obama and the rumors we mentioned last week that the President's State of the Union speech may contain a call for Social Security reform. This is the wrong focus. The focus should be on Medicare fraud and escalating health care costs which were not addressed in the very limited and poorly designed PPACA health care bill (another example of political compromise and poor economics which ignored the models of universal health care provided through private insurance companies at significantly lower cost in France, Switzerland, and the Netherlands). In the past, we have covered two economic discussions on making social security and taxes more equitable by either extending payroll taxes to all income without limits or through income taxes on all income earned or unearned. However, the political agenda appears to be to cut taxes to benefit the wealthy and to cut programs the wealthy do not need or use under the pretext of deficit reduction.
We have written on numerous occasions about the economic necessity to stimulate the economy with targeted spending which creates jobs now in order to grow the economy out of this disinflationary, slow growth, and high unemployment long term economic condition. The original stimulus was too little, too slow, the failure to reform the financial system which precipitated the financial crisis is setting up the next financial crisis, and the tax cut bill stimulus is meaningless, if not welfare for the wealthy. Nothing is well served by increasing economic inequality within a republican democracy; it diminishes and eventually destroys the middle class and the middle class is essential in any sustainable democracy. We have written about studies showing growing inequality since the 1960's and now studies are showing economic inequality may be either one of the causes or an indicator of impending economic crises, because there was significant growth in economic inequality prior to both the Great Depression and this most recent financial crisis.
There is a lot of hype about possible municipal bond defaults in the near future. Much of this is overblown, but there are some towns, cities, and counties under significant stress as the result of insufficient stimulus from the Federal government and, in some instances, mismanagement and/or corruption on the local level. There has been a lot of political talk that some states should be forced into bankruptcy as a means of cutting retirement, health care, and social welfare programs. While municipalities and counties can declare bankruptcy under the Bankruptcy Code, there is no provision allowing a state to declare bankruptcy. With the failure to extend Build America Bonds, there will be more pressure and less liquidity in the municipal bond market, but that does not deter quality investing.
The attempts to banish facts from the economic and political debate extended to the Financial Crisis Inquiry Commission in which a partisan vote resulted in a minority report which banishes the use of any terms which might cast blame for the Financial Crisis on banks and Wall Street choosing to ignore the unpunished financial fraud which caused the financial crisis and, in fact, to show solidarity with those political leaders who would have government serve the bankers. It is unfortunate when facts are inconvenient.
The Federal Reserve Open Market Committee released its December meeting statement in which it reaffirmed the interest rate of zero to 25 bps for an extended period, reinvesting principal payments of securities held, and will begin a $600 billion purchase at $75 billion per month of longer term Treasuries. The sole vote against the monetary policy action was Mr. Hoenig again, who remains concerned about increased risks of future economic and financial imbalances increasing long term inflation expectations over time. While there is some encouraging data, the Fed has still not addressed the demand needed to bring unemployment down and long term interest rates will rise as this slow recovery progresses, but one should not expect the Fed to change direction any time soon.
The Federal Reserve provided approximately $140 billion more in loans to foreign banks during the financial crisis than it disclosed publicly earlier this month. The Fed may be trying to make changes to the rescission and disclosure provisions of the Truth in Lending Act as the pressures build, as the result of the mortgage and foreclosure mess/fraud, on the banks and their servicers to potentially make good on deceptive mortgages and, in fact, the banks are pushing the Fed to do just exactly that.
As many economic and financial commentators have been writing, the HAMP foreclosure prevention and modification program has been failing, if not an outright failure, as the result of banks dragging their feet in the application process (some real horror stories out there), of people whose applications were pending being foreclosed on anyway, and of the government not sufficiently pushing and regulating the process. People are dropping out of the program faster than are they are joining. The Congressional Oversight Panel has issued a pretty nasty report on the Treasury program. Bank of America is being sued by Nevada and Arizona, because the bank proceeded on foreclosures while applications were pending in violation of a 2009 agreement with Arizona.
PricewaterhouseCoopers, LLP has issued two audit reports for two different banks which support contradictory positions in which MBIA is asserting a large asset in the form of refund demands on Bank of America, while Bank of America has not made any reserve provisions to pay the contractual claims of $2.2 billion. This is obviously an example of auditor's reliance upon management to determine value. This deferral to management, when no readily determinable value exists, is a serious and fundamental audit problem from which no professional good will result.
The Dodd-Frank Bill mandated that derivatives will be traded through regulated clearinghouses, but the bankers who control at least two of the risk committees of the two largest clearinghouses are determined to keep transactions through banks and defeating proposals which improved and make more transparent the way derivatives are traded.
Despite consumer protection laws, the banks are desperate for profits and, with the additional protection of the 2005 bankruptcy reform, they are seeking out and actively marketing to risky credit card customers to whom they charge higher fees and interest rates until they hit the wall. The Federal Reserve has the power to stop this if they wanted to do so.
The Ohio Attorney General Richard Cordray has been named to head up the enforcement division of the Consumer Financial Protection Bureau, which will not make the banks happy.
The Bulls minus Bears sentiment index is again approaching +40 (as of December 12). The last time it broke above +40 was October 2007 when the market proceeded to crash. Another reason to be cautious right now is that no one else is; the VIX is approaching levels (as of December 13) of high complacency and, as the VIX goes below 17, investors are leaving more of their portfolios exposed to risk.
The ratio of household debt to disposable income in Canada in Q3 was 1.48 which exceeds the United States ratio of 1.47 and caused Canadian central bankers and finance officials to publicly voice concerns that the growing debt level could threaten recovery. The Bank of Canada sees the vulnerabilities of households as high and the debt levels unprecedented.
The Canadian dollar dropped for the second week as investor's turned to U.S. government debt as safety against the potential problems of the eurozone.
The Governor of the Bank of Canada, Mark Carney, indicated that the current European difficulties are not over and the pattern of global economic growth is changing. Canada should adapt to a world were their will be inflation in emerging markets and disinflation in developed markets.
The eurozone core is more complicated and problem laden than many wish to recognize with political instability in Belgium and Italy, issued debt which has to be periodically rolled over (from which France is not immune), and the German bund has been caught in the sell-off of U.S. Treasuries. All of these factors show the liquidity risks going forward and how vulnerable the eurozone is to any market shock or perceived weakness.
On December 14th, the Spanish 10 year debt yield exploded. Spain and its banks will have to refinance 265 billion euro ($345 billion) in 2011 and Moody's has indicated Spanish banks may actually have $177 billion euro losses on their books, which caused the Spanish Finance Minister, Salgado, to defend the solvency of the Spanish banking system. On Thursday, bond auction yields rose even higher from between 80 to 140 bps from prior auctions for the same maturities. On Friday, the Bank of Spain reported that bad loan ratios for Spanish banks were at a 15 year high. Of importance is the fact that Spanish debt is largely held in European hands and the eurozone crisis has seen an unwinding of the euro carry trade and the funding positions of the Swiss franc, which has seen significant increase in value despite the Swiss Central Bank intervening on numerous occasions to keep its value down.
Trichet, ECB President, said the European nations should extend and broaden the bailout fund. He also reiterated his adherence to deficit reduction while maintaining the European nations should share a larger burden in tackling the fiscal crisis. Some ECB officials were indicating the ECB may need more capital while Trichet refused to comment. However, an analysis of ECB assets (covered and government bonds and potential problem assets) shows the ECB had almost exhausted its 2009 capital funding. Eurozone central banks have lost 5 billlion euro on the ECB's government bond purchases. By the 16th, it was announced the ECB would almost double its capital base by 5 billion euro ($6.6 billion) to protect it from losses as it continues to buy government bonds.
Ireland's Dail approved the bailout which includes more support for Irish banks. The United Kingdom will earn 440 million pounds on its 7.5 year 3.25 million pound loan to Ireland at 5/9% for the first eight tranches.
While the European Union is supplying the bulk of the bailout to Ireland, the EU Commission, in its Autumn forecasts, is not very supportive of the economic possibilities of Ireland obtaining its GDP and budget goals. The Bank of England entered into a foreign exchange swap agreement with the European Central Bank to provide up to 10 billion pounds ($15.5 billion) for euro which would be made available to the Central Bank of Ireland which could provide Irish banks with pounds and UK banks, with their exposure to Irish banks, with euro. With the deteriorating conditions in Ireland, the Lloyds Banking Group will have a 2010 impairment charge with respect to Irish loans of 4.3 billion pounds, which is approximately a 54% increase during 2010.
Prior to the Thursday Euro Summit, Germany's Merkel was trying to stake out a more moderate nine point plan, but still maintaining a resolute position on deficit reduction, on the need to work together with more harmony and asserting that Germany was not trying to dictate to anyone. Germany has begun to recognize the international concern that it needs to address the choices Germany has within the eurozone which revolve around more European integration, a realistic appraisal of financial aid to eurozone members to maintain economic growth or fiscal balance, and how to address the rollover, reduction, and /or restructuring of debt. Despite Germany's reiteration that the euro must be defended, many economists still insist the structure of the euro is directly responsible for the economic problems in the peripheral countries. Internally, political opposition has surfaced in Germany on Merkel's prior hard line policies against the euro bond concept and fiscal integration with a firm opinion piece by two former German ministers on the necessity of Germany to lead the fight for integration despite the costs to Germany. This has "coincided" with Merkel's attempt to protect German interests while moderating her positions to be more accommodating, within fiscal policy boundaries, towards common European interests.
At the European Summit, EU leaders committed to establishing a permanent debt-crisis mechanism by 2013, which has two problems: one, it is too late and two, it remains incorrectly focused on debt and not economic stability and growth. Germany nixed any current addition to bail out funding or providing economic aid to Portugal and Spain, reinforcing market skepticism about eurozone support of the euro. Luxembourg Prime Minister Juncker wanted more flexible use of the emergency funds, but Germany was unwilling to speculate on more flexible uses at this time. The yet to be created European Stability Mechanism will replace the European Financial Stability Facility (EFSF) and will only be able to grant loans on strict conditions to member nations in distress with private sector bond holders sharing the burden.
Germany continues to oppose the creation of a common euro bond based on the fear that Germany, who has prospered the most from the creation of the euro, will have to bear the highest burden of any "joint and several" guarantee and is contradictory of a fiscal/debt policy perspective for which each nation is on its own as if a monetary union did not exist. The Italian Finance Minister, Tremonti, and the Luxembourg Prime Minister, Juncker, have jointly been pushing a euro bond to eventually replace national debt. This is something Germany can never endorse. I have long held that a euro bond is necessary, but I have always envisioned it as separate from national debt and perhaps funding programs for economic growth at the European Investment Bank (although this would require a change in the way they do business), economic stability programs through a stability mechanism, and purchasing and lending programs of the ECB. This seems beyond the current framing of the discussion. Gavyn Davies, who has a better understanding of sectoral balances and a balance sheet economy, is arguing that the failure to address the need for a euro bond will result in the break up of the eurozone. He has discussed two euro bond possibilities other than "joint and several" with one being a proportional guarantee based on GDP, which Germany is likely to oppose as it has the largest GDP and its yields would be higher than the bund, and a second being the creation of blue and red debt with blue debt jointly guaranteed by all eurozone members and red debt remaining national debt. He proposes the necessity to create a default trigger and a ratio of blue debt to red debt for each nation, creating the refinancing of current debt at lower rates improving liquidity and the creation of a bond restructuring plan, and providing the means for all new debt issued during financial crisis situations to be blue debt. While this would broaden the discussion, it still keeps the focus erroneously on fiscal/debt policy rather than economic stability and growth.
The need for structural reforms from member nation to member nation is pointless without an integrated economic stability mechanism which acknowledges that a lack of fiat national money deprives a nation of fiscal policy consistent with its national economic growth and stability needs. Munchau has proposed a mini fiscal union which appears, at best, to be a temporary compromise, because a true fiscal union or mechanism must deal with economic instability directly. He would shift all regulation of banks to the EU. Why not by laws passed and enforced by the EU and regulated by the ECB? He would address asymmetric shocks with EU six month unemployment insurance. He would attempt symmetry by taxing current account balance surpluses and deficits equally to finance a bail out fund. The use of a six month EU unemployment insurance to counteract asymmetric shocks is not a realistically sufficient or broad enough economic stabilizer model. The focus on current account balances, while a significant indicator of the current dysfunction of the euro structure, is the wrong focus for creating symmetry as a fiscal mechanism which responds to member nation economic growth and structural stability needs could make the current account balances irrelevant between an integrated eurozone. How such a mechanism would be funded besides a euro bond is the question.
Bill Mitchell has been an ardent opponent of the euro and long maintained the euro nations would be better off economically if they were to withdraw from the eurozone and have their own fiat money and monetary policy powers. While withdrawing from the eurozone is probably an extreme position and could possibly generate a global economic shock, his argument that the fiscal fallacy of the eurozone leaders has led to a loss of economic perspective is compelling. The fiscal myth has become ingrained to the degree that economic theory and thought has been limited to only one "politically correct" thought process. "The relevant question is never asked – what is the role of fiscal policy and how can governments use this unique capacity (when they are fully sovereign) to improve the lives and outcomes of the citizens. That sort of debate is circumvented by the logic of the fiscal councils and the rules it is charged with enforcing directly or via moral suasion. It results in the sort of austerity madness that we are now seeing." The idea that nations are financially constrained and that government surpluses are government savings is self-destructive. The role of the gold standard in worsening the Great Depression is well documented. The present day attempt to re-institute a pseudo gold standard through the euro is creating the same currency crisis conditions.
The current eurozone policies and compromises are too obviously temporary to assuage the market which judges on decisive actions or lack thereof in pricing swaps and yields. This continued austerity destroys economic growth and increases the risk of a double dip recession globally.
United Kingdom owned banks worldwide reported an increase in consolidated foreign claims of $176 billion in Q3 to a total of $3971.5 billion.
United Kingdom unemployment rose unexpectedly by 35,000 to 2,502,000 or 7.9%. This sudden increase was mainly the result of public sector employment layoffs as the result of austerity. The government projects 330,000 government jobs will be lost in the next four years.
The IMF complimented Greece on its reforms and austerity progress and granted it another payment of $3.3 billion (2.5 billion euro). Greece's GDP is continuing to contract more than expected (which quite bluntly is no surprise) and bond yields remain high. Greek GDP is expected to decline 4.25% in 2010 and 3% in 2011.
China has continued to expand its influence in the EU investments and purchases of government debt primarily in Greece, Spain, Italy, Portugal, and Italy. This is also allowing China to invest their stockpile reserves of euro. Given the austerity policies of the eurozone, member nations are seeking Chinese investment and purchases of debt. Germany has indicated it will support China being recognized by the EU as a market economy within five years, which would make it difficult for the EU to levy anti-dumping duties on Chinese products.
Slovakia's Speaker of the Parliament said Slovakia should be ready to leave the eurozone if the credit crisis continues to spread. It is the most recent member with Estonia to be the 17th member on January 1st. The Slovak government stomped on this idea as impractical, but some Slovak economists are arguing that it would be better sooner than later, despite the temporary investment disruption, as it would have a less important impact on the eurozone.
On the 13th, the Financial Times speculated why China, in the face of rising inflation, is pursuing an anything but rate hikes strategy. November CPI was 5.1% up from the prior month's 4.4% and well above the 3% target. With last weekend's economic conference, Chinese leaders are making a very public display of intent to control inflation with bank reserve requirements, lending restraints, and the need to head off asset bubbles. At the same time, China wants to give the market more sway over rates within the next five years to further China as a global financial center.
Not only has China recognized the importance of a healthy Europe, but Europe is beginning to recognize the importance of China on European recovery and the risk of an emerging Asia slowing down with a hard landing on the European economy, especially Germany, as well as globally.
John Hussman in his weekly commentary dated Monday the 13th listed five conditions which capture basic over valued, over bought, over bullish, rising yields and then lists ten historical periods corresponding to those conditions with December 2010 being the last one. He is hard defensive and suffering for it. He provides a mathematical explanation of why, when one uses per share dividend growth rate to calculate estimates of long term expected equity returns, you should not double count by adding repurchases to dividends as if they were a separate cash flow. He estimates the expected ten year total return of the S&P 500 to be about 3.7% annually. He agrees with Grantham that high quality large caps will most likely present the best prospects for total returns in the coming years. It should be noted that in the past year, and continuing, small caps have presented the best total returns. In response to the sharp spike in Treasury yields, he changed the duration of the Total Return Fund to just under 1 year from 2.5 years.
Doug Short graphs and details the Treasury yields have increased since the November 3rd Fed FOMC meeting announcing the details of QE2 and its longer term Treasury purchases.
Market: There were 6 bank failures for a total of 157; the unofficial problem bank list is 920.
DOW/Volume NASDAQ/Volume
Mon: 18.24/up 5.7% <12.63>/down 1.4%
Tue 47.98/down 0.4% 2.81/down 0.8%
Wed <19.07>/up 16.5% <10.50>/up 2.2%
Thu: 41.78/down 9.8% 20.09/down 8.2%
Fri: <7.34>/up 80.0% 5.66/up 41.2%
Total 81.59 5.43
Mon: Oil was up 82 cents to $88.61; Dollar weaker; rally fizzled.
Tue: Oil was down 33 cents to 88.28; Dollar stronger but weaker against the pound; lagging market volume; retail sales up but Best Buy is big disappointment; no surprises in the Fed statement; 10 year Treasury up 16 bps to 3.4% - highest since May breaching technical support.
Wed: Oil was up 34 cents to 88.62; Dollar stronger; bond yields rising as spread between 2 year and 30 year Treasuries reached a record 395 bps; oil supplies were down 9.9 million barrels (8 year largest drop), gas supplies were up 800,000, and distillate supplies were up 1.1 million.
Thu: Oil was down 92 cents to 87.70; Dollar weaker; credit card companies down in lower volume market with thin traded stocks up; Treasuries start back up; weekly jobless claims were down 3000 to 420,000, 4 week moving average was down 5250 to 422,750, and continuing claims were up 22,000 to 4,135,000.
Fri: Oil was up 32 cents to 88.02; Dollar stronger but weaker against the yen; quadruple options and futures expiration day; new 2010 yearly high for the NASDAQ and S&P 500 with little movement in price.
United States: 10 year Treasury yields (3.36%) at 6 month high as they tumbled in the Asian markets.
A Virginia Federal judge invalidated parts of the PPACA (healthcare) which required individual participation without choice but did not rule on other parts; this will be appealed.
U.S. business inventory for October was up 0.7% to $1.42 trillion -- highest since February 2009 but less than the expected 1% (up 1.3% in September).
Retail sales were up 0.8% in November --- expected up 0.6%; ex-auto it was up 1.2%; October was revised up to 1.7% from 1.2%.
PPI (Producer Price Index) -- wholesale prices -- was up 0.8% in November -- more than expected as the result of energy prices; core prices were up 0.3% which was more than the expected 0.2%.
Best Buy Q3 profit was down 4.4% citing weaker demand for tv and entertainment systems.
A Hartford study found 38.8% of Americans 45 years of age or older will rely on Social security as the primary source of retirement income; this is up from 26.7% in 2006. 27.1% will work for as long as they are healthy. 37.2% are unsure if they will ever be able to retire.
Industrial production was up 0.4% in November (down 0.2% October) to 93.9; capacity utilization was up to 75.2.
New York Fed Empire State Manufacturing Survey for December showed general business conditions were up 22 to 10.6 (it was down 27 in November indicating contraction); prices paid were up 6 to 28.4; employment was down 13 to <3.4>; new orders were up 27 to 2.6.
Bank of America credit card loss rate was down to 9.92% from 10.15%; delinquency was down to 5.47% from 5.6%. J.P. Morgan charge offs were up to 7.16% from 7.0%; delinquencies were down to 3/68% from 3.81%. CapOne delinquencies were down to 4.26% from 4.45%; charge offs were up to 7.56% from 7.26%.
FDIC is proposing bank holding companies maintain the same capital levels as their federally insured banks.
Moody's said it may move closer to cutting U.S. rating if the Republican compromise tax package (which was subsequently passed) is passed.
CoreLogic house prices for October were down 3.93% vs year ago -- third month down.
U.S. housing starts for November were up 3.9%.
Philly Fed Manufacturing Survey for December business activity was up to 24.3 from 22.5, which is a five year high (expected down to 17.5); prices paid were up to 51.2 from 34.0; prices received were up to 10.7 from <2.1>; new orders were up to 14.6 from 10.4; inventory was down to <5.9> from <2.0>.
Oracle EPS was up 33% to 51 cents per share; revenue was up 47% to $8.6 billion.
U.S. current account deficit was up 3.3% in Q3 to $127.2 billion.
30 year mortgage rate was up 22 bps to 4.83%.
Global mergers and acquisitions were up approximately 20% in 2010 to $2.25 trillion with emerging markets involved in 17% of the deals and the energy sector was involved in 40% of the deals.
ECRI Weekly Leading Indicators (WLI) was <0.1> from last week's <1.4>.
Unemployment was up in 21 states, down in 15, and steady in 14.
International: The Chinese selective reserve requirement of 19% for the six largest banks was extended 3 months.
BIS (Bank of International Settlements) and the EIB (European Investment Bank) both said Germany's call for bond holder haircuts in bank bonds intensified the euro crisis. The ECB may as for more capital from the eurozone nations; it bought 2.667 billion euro ($3.5 billion) in government debt last week.
Canadian industrial capacity utilization was up 1.2% Q3 to 78.1, which is a two year high; output of manufactured goods was up 0.6%.
The Japanese Prime Minister is proposing a 5% corporate tax cut (currently at 40%).
UK November inflation was 3.3% (CPI) with the expectation it will reach 3.5% in early 2011; core inflation was stable at 2.7%.
China will raise export duties on rare earths in 2011 to curb shipments. It will target 4% inflation rate for 2011 (up from 3% target) and 8% growth (economists expects 9%).
China attracted $91.7 billion in foreign direct investment in the first 11 months of 2010, which is up 18% from the same period in 2009.
Moody's cut Spain's debt rating to Aa1 citing mounting debt and funding needs as well as worries the central government will not be able to control local authorities in achieving structural improvement.
S&P may cut Belgium's credit rating in 6 months if political impasse is not resolved (very little progress is being made).
Germany said it would give the ECB more capital if it was needed to combat the "debt" crisis.
ECB will almost double its capital base effective 12.29 by 5 billion euro to 10.76 billion euro.
Sweden raised its interest rates 25 bps to 1.25% and boosted its economic growth forecast this year and next. It sees continuing rate hikes coming.
UK retail sales in November were up 0.3% (October was revised to up 0.7%) on food, toys, and jewelry.
Ireland's GDP Q3 was up 0.5% (down 1% in Q2) with exports up 3.6%; GDP vs year ago was down 0.5%.
Moody's slashed Ireland's credit rating 5 notches to Baa1 from Aa2. Last week Fitch lowered it 3 notches to BBB+.
RIM sales were up 40%.
Eurozone PMI (Markit Purchasing Manager's Index survey) was down 1.7 in December to 53.7 for services and up 1.5 to 56.8 for manufacturing. Eurozone trade surplus was up to $6.92 billion in October; up 7.7% from September.
Spanish Prime Minister Zapatero said he was determined to raise the retirement age to 67 from 65 to slash the deficit despite opposition of labor unions.
Moody's palced 6 Greek banks on review for possible downgrade: National Bank of Greece, EFG Eurobank Ergasias, Alpha Bank, Piraeus Bank, Agricultural Bank of Greece, and Attica Bank.
China's CPI was up to 5.1% in November vs year ago.
Swiss National Bank held interest rates at zero to 0.75% on concerns the European crisis could derail economic recovery.
Bank of Montreal will acquire Marshall & Isley for $4.16 billion.
The IMF said Ireland might grow 0.9% in 2011.
Print Page
Inflation (CPI) in the United States for the month of November came in at 1.14% (1.17% in October). If the 1990's calculation was used it would be approximately 4.3%; if the 1980's calculation was used it would be approximately 8.8%. From October to November it rose 0.04% but December may show a larger increase as December 2009 was <.18%> and may also be affected by QE2.
As we have mentioned, the new tax cut bill does nothing for those who have been unemployed for longer than 99 weeks and they will slide off into uncounted anonymous limbo. Here are the unemployment figures by state. Illinois has 9.6% unemployment.
The deleveraging process has been a subject of interest for some time and I have often commented on it. The sad fact is that the develeraging process by consumers is being driven by debt default just as I have written in the past that business deleveraging is fueled by write-offs of bad loans and asset values.
1.6 million Americans have put off retirement to continue working as the result of falling asset prices.
The cut in the payroll tax is being seen by some Republicans as a means to change Social Security, which has been a concern to many economists as the result of the President's Deficit Commission Report, despite it not receiving the necessary 14 votes to be recommended to Congress. It is interesting to note that one of the 11 votes for the Deficit Commission Report was Illinois Senator Dick Durbin who said "It is just a step forward in the debate." Considering how close Dick is to President Obama and the rumors we mentioned last week that the President's State of the Union speech may contain a call for Social Security reform. This is the wrong focus. The focus should be on Medicare fraud and escalating health care costs which were not addressed in the very limited and poorly designed PPACA health care bill (another example of political compromise and poor economics which ignored the models of universal health care provided through private insurance companies at significantly lower cost in France, Switzerland, and the Netherlands). In the past, we have covered two economic discussions on making social security and taxes more equitable by either extending payroll taxes to all income without limits or through income taxes on all income earned or unearned. However, the political agenda appears to be to cut taxes to benefit the wealthy and to cut programs the wealthy do not need or use under the pretext of deficit reduction.
We have written on numerous occasions about the economic necessity to stimulate the economy with targeted spending which creates jobs now in order to grow the economy out of this disinflationary, slow growth, and high unemployment long term economic condition. The original stimulus was too little, too slow, the failure to reform the financial system which precipitated the financial crisis is setting up the next financial crisis, and the tax cut bill stimulus is meaningless, if not welfare for the wealthy. Nothing is well served by increasing economic inequality within a republican democracy; it diminishes and eventually destroys the middle class and the middle class is essential in any sustainable democracy. We have written about studies showing growing inequality since the 1960's and now studies are showing economic inequality may be either one of the causes or an indicator of impending economic crises, because there was significant growth in economic inequality prior to both the Great Depression and this most recent financial crisis.
There is a lot of hype about possible municipal bond defaults in the near future. Much of this is overblown, but there are some towns, cities, and counties under significant stress as the result of insufficient stimulus from the Federal government and, in some instances, mismanagement and/or corruption on the local level. There has been a lot of political talk that some states should be forced into bankruptcy as a means of cutting retirement, health care, and social welfare programs. While municipalities and counties can declare bankruptcy under the Bankruptcy Code, there is no provision allowing a state to declare bankruptcy. With the failure to extend Build America Bonds, there will be more pressure and less liquidity in the municipal bond market, but that does not deter quality investing.
The attempts to banish facts from the economic and political debate extended to the Financial Crisis Inquiry Commission in which a partisan vote resulted in a minority report which banishes the use of any terms which might cast blame for the Financial Crisis on banks and Wall Street choosing to ignore the unpunished financial fraud which caused the financial crisis and, in fact, to show solidarity with those political leaders who would have government serve the bankers. It is unfortunate when facts are inconvenient.
The Federal Reserve Open Market Committee released its December meeting statement in which it reaffirmed the interest rate of zero to 25 bps for an extended period, reinvesting principal payments of securities held, and will begin a $600 billion purchase at $75 billion per month of longer term Treasuries. The sole vote against the monetary policy action was Mr. Hoenig again, who remains concerned about increased risks of future economic and financial imbalances increasing long term inflation expectations over time. While there is some encouraging data, the Fed has still not addressed the demand needed to bring unemployment down and long term interest rates will rise as this slow recovery progresses, but one should not expect the Fed to change direction any time soon.
The Federal Reserve provided approximately $140 billion more in loans to foreign banks during the financial crisis than it disclosed publicly earlier this month. The Fed may be trying to make changes to the rescission and disclosure provisions of the Truth in Lending Act as the pressures build, as the result of the mortgage and foreclosure mess/fraud, on the banks and their servicers to potentially make good on deceptive mortgages and, in fact, the banks are pushing the Fed to do just exactly that.
As many economic and financial commentators have been writing, the HAMP foreclosure prevention and modification program has been failing, if not an outright failure, as the result of banks dragging their feet in the application process (some real horror stories out there), of people whose applications were pending being foreclosed on anyway, and of the government not sufficiently pushing and regulating the process. People are dropping out of the program faster than are they are joining. The Congressional Oversight Panel has issued a pretty nasty report on the Treasury program. Bank of America is being sued by Nevada and Arizona, because the bank proceeded on foreclosures while applications were pending in violation of a 2009 agreement with Arizona.
PricewaterhouseCoopers, LLP has issued two audit reports for two different banks which support contradictory positions in which MBIA is asserting a large asset in the form of refund demands on Bank of America, while Bank of America has not made any reserve provisions to pay the contractual claims of $2.2 billion. This is obviously an example of auditor's reliance upon management to determine value. This deferral to management, when no readily determinable value exists, is a serious and fundamental audit problem from which no professional good will result.
The Dodd-Frank Bill mandated that derivatives will be traded through regulated clearinghouses, but the bankers who control at least two of the risk committees of the two largest clearinghouses are determined to keep transactions through banks and defeating proposals which improved and make more transparent the way derivatives are traded.
Despite consumer protection laws, the banks are desperate for profits and, with the additional protection of the 2005 bankruptcy reform, they are seeking out and actively marketing to risky credit card customers to whom they charge higher fees and interest rates until they hit the wall. The Federal Reserve has the power to stop this if they wanted to do so.
The Ohio Attorney General Richard Cordray has been named to head up the enforcement division of the Consumer Financial Protection Bureau, which will not make the banks happy.
The Bulls minus Bears sentiment index is again approaching +40 (as of December 12). The last time it broke above +40 was October 2007 when the market proceeded to crash. Another reason to be cautious right now is that no one else is; the VIX is approaching levels (as of December 13) of high complacency and, as the VIX goes below 17, investors are leaving more of their portfolios exposed to risk.
The ratio of household debt to disposable income in Canada in Q3 was 1.48 which exceeds the United States ratio of 1.47 and caused Canadian central bankers and finance officials to publicly voice concerns that the growing debt level could threaten recovery. The Bank of Canada sees the vulnerabilities of households as high and the debt levels unprecedented.
The Canadian dollar dropped for the second week as investor's turned to U.S. government debt as safety against the potential problems of the eurozone.
The Governor of the Bank of Canada, Mark Carney, indicated that the current European difficulties are not over and the pattern of global economic growth is changing. Canada should adapt to a world were their will be inflation in emerging markets and disinflation in developed markets.
The eurozone core is more complicated and problem laden than many wish to recognize with political instability in Belgium and Italy, issued debt which has to be periodically rolled over (from which France is not immune), and the German bund has been caught in the sell-off of U.S. Treasuries. All of these factors show the liquidity risks going forward and how vulnerable the eurozone is to any market shock or perceived weakness.
On December 14th, the Spanish 10 year debt yield exploded. Spain and its banks will have to refinance 265 billion euro ($345 billion) in 2011 and Moody's has indicated Spanish banks may actually have $177 billion euro losses on their books, which caused the Spanish Finance Minister, Salgado, to defend the solvency of the Spanish banking system. On Thursday, bond auction yields rose even higher from between 80 to 140 bps from prior auctions for the same maturities. On Friday, the Bank of Spain reported that bad loan ratios for Spanish banks were at a 15 year high. Of importance is the fact that Spanish debt is largely held in European hands and the eurozone crisis has seen an unwinding of the euro carry trade and the funding positions of the Swiss franc, which has seen significant increase in value despite the Swiss Central Bank intervening on numerous occasions to keep its value down.
Trichet, ECB President, said the European nations should extend and broaden the bailout fund. He also reiterated his adherence to deficit reduction while maintaining the European nations should share a larger burden in tackling the fiscal crisis. Some ECB officials were indicating the ECB may need more capital while Trichet refused to comment. However, an analysis of ECB assets (covered and government bonds and potential problem assets) shows the ECB had almost exhausted its 2009 capital funding. Eurozone central banks have lost 5 billlion euro on the ECB's government bond purchases. By the 16th, it was announced the ECB would almost double its capital base by 5 billion euro ($6.6 billion) to protect it from losses as it continues to buy government bonds.
Ireland's Dail approved the bailout which includes more support for Irish banks. The United Kingdom will earn 440 million pounds on its 7.5 year 3.25 million pound loan to Ireland at 5/9% for the first eight tranches.
While the European Union is supplying the bulk of the bailout to Ireland, the EU Commission, in its Autumn forecasts, is not very supportive of the economic possibilities of Ireland obtaining its GDP and budget goals. The Bank of England entered into a foreign exchange swap agreement with the European Central Bank to provide up to 10 billion pounds ($15.5 billion) for euro which would be made available to the Central Bank of Ireland which could provide Irish banks with pounds and UK banks, with their exposure to Irish banks, with euro. With the deteriorating conditions in Ireland, the Lloyds Banking Group will have a 2010 impairment charge with respect to Irish loans of 4.3 billion pounds, which is approximately a 54% increase during 2010.
Prior to the Thursday Euro Summit, Germany's Merkel was trying to stake out a more moderate nine point plan, but still maintaining a resolute position on deficit reduction, on the need to work together with more harmony and asserting that Germany was not trying to dictate to anyone. Germany has begun to recognize the international concern that it needs to address the choices Germany has within the eurozone which revolve around more European integration, a realistic appraisal of financial aid to eurozone members to maintain economic growth or fiscal balance, and how to address the rollover, reduction, and /or restructuring of debt. Despite Germany's reiteration that the euro must be defended, many economists still insist the structure of the euro is directly responsible for the economic problems in the peripheral countries. Internally, political opposition has surfaced in Germany on Merkel's prior hard line policies against the euro bond concept and fiscal integration with a firm opinion piece by two former German ministers on the necessity of Germany to lead the fight for integration despite the costs to Germany. This has "coincided" with Merkel's attempt to protect German interests while moderating her positions to be more accommodating, within fiscal policy boundaries, towards common European interests.
At the European Summit, EU leaders committed to establishing a permanent debt-crisis mechanism by 2013, which has two problems: one, it is too late and two, it remains incorrectly focused on debt and not economic stability and growth. Germany nixed any current addition to bail out funding or providing economic aid to Portugal and Spain, reinforcing market skepticism about eurozone support of the euro. Luxembourg Prime Minister Juncker wanted more flexible use of the emergency funds, but Germany was unwilling to speculate on more flexible uses at this time. The yet to be created European Stability Mechanism will replace the European Financial Stability Facility (EFSF) and will only be able to grant loans on strict conditions to member nations in distress with private sector bond holders sharing the burden.
Germany continues to oppose the creation of a common euro bond based on the fear that Germany, who has prospered the most from the creation of the euro, will have to bear the highest burden of any "joint and several" guarantee and is contradictory of a fiscal/debt policy perspective for which each nation is on its own as if a monetary union did not exist. The Italian Finance Minister, Tremonti, and the Luxembourg Prime Minister, Juncker, have jointly been pushing a euro bond to eventually replace national debt. This is something Germany can never endorse. I have long held that a euro bond is necessary, but I have always envisioned it as separate from national debt and perhaps funding programs for economic growth at the European Investment Bank (although this would require a change in the way they do business), economic stability programs through a stability mechanism, and purchasing and lending programs of the ECB. This seems beyond the current framing of the discussion. Gavyn Davies, who has a better understanding of sectoral balances and a balance sheet economy, is arguing that the failure to address the need for a euro bond will result in the break up of the eurozone. He has discussed two euro bond possibilities other than "joint and several" with one being a proportional guarantee based on GDP, which Germany is likely to oppose as it has the largest GDP and its yields would be higher than the bund, and a second being the creation of blue and red debt with blue debt jointly guaranteed by all eurozone members and red debt remaining national debt. He proposes the necessity to create a default trigger and a ratio of blue debt to red debt for each nation, creating the refinancing of current debt at lower rates improving liquidity and the creation of a bond restructuring plan, and providing the means for all new debt issued during financial crisis situations to be blue debt. While this would broaden the discussion, it still keeps the focus erroneously on fiscal/debt policy rather than economic stability and growth.
The need for structural reforms from member nation to member nation is pointless without an integrated economic stability mechanism which acknowledges that a lack of fiat national money deprives a nation of fiscal policy consistent with its national economic growth and stability needs. Munchau has proposed a mini fiscal union which appears, at best, to be a temporary compromise, because a true fiscal union or mechanism must deal with economic instability directly. He would shift all regulation of banks to the EU. Why not by laws passed and enforced by the EU and regulated by the ECB? He would address asymmetric shocks with EU six month unemployment insurance. He would attempt symmetry by taxing current account balance surpluses and deficits equally to finance a bail out fund. The use of a six month EU unemployment insurance to counteract asymmetric shocks is not a realistically sufficient or broad enough economic stabilizer model. The focus on current account balances, while a significant indicator of the current dysfunction of the euro structure, is the wrong focus for creating symmetry as a fiscal mechanism which responds to member nation economic growth and structural stability needs could make the current account balances irrelevant between an integrated eurozone. How such a mechanism would be funded besides a euro bond is the question.
Bill Mitchell has been an ardent opponent of the euro and long maintained the euro nations would be better off economically if they were to withdraw from the eurozone and have their own fiat money and monetary policy powers. While withdrawing from the eurozone is probably an extreme position and could possibly generate a global economic shock, his argument that the fiscal fallacy of the eurozone leaders has led to a loss of economic perspective is compelling. The fiscal myth has become ingrained to the degree that economic theory and thought has been limited to only one "politically correct" thought process. "The relevant question is never asked – what is the role of fiscal policy and how can governments use this unique capacity (when they are fully sovereign) to improve the lives and outcomes of the citizens. That sort of debate is circumvented by the logic of the fiscal councils and the rules it is charged with enforcing directly or via moral suasion. It results in the sort of austerity madness that we are now seeing." The idea that nations are financially constrained and that government surpluses are government savings is self-destructive. The role of the gold standard in worsening the Great Depression is well documented. The present day attempt to re-institute a pseudo gold standard through the euro is creating the same currency crisis conditions.
The current eurozone policies and compromises are too obviously temporary to assuage the market which judges on decisive actions or lack thereof in pricing swaps and yields. This continued austerity destroys economic growth and increases the risk of a double dip recession globally.
United Kingdom owned banks worldwide reported an increase in consolidated foreign claims of $176 billion in Q3 to a total of $3971.5 billion.
United Kingdom unemployment rose unexpectedly by 35,000 to 2,502,000 or 7.9%. This sudden increase was mainly the result of public sector employment layoffs as the result of austerity. The government projects 330,000 government jobs will be lost in the next four years.
The IMF complimented Greece on its reforms and austerity progress and granted it another payment of $3.3 billion (2.5 billion euro). Greece's GDP is continuing to contract more than expected (which quite bluntly is no surprise) and bond yields remain high. Greek GDP is expected to decline 4.25% in 2010 and 3% in 2011.
China has continued to expand its influence in the EU investments and purchases of government debt primarily in Greece, Spain, Italy, Portugal, and Italy. This is also allowing China to invest their stockpile reserves of euro. Given the austerity policies of the eurozone, member nations are seeking Chinese investment and purchases of debt. Germany has indicated it will support China being recognized by the EU as a market economy within five years, which would make it difficult for the EU to levy anti-dumping duties on Chinese products.
Slovakia's Speaker of the Parliament said Slovakia should be ready to leave the eurozone if the credit crisis continues to spread. It is the most recent member with Estonia to be the 17th member on January 1st. The Slovak government stomped on this idea as impractical, but some Slovak economists are arguing that it would be better sooner than later, despite the temporary investment disruption, as it would have a less important impact on the eurozone.
On the 13th, the Financial Times speculated why China, in the face of rising inflation, is pursuing an anything but rate hikes strategy. November CPI was 5.1% up from the prior month's 4.4% and well above the 3% target. With last weekend's economic conference, Chinese leaders are making a very public display of intent to control inflation with bank reserve requirements, lending restraints, and the need to head off asset bubbles. At the same time, China wants to give the market more sway over rates within the next five years to further China as a global financial center.
Not only has China recognized the importance of a healthy Europe, but Europe is beginning to recognize the importance of China on European recovery and the risk of an emerging Asia slowing down with a hard landing on the European economy, especially Germany, as well as globally.
John Hussman in his weekly commentary dated Monday the 13th listed five conditions which capture basic over valued, over bought, over bullish, rising yields and then lists ten historical periods corresponding to those conditions with December 2010 being the last one. He is hard defensive and suffering for it. He provides a mathematical explanation of why, when one uses per share dividend growth rate to calculate estimates of long term expected equity returns, you should not double count by adding repurchases to dividends as if they were a separate cash flow. He estimates the expected ten year total return of the S&P 500 to be about 3.7% annually. He agrees with Grantham that high quality large caps will most likely present the best prospects for total returns in the coming years. It should be noted that in the past year, and continuing, small caps have presented the best total returns. In response to the sharp spike in Treasury yields, he changed the duration of the Total Return Fund to just under 1 year from 2.5 years.
Doug Short graphs and details the Treasury yields have increased since the November 3rd Fed FOMC meeting announcing the details of QE2 and its longer term Treasury purchases.
Market: There were 6 bank failures for a total of 157; the unofficial problem bank list is 920.
DOW/Volume NASDAQ/Volume
Mon: 18.24/up 5.7% <12.63>/down 1.4%
Tue 47.98/down 0.4% 2.81/down 0.8%
Wed <19.07>/up 16.5% <10.50>/up 2.2%
Thu: 41.78/down 9.8% 20.09/down 8.2%
Fri: <7.34>/up 80.0% 5.66/up 41.2%
Total 81.59 5.43
Mon: Oil was up 82 cents to $88.61; Dollar weaker; rally fizzled.
Tue: Oil was down 33 cents to 88.28; Dollar stronger but weaker against the pound; lagging market volume; retail sales up but Best Buy is big disappointment; no surprises in the Fed statement; 10 year Treasury up 16 bps to 3.4% - highest since May breaching technical support.
Wed: Oil was up 34 cents to 88.62; Dollar stronger; bond yields rising as spread between 2 year and 30 year Treasuries reached a record 395 bps; oil supplies were down 9.9 million barrels (8 year largest drop), gas supplies were up 800,000, and distillate supplies were up 1.1 million.
Thu: Oil was down 92 cents to 87.70; Dollar weaker; credit card companies down in lower volume market with thin traded stocks up; Treasuries start back up; weekly jobless claims were down 3000 to 420,000, 4 week moving average was down 5250 to 422,750, and continuing claims were up 22,000 to 4,135,000.
Fri: Oil was up 32 cents to 88.02; Dollar stronger but weaker against the yen; quadruple options and futures expiration day; new 2010 yearly high for the NASDAQ and S&P 500 with little movement in price.
United States: 10 year Treasury yields (3.36%) at 6 month high as they tumbled in the Asian markets.
A Virginia Federal judge invalidated parts of the PPACA (healthcare) which required individual participation without choice but did not rule on other parts; this will be appealed.
U.S. business inventory for October was up 0.7% to $1.42 trillion -- highest since February 2009 but less than the expected 1% (up 1.3% in September).
Retail sales were up 0.8% in November --- expected up 0.6%; ex-auto it was up 1.2%; October was revised up to 1.7% from 1.2%.
PPI (Producer Price Index) -- wholesale prices -- was up 0.8% in November -- more than expected as the result of energy prices; core prices were up 0.3% which was more than the expected 0.2%.
Best Buy Q3 profit was down 4.4% citing weaker demand for tv and entertainment systems.
A Hartford study found 38.8% of Americans 45 years of age or older will rely on Social security as the primary source of retirement income; this is up from 26.7% in 2006. 27.1% will work for as long as they are healthy. 37.2% are unsure if they will ever be able to retire.
Industrial production was up 0.4% in November (down 0.2% October) to 93.9; capacity utilization was up to 75.2.
New York Fed Empire State Manufacturing Survey for December showed general business conditions were up 22 to 10.6 (it was down 27 in November indicating contraction); prices paid were up 6 to 28.4; employment was down 13 to <3.4>; new orders were up 27 to 2.6.
Bank of America credit card loss rate was down to 9.92% from 10.15%; delinquency was down to 5.47% from 5.6%. J.P. Morgan charge offs were up to 7.16% from 7.0%; delinquencies were down to 3/68% from 3.81%. CapOne delinquencies were down to 4.26% from 4.45%; charge offs were up to 7.56% from 7.26%.
FDIC is proposing bank holding companies maintain the same capital levels as their federally insured banks.
Moody's said it may move closer to cutting U.S. rating if the Republican compromise tax package (which was subsequently passed) is passed.
CoreLogic house prices for October were down 3.93% vs year ago -- third month down.
U.S. housing starts for November were up 3.9%.
Philly Fed Manufacturing Survey for December business activity was up to 24.3 from 22.5, which is a five year high (expected down to 17.5); prices paid were up to 51.2 from 34.0; prices received were up to 10.7 from <2.1>; new orders were up to 14.6 from 10.4; inventory was down to <5.9> from <2.0>.
Oracle EPS was up 33% to 51 cents per share; revenue was up 47% to $8.6 billion.
U.S. current account deficit was up 3.3% in Q3 to $127.2 billion.
30 year mortgage rate was up 22 bps to 4.83%.
Global mergers and acquisitions were up approximately 20% in 2010 to $2.25 trillion with emerging markets involved in 17% of the deals and the energy sector was involved in 40% of the deals.
ECRI Weekly Leading Indicators (WLI) was <0.1> from last week's <1.4>.
Unemployment was up in 21 states, down in 15, and steady in 14.
International: The Chinese selective reserve requirement of 19% for the six largest banks was extended 3 months.
BIS (Bank of International Settlements) and the EIB (European Investment Bank) both said Germany's call for bond holder haircuts in bank bonds intensified the euro crisis. The ECB may as for more capital from the eurozone nations; it bought 2.667 billion euro ($3.5 billion) in government debt last week.
Canadian industrial capacity utilization was up 1.2% Q3 to 78.1, which is a two year high; output of manufactured goods was up 0.6%.
The Japanese Prime Minister is proposing a 5% corporate tax cut (currently at 40%).
UK November inflation was 3.3% (CPI) with the expectation it will reach 3.5% in early 2011; core inflation was stable at 2.7%.
China will raise export duties on rare earths in 2011 to curb shipments. It will target 4% inflation rate for 2011 (up from 3% target) and 8% growth (economists expects 9%).
China attracted $91.7 billion in foreign direct investment in the first 11 months of 2010, which is up 18% from the same period in 2009.
Moody's cut Spain's debt rating to Aa1 citing mounting debt and funding needs as well as worries the central government will not be able to control local authorities in achieving structural improvement.
S&P may cut Belgium's credit rating in 6 months if political impasse is not resolved (very little progress is being made).
Germany said it would give the ECB more capital if it was needed to combat the "debt" crisis.
ECB will almost double its capital base effective 12.29 by 5 billion euro to 10.76 billion euro.
Sweden raised its interest rates 25 bps to 1.25% and boosted its economic growth forecast this year and next. It sees continuing rate hikes coming.
UK retail sales in November were up 0.3% (October was revised to up 0.7%) on food, toys, and jewelry.
Ireland's GDP Q3 was up 0.5% (down 1% in Q2) with exports up 3.6%; GDP vs year ago was down 0.5%.
Moody's slashed Ireland's credit rating 5 notches to Baa1 from Aa2. Last week Fitch lowered it 3 notches to BBB+.
RIM sales were up 40%.
Eurozone PMI (Markit Purchasing Manager's Index survey) was down 1.7 in December to 53.7 for services and up 1.5 to 56.8 for manufacturing. Eurozone trade surplus was up to $6.92 billion in October; up 7.7% from September.
Spanish Prime Minister Zapatero said he was determined to raise the retirement age to 67 from 65 to slash the deficit despite opposition of labor unions.
Moody's palced 6 Greek banks on review for possible downgrade: National Bank of Greece, EFG Eurobank Ergasias, Alpha Bank, Piraeus Bank, Agricultural Bank of Greece, and Attica Bank.
China's CPI was up to 5.1% in November vs year ago.
Swiss National Bank held interest rates at zero to 0.75% on concerns the European crisis could derail economic recovery.
Bank of Montreal will acquire Marshall & Isley for $4.16 billion.
The IMF said Ireland might grow 0.9% in 2011.
Print Page
Wednesday, December 22, 2010
Economy & Market Week Ended 12/11/2010
As we wrote in "Political Economics vs Political Compromise", which was our analysis of the new tax cut law which passed on the 17th of December, it was very disappointing to have the President of the United States publicly demonstrate that he does not know the history of the beginning of Social Security. Social Security is easy to class warfare criticize if you do not need it, but the real problem is the insurance and medical provider fraud in Medicare and the increasing costs that fraud causes. We have a President who promised change and has delivered a style of compromise which has failed to deliver opening the door to economic stagnation, a further institutionalization of inequality, and left a vacuum being filled by the political instability of discontent.
Consumer credit rebounded off its 2009 lows, but a closer inspection shows an increase of student loan debt has increased 80% vs year ago expanding $120 billion as the result of the Department of Education stepping in and buying privately originated student loans meant to be securitized but which could not be marketed starting in 2008 when the credit market dried up. Since then, this program has been expanded and may be totally distorting consumer credit in 2010.
The Cleveland Federal Reserve, in a report, visually shows the meaning of a "Jobless Recovery" after an 18 month Recession, which average 10 months historically, in which payroll employment is still 5.4 points below the pre-Recession peak after 35 months (usually takes 23 months) and only adding a average of 86,000 jobs per month since the beginning of 2010. In fact, the recession and continued high unemployment have had a tremendous negative impact on American families and households in which 39% of American households have been either unemployed, had negative equity in their home, or been arrears in house payments. Of long term concern is the 10% drop in employment among young workers, particularly recent college graduates facing years of lost income and lower future earnings.
Bill Mitchell took an in-depth look at Australian employment/unemployment figures for the month of November in which there was noticeable improvement but with significant remaining slack. One area of Bill Mitchell's economic concentration is employment and his observations of Australian employment and governmental policies with its aging population, of increasing underemployment among 15-24 year olds, of growing part-time employment, and of higher overall underemployment than the severe 1984 recession are relevant to the United States and many other developed countries with an aging population..
The sell off of 10 year U.S. Treasuries with yield rising to 3.3% by the 8th of December has been accompanied by increasing yields of other nation's bonds globally including the German bund. There may be market fear that future bond losses will neutralize QE2 and lead to stagflation. As of the 11th, three German bond auctions have failed. Many saw the German bond, which has been treated as a safe haven, auction failure as reason to question the U.S. Treasury auction when the bonds are not comparable. Germany does not have its own currency and is fiscally constrained and the United States fiat currency is a global reserve currency, making United States debt desirable.
As we have repeatedly reported, the comparison of U.S. states to the eurozone sovereign member nations is not legitimate. However, it continues to be used by deficit hawks. The portrayal of the Build America Bonds as a failed jobs program miring the states in debt is wrong; it was (it is being allowed to expire) a program which opened municipal bond market participation and targeted a decaying infrastructure. It was investment and economic recovery is always dependent on investment. Investment in the short term leads to deficit and debt reduction long term not the other way around. Investment leads to an increase in aggregate demand through infrastructure, research, and defense government investment spending. Those hoping and pushing for large deficit reductions will be disappointed by the resulting decline in tax revenues and increasing unemployment with demands for increased jobless benefits and increased taxes. A more efficient and fair tax system would efficiently reduce a deficit, but it would not benefit the corporate and monied interests, who benefit from the current corporate welfare programs, financing the deficit hawk politicians.
The Deficit Commission proposals, which will not receive enough Commission votes to be recommended, are ill conceived and antithetical to the free market principles of Adam Smith. The proposals would continue to promote financial bubbles and competitive inequality. The present Tax Cut proposed law (since passed) runs the risk of not serving public needs but rather supporting the ability of private oligopolies to dominate state policy making against the interests of the people. Investment, targeted efficient expenditures, and a return to full employment are the quickest ways to economic recovery and deficit and debt reduction.
An IMF working paper entitled "Inequality, Leverage, and Crises" has been creating quite a stir in economic circles with its analysis of a comparative growth of income and wealth inequality in the years preceding both the Great Depression and this most recent financial crisis directly contributed to causing both economic crises. Consumption inequality increased the need for financial services. With the growth of the financial sector with wealthy saving, leverage increased without prospect of recovery of household incomes and the bargaining power of lower and middle class were limited decreasing demand and increasing household default. Economists are amazed that a paper on income and wealth inequality showing the importance of household bargaining power as necessary for increased demand and growth is coming from the IMF. I was more impressed with the study of leverage and income inequality, because they seem to have a direct relationship with financial bubbles and crises which in effect concentrate more power in the financial elite and diminish the power and numbers of the middle class. Without a strong middle class a republican democracy is not sustainable.
Along the same lines a new NBER paper, "Financial Crises, Credit Booms, and External Imbalances: 140 Years of Lessons", shows credit growth (leverage) -- not current account balances -- generates the best predictive signals of impending financial instability.
A broad review of prices shows significant disinflationary trends and why the Fed is worried about deflation. Over a sixth of consumer spending is on goods and services for which the prices are falling and three-fourths on goods and services for which prices have slowed. A relatively high level of these disinflationary trends is located in goods and services which make up core inflation. Deflationary and disinflationary pressures are relatively large in historical terms.
The U.S. Treasury Department solicited an legal opinion it had no legal need to request to lend credence to the position of the Treasury Department that it did not want to (and will not) use TARP funds to help borrowers facing foreclosure despite having the "extraordinary" power within TARP to do whatever is necessary to protect housing values, home ownership, and economic growth. Evidently, it is more important to protect banks than home owners during depressed prices. The banks foreclosure mess and frauds have revealed just how financially vulnerable the banks really are and they are using that weakness to blackmail and co-opt the government into looking the other way. To further silence critics and advocates of due process, lawsuits are being filed against foreclosure defense attorneys to exhaust their time and money. Reports of threats on attorneys and their families are also circulating.
An MBIA lawsuit against Morgan Stanley and its mortgage servicer over a group of second liens which were rate AAA it insured and for which MBIA has already paid $70 million in claims. What is interesting about this lawsuit is a further claim that Morgan Stanley's servicers has failed to charge off these second liens after 180 days as required by the servicing agreement. Banks do not want to charge off loan assets and reduce their capital ratio as is witnessed by other reports that banks are holding foreclosed homes on their books at full price rather than sell them for less and not taking any action of any kind against high income home owners (with large mortgages) who have not paid their mortgage payments (some are over $20,000 per month) for over a year.
We have reported on numerous occasions how banks "doctor" their income and balance sheets to the point that no reasonable investor can depend on their financial representations. The Bank of New York serves as a good example in how it uses "income from continuing operations" as its preferred public figure, because it has change the definition and construct of "income from continuing operations" for at least each of the last three years to make its operations look better.
While economic news has been playing up the increase in household net worth, if you look at debt and the deleveraging process, which has been on-going on the household level, you will see that households need to shed another $2.5 trillion in debt to return to 2002 levels.
Proper investing is about having a macroeconomic view and applying it to disciplined, rule based, fact driven investing. Given the current national balance sheet recession and high unemployment and global economies, buy and hold investing is more difficult than short term investing where you limit your losses and lock your gains in.
The NFIB small business survey for December gained 1.5 points in November (up 2.7 in October) to 93.2 but is still in recession territory with no evidence of a surge. Sales fell 2 points to <15>. Reports of positive earnings fell 4 points to <30>. It is still all about sales and sales are dependent on demand which is driven by economic growth and employment.
If China were to appreciate its currency, it would long term, after managing internal rebalancing, be the beneficiary and most other countries would be losers, including the United States. The Australian economist, Bill Mitchell, took on the doctrinaire critics of China --- as in China is the problem --- and the focus on current account deficits which avoids the internal problems of an export driven economy, which has nothing to do with rather a nation is free or not but is directly related to the application, or the lack of application, of resources to internal imbalances. Economic growth is not always a piece of cake.
Bill Black delineated how U.S. systemically dangerous institutions have not been regulated and in fact have blocked being fixed; how the systemically dangerous institutions of Ireland and Iceland became so large they dominated the regulators, the economy, and their governments; how the German systemically dangerous institutions have been allowed to be self-destructive, inefficient, and to fund destructive loans to Eastern Europe and EU periphery countries as if they were a drug cartel. His conclusion is systemically dangerous institutions are too big to regulate. This is why they need, in my opinion, to be broken up --- no matter how large or small they appear --- until the resulting units are responsive to proper risk management and regulation designed to identify systemic danger.
Bill Black has also recently written about how the deregulatory process (desupervision) of the Bank of England and its junking of the Financial Services Agency is sowing the seeds of the next UK financial crisis. The BBC economics editor, Stephanie Flanders, has written the UK recent GDP numbers may be implying the economy is stronger than it really is, because construction has accounted for 40% of the GDP growth while only comprising 6% of the economy. Construction output figures indicate it is growing at an annualized rate of 27% since April but the employment figures for construction have not risen. This would appear to be inconsistent and indicate something is wrong with the data. The UK has recently had some very notable revisions of economic data. Is more forthcoming? Meanwhile Parliament approved substantial educational fee hikes which have been the subject of demonstrations and riots. These anti-austerity UK demonstrations are just a small part of the demonstrations going on across Europe.
During this week ending the 11th of December, Germany continued to reject an expanded bailout mechanism. Germany and France both declared they would not support the concept of a European bond, despite EU proposal by Tremonti and Juncker. Wolfgang Munchau has commented in an analysis that the longer an E-bond is put off the bigger the crisis will become. With the debt scheduled to be paid by banks in 2011, European banks will be subject to challenges in filling big gaps beyond just winning the confidence of bond and equity investors and beyond the borders of Spain and Italy, in both of which the banks are not as strongly capitalized as they should be. Italy has found European collateral guarantees in interbank lending to be so successful they began there own before the European version expired.
The bottom line of austerity, in a country which does not have its own currency, is if you are left with only internal devaluation of wages and prices to spur the economy then you are setting up the necessity to reduce debt which can only be done by restructuring debt.
As the balance sheets of Ireland's banks became more apparent, they were facing further downgrades by the rating agencies and Ireland again iterated they could be for sell to sovereign wealth funds as the value of the euro deteriorated. The reality was that the Irish banks were being sustained by loans from the Irish central Bank which were also coming from the European Central Bank to the point where the central banks exposure were at trigger points and even the most ardent proponents of European Union economic austerity were questioning whether a bailout, which had become necessary, was being constructed in the best interests of Ireland. Yet, with the imminent bailout, AIB (Allied Irish Bank), which is one of the two more solvent banks in Ireland, attempted to hurriedly make 40 million euro in bonuses at a bank whose value was 540 million euro. Banks worldwide just do not get it.
The current eurozone troubles and Germany's failure to commit to common goals has had some observers, such as Marshall Auerback, theorizing what would happen if Germany left the eurozone. It would create a strong Deutschmark which, however, would not be a reserve currency. It would save the German banks but at the cost of its private household sector. It would cause a trade shock within the eurozone as well as the world and lead to a drop of German exports, a dramatic slowing of economic growth, and a German budget deficit.
Bill Mitchell lambastes the European Central Bank boss, Trichet, for Trichet's ardent defense of austerity fiscal policies and his attempt to blame the current European economic problems on poor fiscal policy discipline of member nations, when the current crisis has been caused by an aggregate demand shock which exposed the flaws inherent in the lack of a fiscal mechanism within the European Monetary Union. Mitchell questions why a blind eye has been turned to the criminal and/or incompetent behavior of individuals within the financial sector, why more austerity is demanded when it will depress growth, and why there is continued reliance on exports for growth which cannot be sustained or adequately developed. In doing so, Mitchell asks who is going to pay for the economic hardship and lost opportunity of those who did not cause this crisis while those who did cause it get away scot-free. These denials of the causes of the current financial crisis will only lead directly to the next financial crisis.
Pragmatic Capitalist points out that the European problems are indicative of the early stages of crisis, and not the later stages of crisis, as the result of denying there is a problem, denying there is a big problem, and denying the problem has anything to do with us, which characterize the three stages of delusion. The ESFS emergency mechanism is flawed and invites speculative attack. Simply raising more funds for an expanded ESFS will not be enough. Pragmatic Capitalist draws comparisons to the current European crisis and the 1997 Russian currency crisis which expanded into the Asian Financial Crisis. To solve the problems, Pragmatic Capitalist sees four options 1)Marshall Plan II, 2) Versailles Treaty II, 3) quantitative easing, or 4) the Icelandic option. Of the four, Pragmatic Capitalist sees the first option as the best, because it would provide investment consistent with the development needs of each country, such as improved shipping ports in Greece to enable it to become a transportation hub between Europe and Africa and the Middle East, and such investment in the peripheral countries would also provide long-term benefits to countries like Germany.
I have long been a proponent of targeted investment as a means of promoting economic growth and correcting imbalances long-term within the eurozone.
Bill Mitchell discussed the importance of information in making informed decisions as investors and citizens. As such, censorship of information, whether in China or the United States, is detrimental to informed participation in government, a denial of access to information, and a denial of freedom in which government is limited by necessity to be agents of the people and not our masters. His discussion used the framing of information and public opinion in Europe as an example of how the European Monetary Union has been sold and is being defended by an elite who are not serving the best interests of citizens of the respective member nations. His discussion then moves on to how the corrupt private financial sector in the United States is being protected and rewarded rather than being forced to confront the consequences of financial and foreclosure fraud as well as continued business conduct which poses a systemically dangerous financial risk to the world, while the current policy debate moves in the exact opposite direction away from the people.
John Hussman, in his weekly commentary on December 6th, said bonds do not warrant an extension of investment duration, the intermediate risks of gold are elevated, and the market conditions of stocks is continuing to deteriorate. He continues to remain defensive, because stocks are overvalued, overbought, and overbullish combined with rising yield bond pressures. He indicates one market investing rule is to not fight the market and he has revisited his different proprietary "climate" conditions to be more responsive and accept moderate, transitory exposures to market fluctuations. If one looks at the projected 17 year annual return of the S&P 500 based on an average of three models he uses (forward operating earnings adjusted for cyclical margins, normalized earnings, and yields), the implied risk premium is only slightly over 1%. Prior to the 1990's bubble it was closer to 5%. Consequently, equity investors are accepting a duration which is three times that of a 30 year Treasury.
In a criticism of the Bernanke at the Fed, Geithner at the U.S. Treasury, and Trichet at the ECB, Hussman said, "We are allowing 99% of the world to accept budget cuts and austerity in order to defend bondholders from taking losses or having to accept debt restructuring. When bondholders lend money to a financial company or to a country, at a spread over the yield available safe debt, they are explicitly accepting the risk that the bet will not work out, and that they may lose money in the event of a restructuring. When government policy at every level focuses on making bondholders whole, then government policy at every level focuses equivalently on protecting the inefficient and dangerous misallocation of capital."
In discussing Social Security, Hussman said, as I have written, "My personal view is that the Social Security tax rate should be significantly lowered, but should apply to all income, wage and non-wage, while at the same time the income tax should be flattened. People at higher incomes would have a slightly higher total tax burden in the end, but lower marginal rates that would encourage work and discourage inefficient sheltering of income."
Hussman points out there are natural and useful counter cyclical argument to deficits that serves as automatic stabilizers. Consequently, "Rather than targeting a balanced budget in the midst of a deep economic downturn (still more than 6% below potential GDP), we should be focused on policies that could reasonably be expected to achieve a deficit of between 0-1.5% of GDP at the point where GDP is again operating at potential. While I certainly think there is room to integrate unemployment compensation, earned income tax credits and Social Security in a way that strengthens the incentive for part-time work (I have friends with special needs who would lose all benefits if they worked even a few hours a week), I also believe that extending unemployment compensation is the smallest of our budget problems, and is a necessary response in an economy whose problems have been largely brought on by people at the highest income levels (particularly in the banking sector and Wall Street)." Hussman concludes by saying, "The public is being abused for the sake of protecting bondholders that lent at a spread. This protection should end, or the resulting "austerity" will either weaken our defense or remove our automatic stabilizers."
On a personal investment level, I have been communicating current finance and economic research on the need to consider having the higher wage earning spouse waiting until full Social Security age to file for benefits and delay until age 70. This option, among other Social Security filing options, needs to be seriously considered as the economic benefits can be substantial, particularly for the surviving spouse. Evidently, more and more people have decided change their filing decision and delay until 70 and pay back benefits already received without interest. This has caused the Social Security Administration to change the rules and only allow the payback of benefits when electing to change to delayed benefits. Under the new rules, the claim for change of the beginning of benefits and delay can only be done within the first twelve months of their first Social Security check. The withdrawal is limited to one per lifetime. The election to suspend benefits is now only limited to future months with no payback of past benefits. This makes it all the more important that the different Social security options be evaluated prior to the age of 62.
Market: 2 banks failed = 151 for year; the unofficial problem bank list is 919.
DOW/Volume NASDAQ/Volume
Mon: <19.90>/down 11.4% 3.46/down 7.7%
Tue: <3.03>/up 72.5% 3.57/up 14.8%
Wed: 13.32/down 20.3% 10.67/down 7.2%
Thu: <2.42>/down 8.7% 7.51/up 7.6%
Fri: 40.26/down 3.5% 20.87/down 8.7%
Total 28.23 46.08
Mon: Oil up 19 cents to $89.38; Dollar stronger but weaker against the yen; Germany rejects larger European rescue fund; banks and discount retailers are down.
Tue: Oil down 69 cents to 88.69; Dollar stronger but weaker against the pound; much larger Dow volume is the result of institutional selling; Dow was up 1.1% during the day but sold off in the last 75 minutes in high volume.
Wed: Oil down 41 cents to 88.28; Dollar weaker but stronger against the yen; Treasury yields up on tax cut deficit fears; market see-sawed up/down; oil supplies were down 3.8 million barrels, gas supplies were up 3.8 million barrels, and distillate supplies were up 2.2 million barrels on the same day the price of gasoline locally jumped up 20 cents per gallon.
Thu: Oil up 9 cents to 88.37; Dollar stronger but weaker against the yen; 10 year Treasury yields fell 6 bps to 3.21%; auto parts, food companies, and financials led in mixed action; weekly jobless claims were down 17,000 to 421,000, 4 week moving average was down 4000 to 427,500, and continuing claims were down 191,000 to 4,086,000.
Fri: Oil down 58 cents to 87.79; Dollar stronger but weaker against the pound; volume fell across the board; 10 year Treasuries were up 31 bps to 3.33%.
United States: The U.S. Senate is considering stronger oversight of the Pension Benefit Guaranty Corporation as its deficit reaches $23 billion. A recent Inspector General report raised questions about the ability of the PBGC to ability to cope with a new financial crisis. The Employee Benefits Security Administration released a proposed rule to require all defined benefit pension plans to report annual funding to the EBSA.
Bank of America has told regulators it has raised enough capital this year to qualify for permission to make its last TARP payback.
New $100 bills with high tech security features are a printer's nightmare with 30% or more of the bills unusable as the paper folds during the printing process. The printing has been halted as government is faced with going through $100 billion already printed by hand. It would have been the first bill with Geithner's signature.
HSBC is being sued by the Madoff trustee for $9 billion alleging the bank had warning signs as early as 2001 and still remained a prime provider of feeder funds to Madoff.
Gasoline retail price is highest in 2 years (since mid October 2008).
The federal insider trading investigation has been ramped up.
Home Depot issued FY 2010 guidance revising net income projections to $1.97/share up from $1.94 and now expects revenue to be up 2.3% from prior estimate of 2.2%.
The Federal government is pressuring Fannie Mae and Freddie Mac to join the government program to reduce mortgage balances where borrowers owe more than the value of their home. They have been reluctant to do so, particularly if borrowers are still making payments. If they participate the written down mortgages could be handed off to the FHA just as private banks, who participate, can.
Bank of America agreed to pay $137 million in restitution for municipal bond bid rigging.
U.S. Treasury sold 2.4 billion shares of Citi at $4.35 each with the last share sold on Tuesday.
Citi hired former Obama Administration Budget Director, Peter Orzig, to be vice-chairman of its investment bank division.
Morgan Stanley has been sued by MBIA over claims made by the bank regarding MBS it sold; "made false representations regarding the underwriting standards". MBIA may be considered indemnified by the Pooling and Servicing Agreement and Morgan Stanley may not have set aside reserves for this purpose. The pool is composed of approximately 5000 securities rated AAA, which are subordinated-lien residential mortgages upon which MBIA has already paid $71million in unreimbursed claims.
The U.S. trade deficit went down to $38.7 billion in October from $44.6 billion in September (expected 43.6 billion); exports were up $4.9 billion and imports were down $900 million.
U.S. household net worth was up 2.2% Q3 as borrowing and credit card use fell.
Foreign central banks holdings of U.S. securities were down $5.68 billion for the week ending December 8th; Treasury holdings were down $2.87 billion; mortgage securities holdings were down $2.81 billion.
U.S. Treasury may be planning to sell approximately $15 billion of AIG shares in 2011 which would cut its stake 20% from 92.4%.
GE is raising its dividend 2 cents to 14 cents (17% up) for the second time this year (2 cents in July).
TJX (TJMaxx, Marshalls) will cut 4400 jobs as it shutters 71 A.J. Wright stores and converts 91 stores to either those two formats or the Homewoods format.
Bank of America refiled 16,000 foreclosures this week in both judicial approval and non-judicial states.
Mortgage rates hit a six month high of 4.61%.
According to the Fed, household real estate values declined $684 billion in Q3
U.S. wholesale inventory in October was up 1.9% --- expected up 0.8% ---(September revised to up 2.1%) and October wholesale sales were up 2.2%.
ECRI Weekly Leading Index rose to <1.5> from <2.4>.
Tobin's Q Ratio has moved into nosebleed territory with the market overvalued by 59% using the arithmetic adjusted method and 72% using the geometric adjusted method.
U.S. Treasury auctions:
3 year Treasury, $32 billion, yield .862%, bid to cover 2.91, foreign 36.7%, direct 18.0%.
10 year Treasury, $21 billion, yield 3.340%, bid to cover 2.92, foreign 44.4%, direct 11.4
30 year Treasury, $13 billion, yield 4.410%, bid to cover 2.75, foreign 49.5%, direct 8.13%.
International: Bank of Canada kept its interest rate at 1% citing weak exports and global risks such as the European Monetary Union. Bank of Canada said the European crisis could have adverse effect on other countries including Canada and the risks to Canada's financial system are up in the last six months.
S&P raised the debt rating of Latvia one step to BB+ with a stable outlook.
Moody's cut Hungary's debt rating one notch to just above junk and warned of more cuts if Hungary's budget deficit is not reduced. Hungary rejected austerity and intends to impose taxes on bank and other businesses as well as tap pensions.
German exports in October were down 1.1% with imports up 0.3% to a record high of 72.6 euro.
German production was up 2.9% in October (down 1% in September) -- expected up 1%; output was up 11.7% adjusted for days worked; factory orders were up 1.6% in October.
Russia and the European Union are near a bilateral trade agreement which may pave the way for Russia to join the WTO.
The Australian Central Bank held interest rates at 4.5%.
Australian employment was up 54,600 in November exceeding the estimate; unemployment was down to 5.2% (5.4% in October); the participation rate was 66.1% which is a record; employment is over 11,000,000 for the first time. For a more in-depth analysis make sure you review the Bill Mitchell comments on Australian unemployment linked to above in this weekly commentary.
New EU bank stress tests on 91 banks have been ordered for July.
Japanese GDP Q3 was revised to up 1.1%. Weak economic data indicates Q4 will contract to an estimated <0.1%>. Annualized growth is at 4.5%; capital spending Q3 is up 1.3%; personal consumption is up 1.2%.
Bank of England kept interest rates at 0.5% and made no change in monetary policy, because it wants to wait and see the effect of the government's austerity program on economic growth next year.
Fitch downgraded Ireland's debt rating three notches to BBB+.
Ireland is planning a 90% tax on banker bonuses.
China raised banks required reserves for the third time in a month by 50 bps to 19% for its largest banks.
China's auto sales were up 27% in November.
Bank of Korea kept its interest rate at 2.5%.
Britain's trade deficit increased 1.6% in October, which was unexpected; imports hit a record high.
UK producer prices were up 3.9% in November vs year ago, which was less than expected.
Canada's trade deficit was down 39% ($ 0.6 billion to $1.7 billion) in October (more than expected) as exports of copper and precious metals rose.
French industrial production was down 0.8% in October, which was more than expected; Italy's was down 0.1% (down 2.1% in September); Germany's was up 2.9%.
Spain began a 5 year $111 billion program to make its industries more competitive.
Print Page
Consumer credit rebounded off its 2009 lows, but a closer inspection shows an increase of student loan debt has increased 80% vs year ago expanding $120 billion as the result of the Department of Education stepping in and buying privately originated student loans meant to be securitized but which could not be marketed starting in 2008 when the credit market dried up. Since then, this program has been expanded and may be totally distorting consumer credit in 2010.
The Cleveland Federal Reserve, in a report, visually shows the meaning of a "Jobless Recovery" after an 18 month Recession, which average 10 months historically, in which payroll employment is still 5.4 points below the pre-Recession peak after 35 months (usually takes 23 months) and only adding a average of 86,000 jobs per month since the beginning of 2010. In fact, the recession and continued high unemployment have had a tremendous negative impact on American families and households in which 39% of American households have been either unemployed, had negative equity in their home, or been arrears in house payments. Of long term concern is the 10% drop in employment among young workers, particularly recent college graduates facing years of lost income and lower future earnings.
Bill Mitchell took an in-depth look at Australian employment/unemployment figures for the month of November in which there was noticeable improvement but with significant remaining slack. One area of Bill Mitchell's economic concentration is employment and his observations of Australian employment and governmental policies with its aging population, of increasing underemployment among 15-24 year olds, of growing part-time employment, and of higher overall underemployment than the severe 1984 recession are relevant to the United States and many other developed countries with an aging population..
The sell off of 10 year U.S. Treasuries with yield rising to 3.3% by the 8th of December has been accompanied by increasing yields of other nation's bonds globally including the German bund. There may be market fear that future bond losses will neutralize QE2 and lead to stagflation. As of the 11th, three German bond auctions have failed. Many saw the German bond, which has been treated as a safe haven, auction failure as reason to question the U.S. Treasury auction when the bonds are not comparable. Germany does not have its own currency and is fiscally constrained and the United States fiat currency is a global reserve currency, making United States debt desirable.
As we have repeatedly reported, the comparison of U.S. states to the eurozone sovereign member nations is not legitimate. However, it continues to be used by deficit hawks. The portrayal of the Build America Bonds as a failed jobs program miring the states in debt is wrong; it was (it is being allowed to expire) a program which opened municipal bond market participation and targeted a decaying infrastructure. It was investment and economic recovery is always dependent on investment. Investment in the short term leads to deficit and debt reduction long term not the other way around. Investment leads to an increase in aggregate demand through infrastructure, research, and defense government investment spending. Those hoping and pushing for large deficit reductions will be disappointed by the resulting decline in tax revenues and increasing unemployment with demands for increased jobless benefits and increased taxes. A more efficient and fair tax system would efficiently reduce a deficit, but it would not benefit the corporate and monied interests, who benefit from the current corporate welfare programs, financing the deficit hawk politicians.
The Deficit Commission proposals, which will not receive enough Commission votes to be recommended, are ill conceived and antithetical to the free market principles of Adam Smith. The proposals would continue to promote financial bubbles and competitive inequality. The present Tax Cut proposed law (since passed) runs the risk of not serving public needs but rather supporting the ability of private oligopolies to dominate state policy making against the interests of the people. Investment, targeted efficient expenditures, and a return to full employment are the quickest ways to economic recovery and deficit and debt reduction.
An IMF working paper entitled "Inequality, Leverage, and Crises" has been creating quite a stir in economic circles with its analysis of a comparative growth of income and wealth inequality in the years preceding both the Great Depression and this most recent financial crisis directly contributed to causing both economic crises. Consumption inequality increased the need for financial services. With the growth of the financial sector with wealthy saving, leverage increased without prospect of recovery of household incomes and the bargaining power of lower and middle class were limited decreasing demand and increasing household default. Economists are amazed that a paper on income and wealth inequality showing the importance of household bargaining power as necessary for increased demand and growth is coming from the IMF. I was more impressed with the study of leverage and income inequality, because they seem to have a direct relationship with financial bubbles and crises which in effect concentrate more power in the financial elite and diminish the power and numbers of the middle class. Without a strong middle class a republican democracy is not sustainable.
Along the same lines a new NBER paper, "Financial Crises, Credit Booms, and External Imbalances: 140 Years of Lessons", shows credit growth (leverage) -- not current account balances -- generates the best predictive signals of impending financial instability.
A broad review of prices shows significant disinflationary trends and why the Fed is worried about deflation. Over a sixth of consumer spending is on goods and services for which the prices are falling and three-fourths on goods and services for which prices have slowed. A relatively high level of these disinflationary trends is located in goods and services which make up core inflation. Deflationary and disinflationary pressures are relatively large in historical terms.
The U.S. Treasury Department solicited an legal opinion it had no legal need to request to lend credence to the position of the Treasury Department that it did not want to (and will not) use TARP funds to help borrowers facing foreclosure despite having the "extraordinary" power within TARP to do whatever is necessary to protect housing values, home ownership, and economic growth. Evidently, it is more important to protect banks than home owners during depressed prices. The banks foreclosure mess and frauds have revealed just how financially vulnerable the banks really are and they are using that weakness to blackmail and co-opt the government into looking the other way. To further silence critics and advocates of due process, lawsuits are being filed against foreclosure defense attorneys to exhaust their time and money. Reports of threats on attorneys and their families are also circulating.
An MBIA lawsuit against Morgan Stanley and its mortgage servicer over a group of second liens which were rate AAA it insured and for which MBIA has already paid $70 million in claims. What is interesting about this lawsuit is a further claim that Morgan Stanley's servicers has failed to charge off these second liens after 180 days as required by the servicing agreement. Banks do not want to charge off loan assets and reduce their capital ratio as is witnessed by other reports that banks are holding foreclosed homes on their books at full price rather than sell them for less and not taking any action of any kind against high income home owners (with large mortgages) who have not paid their mortgage payments (some are over $20,000 per month) for over a year.
We have reported on numerous occasions how banks "doctor" their income and balance sheets to the point that no reasonable investor can depend on their financial representations. The Bank of New York serves as a good example in how it uses "income from continuing operations" as its preferred public figure, because it has change the definition and construct of "income from continuing operations" for at least each of the last three years to make its operations look better.
While economic news has been playing up the increase in household net worth, if you look at debt and the deleveraging process, which has been on-going on the household level, you will see that households need to shed another $2.5 trillion in debt to return to 2002 levels.
Proper investing is about having a macroeconomic view and applying it to disciplined, rule based, fact driven investing. Given the current national balance sheet recession and high unemployment and global economies, buy and hold investing is more difficult than short term investing where you limit your losses and lock your gains in.
The NFIB small business survey for December gained 1.5 points in November (up 2.7 in October) to 93.2 but is still in recession territory with no evidence of a surge. Sales fell 2 points to <15>. Reports of positive earnings fell 4 points to <30>. It is still all about sales and sales are dependent on demand which is driven by economic growth and employment.
If China were to appreciate its currency, it would long term, after managing internal rebalancing, be the beneficiary and most other countries would be losers, including the United States. The Australian economist, Bill Mitchell, took on the doctrinaire critics of China --- as in China is the problem --- and the focus on current account deficits which avoids the internal problems of an export driven economy, which has nothing to do with rather a nation is free or not but is directly related to the application, or the lack of application, of resources to internal imbalances. Economic growth is not always a piece of cake.
Bill Black delineated how U.S. systemically dangerous institutions have not been regulated and in fact have blocked being fixed; how the systemically dangerous institutions of Ireland and Iceland became so large they dominated the regulators, the economy, and their governments; how the German systemically dangerous institutions have been allowed to be self-destructive, inefficient, and to fund destructive loans to Eastern Europe and EU periphery countries as if they were a drug cartel. His conclusion is systemically dangerous institutions are too big to regulate. This is why they need, in my opinion, to be broken up --- no matter how large or small they appear --- until the resulting units are responsive to proper risk management and regulation designed to identify systemic danger.
Bill Black has also recently written about how the deregulatory process (desupervision) of the Bank of England and its junking of the Financial Services Agency is sowing the seeds of the next UK financial crisis. The BBC economics editor, Stephanie Flanders, has written the UK recent GDP numbers may be implying the economy is stronger than it really is, because construction has accounted for 40% of the GDP growth while only comprising 6% of the economy. Construction output figures indicate it is growing at an annualized rate of 27% since April but the employment figures for construction have not risen. This would appear to be inconsistent and indicate something is wrong with the data. The UK has recently had some very notable revisions of economic data. Is more forthcoming? Meanwhile Parliament approved substantial educational fee hikes which have been the subject of demonstrations and riots. These anti-austerity UK demonstrations are just a small part of the demonstrations going on across Europe.
During this week ending the 11th of December, Germany continued to reject an expanded bailout mechanism. Germany and France both declared they would not support the concept of a European bond, despite EU proposal by Tremonti and Juncker. Wolfgang Munchau has commented in an analysis that the longer an E-bond is put off the bigger the crisis will become. With the debt scheduled to be paid by banks in 2011, European banks will be subject to challenges in filling big gaps beyond just winning the confidence of bond and equity investors and beyond the borders of Spain and Italy, in both of which the banks are not as strongly capitalized as they should be. Italy has found European collateral guarantees in interbank lending to be so successful they began there own before the European version expired.
The bottom line of austerity, in a country which does not have its own currency, is if you are left with only internal devaluation of wages and prices to spur the economy then you are setting up the necessity to reduce debt which can only be done by restructuring debt.
As the balance sheets of Ireland's banks became more apparent, they were facing further downgrades by the rating agencies and Ireland again iterated they could be for sell to sovereign wealth funds as the value of the euro deteriorated. The reality was that the Irish banks were being sustained by loans from the Irish central Bank which were also coming from the European Central Bank to the point where the central banks exposure were at trigger points and even the most ardent proponents of European Union economic austerity were questioning whether a bailout, which had become necessary, was being constructed in the best interests of Ireland. Yet, with the imminent bailout, AIB (Allied Irish Bank), which is one of the two more solvent banks in Ireland, attempted to hurriedly make 40 million euro in bonuses at a bank whose value was 540 million euro. Banks worldwide just do not get it.
The current eurozone troubles and Germany's failure to commit to common goals has had some observers, such as Marshall Auerback, theorizing what would happen if Germany left the eurozone. It would create a strong Deutschmark which, however, would not be a reserve currency. It would save the German banks but at the cost of its private household sector. It would cause a trade shock within the eurozone as well as the world and lead to a drop of German exports, a dramatic slowing of economic growth, and a German budget deficit.
Bill Mitchell lambastes the European Central Bank boss, Trichet, for Trichet's ardent defense of austerity fiscal policies and his attempt to blame the current European economic problems on poor fiscal policy discipline of member nations, when the current crisis has been caused by an aggregate demand shock which exposed the flaws inherent in the lack of a fiscal mechanism within the European Monetary Union. Mitchell questions why a blind eye has been turned to the criminal and/or incompetent behavior of individuals within the financial sector, why more austerity is demanded when it will depress growth, and why there is continued reliance on exports for growth which cannot be sustained or adequately developed. In doing so, Mitchell asks who is going to pay for the economic hardship and lost opportunity of those who did not cause this crisis while those who did cause it get away scot-free. These denials of the causes of the current financial crisis will only lead directly to the next financial crisis.
Pragmatic Capitalist points out that the European problems are indicative of the early stages of crisis, and not the later stages of crisis, as the result of denying there is a problem, denying there is a big problem, and denying the problem has anything to do with us, which characterize the three stages of delusion. The ESFS emergency mechanism is flawed and invites speculative attack. Simply raising more funds for an expanded ESFS will not be enough. Pragmatic Capitalist draws comparisons to the current European crisis and the 1997 Russian currency crisis which expanded into the Asian Financial Crisis. To solve the problems, Pragmatic Capitalist sees four options 1)Marshall Plan II, 2) Versailles Treaty II, 3) quantitative easing, or 4) the Icelandic option. Of the four, Pragmatic Capitalist sees the first option as the best, because it would provide investment consistent with the development needs of each country, such as improved shipping ports in Greece to enable it to become a transportation hub between Europe and Africa and the Middle East, and such investment in the peripheral countries would also provide long-term benefits to countries like Germany.
I have long been a proponent of targeted investment as a means of promoting economic growth and correcting imbalances long-term within the eurozone.
Bill Mitchell discussed the importance of information in making informed decisions as investors and citizens. As such, censorship of information, whether in China or the United States, is detrimental to informed participation in government, a denial of access to information, and a denial of freedom in which government is limited by necessity to be agents of the people and not our masters. His discussion used the framing of information and public opinion in Europe as an example of how the European Monetary Union has been sold and is being defended by an elite who are not serving the best interests of citizens of the respective member nations. His discussion then moves on to how the corrupt private financial sector in the United States is being protected and rewarded rather than being forced to confront the consequences of financial and foreclosure fraud as well as continued business conduct which poses a systemically dangerous financial risk to the world, while the current policy debate moves in the exact opposite direction away from the people.
John Hussman, in his weekly commentary on December 6th, said bonds do not warrant an extension of investment duration, the intermediate risks of gold are elevated, and the market conditions of stocks is continuing to deteriorate. He continues to remain defensive, because stocks are overvalued, overbought, and overbullish combined with rising yield bond pressures. He indicates one market investing rule is to not fight the market and he has revisited his different proprietary "climate" conditions to be more responsive and accept moderate, transitory exposures to market fluctuations. If one looks at the projected 17 year annual return of the S&P 500 based on an average of three models he uses (forward operating earnings adjusted for cyclical margins, normalized earnings, and yields), the implied risk premium is only slightly over 1%. Prior to the 1990's bubble it was closer to 5%. Consequently, equity investors are accepting a duration which is three times that of a 30 year Treasury.
In a criticism of the Bernanke at the Fed, Geithner at the U.S. Treasury, and Trichet at the ECB, Hussman said, "We are allowing 99% of the world to accept budget cuts and austerity in order to defend bondholders from taking losses or having to accept debt restructuring. When bondholders lend money to a financial company or to a country, at a spread over the yield available safe debt, they are explicitly accepting the risk that the bet will not work out, and that they may lose money in the event of a restructuring. When government policy at every level focuses on making bondholders whole, then government policy at every level focuses equivalently on protecting the inefficient and dangerous misallocation of capital."
In discussing Social Security, Hussman said, as I have written, "My personal view is that the Social Security tax rate should be significantly lowered, but should apply to all income, wage and non-wage, while at the same time the income tax should be flattened. People at higher incomes would have a slightly higher total tax burden in the end, but lower marginal rates that would encourage work and discourage inefficient sheltering of income."
Hussman points out there are natural and useful counter cyclical argument to deficits that serves as automatic stabilizers. Consequently, "Rather than targeting a balanced budget in the midst of a deep economic downturn (still more than 6% below potential GDP), we should be focused on policies that could reasonably be expected to achieve a deficit of between 0-1.5% of GDP at the point where GDP is again operating at potential. While I certainly think there is room to integrate unemployment compensation, earned income tax credits and Social Security in a way that strengthens the incentive for part-time work (I have friends with special needs who would lose all benefits if they worked even a few hours a week), I also believe that extending unemployment compensation is the smallest of our budget problems, and is a necessary response in an economy whose problems have been largely brought on by people at the highest income levels (particularly in the banking sector and Wall Street)." Hussman concludes by saying, "The public is being abused for the sake of protecting bondholders that lent at a spread. This protection should end, or the resulting "austerity" will either weaken our defense or remove our automatic stabilizers."
On a personal investment level, I have been communicating current finance and economic research on the need to consider having the higher wage earning spouse waiting until full Social Security age to file for benefits and delay until age 70. This option, among other Social Security filing options, needs to be seriously considered as the economic benefits can be substantial, particularly for the surviving spouse. Evidently, more and more people have decided change their filing decision and delay until 70 and pay back benefits already received without interest. This has caused the Social Security Administration to change the rules and only allow the payback of benefits when electing to change to delayed benefits. Under the new rules, the claim for change of the beginning of benefits and delay can only be done within the first twelve months of their first Social Security check. The withdrawal is limited to one per lifetime. The election to suspend benefits is now only limited to future months with no payback of past benefits. This makes it all the more important that the different Social security options be evaluated prior to the age of 62.
Market: 2 banks failed = 151 for year; the unofficial problem bank list is 919.
DOW/Volume NASDAQ/Volume
Mon: <19.90>/down 11.4% 3.46/down 7.7%
Tue: <3.03>/up 72.5% 3.57/up 14.8%
Wed: 13.32/down 20.3% 10.67/down 7.2%
Thu: <2.42>/down 8.7% 7.51/up 7.6%
Fri: 40.26/down 3.5% 20.87/down 8.7%
Total 28.23 46.08
Mon: Oil up 19 cents to $89.38; Dollar stronger but weaker against the yen; Germany rejects larger European rescue fund; banks and discount retailers are down.
Tue: Oil down 69 cents to 88.69; Dollar stronger but weaker against the pound; much larger Dow volume is the result of institutional selling; Dow was up 1.1% during the day but sold off in the last 75 minutes in high volume.
Wed: Oil down 41 cents to 88.28; Dollar weaker but stronger against the yen; Treasury yields up on tax cut deficit fears; market see-sawed up/down; oil supplies were down 3.8 million barrels, gas supplies were up 3.8 million barrels, and distillate supplies were up 2.2 million barrels on the same day the price of gasoline locally jumped up 20 cents per gallon.
Thu: Oil up 9 cents to 88.37; Dollar stronger but weaker against the yen; 10 year Treasury yields fell 6 bps to 3.21%; auto parts, food companies, and financials led in mixed action; weekly jobless claims were down 17,000 to 421,000, 4 week moving average was down 4000 to 427,500, and continuing claims were down 191,000 to 4,086,000.
Fri: Oil down 58 cents to 87.79; Dollar stronger but weaker against the pound; volume fell across the board; 10 year Treasuries were up 31 bps to 3.33%.
United States: The U.S. Senate is considering stronger oversight of the Pension Benefit Guaranty Corporation as its deficit reaches $23 billion. A recent Inspector General report raised questions about the ability of the PBGC to ability to cope with a new financial crisis. The Employee Benefits Security Administration released a proposed rule to require all defined benefit pension plans to report annual funding to the EBSA.
Bank of America has told regulators it has raised enough capital this year to qualify for permission to make its last TARP payback.
New $100 bills with high tech security features are a printer's nightmare with 30% or more of the bills unusable as the paper folds during the printing process. The printing has been halted as government is faced with going through $100 billion already printed by hand. It would have been the first bill with Geithner's signature.
HSBC is being sued by the Madoff trustee for $9 billion alleging the bank had warning signs as early as 2001 and still remained a prime provider of feeder funds to Madoff.
Gasoline retail price is highest in 2 years (since mid October 2008).
The federal insider trading investigation has been ramped up.
Home Depot issued FY 2010 guidance revising net income projections to $1.97/share up from $1.94 and now expects revenue to be up 2.3% from prior estimate of 2.2%.
The Federal government is pressuring Fannie Mae and Freddie Mac to join the government program to reduce mortgage balances where borrowers owe more than the value of their home. They have been reluctant to do so, particularly if borrowers are still making payments. If they participate the written down mortgages could be handed off to the FHA just as private banks, who participate, can.
Bank of America agreed to pay $137 million in restitution for municipal bond bid rigging.
U.S. Treasury sold 2.4 billion shares of Citi at $4.35 each with the last share sold on Tuesday.
Citi hired former Obama Administration Budget Director, Peter Orzig, to be vice-chairman of its investment bank division.
Morgan Stanley has been sued by MBIA over claims made by the bank regarding MBS it sold; "made false representations regarding the underwriting standards". MBIA may be considered indemnified by the Pooling and Servicing Agreement and Morgan Stanley may not have set aside reserves for this purpose. The pool is composed of approximately 5000 securities rated AAA, which are subordinated-lien residential mortgages upon which MBIA has already paid $71million in unreimbursed claims.
The U.S. trade deficit went down to $38.7 billion in October from $44.6 billion in September (expected 43.6 billion); exports were up $4.9 billion and imports were down $900 million.
U.S. household net worth was up 2.2% Q3 as borrowing and credit card use fell.
Foreign central banks holdings of U.S. securities were down $5.68 billion for the week ending December 8th; Treasury holdings were down $2.87 billion; mortgage securities holdings were down $2.81 billion.
U.S. Treasury may be planning to sell approximately $15 billion of AIG shares in 2011 which would cut its stake 20% from 92.4%.
GE is raising its dividend 2 cents to 14 cents (17% up) for the second time this year (2 cents in July).
TJX (TJMaxx, Marshalls) will cut 4400 jobs as it shutters 71 A.J. Wright stores and converts 91 stores to either those two formats or the Homewoods format.
Bank of America refiled 16,000 foreclosures this week in both judicial approval and non-judicial states.
Mortgage rates hit a six month high of 4.61%.
According to the Fed, household real estate values declined $684 billion in Q3
U.S. wholesale inventory in October was up 1.9% --- expected up 0.8% ---(September revised to up 2.1%) and October wholesale sales were up 2.2%.
ECRI Weekly Leading Index rose to <1.5> from <2.4>.
Tobin's Q Ratio has moved into nosebleed territory with the market overvalued by 59% using the arithmetic adjusted method and 72% using the geometric adjusted method.
U.S. Treasury auctions:
3 year Treasury, $32 billion, yield .862%, bid to cover 2.91, foreign 36.7%, direct 18.0%.
10 year Treasury, $21 billion, yield 3.340%, bid to cover 2.92, foreign 44.4%, direct 11.4
30 year Treasury, $13 billion, yield 4.410%, bid to cover 2.75, foreign 49.5%, direct 8.13%.
International: Bank of Canada kept its interest rate at 1% citing weak exports and global risks such as the European Monetary Union. Bank of Canada said the European crisis could have adverse effect on other countries including Canada and the risks to Canada's financial system are up in the last six months.
S&P raised the debt rating of Latvia one step to BB+ with a stable outlook.
Moody's cut Hungary's debt rating one notch to just above junk and warned of more cuts if Hungary's budget deficit is not reduced. Hungary rejected austerity and intends to impose taxes on bank and other businesses as well as tap pensions.
German exports in October were down 1.1% with imports up 0.3% to a record high of 72.6 euro.
German production was up 2.9% in October (down 1% in September) -- expected up 1%; output was up 11.7% adjusted for days worked; factory orders were up 1.6% in October.
Russia and the European Union are near a bilateral trade agreement which may pave the way for Russia to join the WTO.
The Australian Central Bank held interest rates at 4.5%.
Australian employment was up 54,600 in November exceeding the estimate; unemployment was down to 5.2% (5.4% in October); the participation rate was 66.1% which is a record; employment is over 11,000,000 for the first time. For a more in-depth analysis make sure you review the Bill Mitchell comments on Australian unemployment linked to above in this weekly commentary.
New EU bank stress tests on 91 banks have been ordered for July.
Japanese GDP Q3 was revised to up 1.1%. Weak economic data indicates Q4 will contract to an estimated <0.1%>. Annualized growth is at 4.5%; capital spending Q3 is up 1.3%; personal consumption is up 1.2%.
Bank of England kept interest rates at 0.5% and made no change in monetary policy, because it wants to wait and see the effect of the government's austerity program on economic growth next year.
Fitch downgraded Ireland's debt rating three notches to BBB+.
Ireland is planning a 90% tax on banker bonuses.
China raised banks required reserves for the third time in a month by 50 bps to 19% for its largest banks.
China's auto sales were up 27% in November.
Bank of Korea kept its interest rate at 2.5%.
Britain's trade deficit increased 1.6% in October, which was unexpected; imports hit a record high.
UK producer prices were up 3.9% in November vs year ago, which was less than expected.
Canada's trade deficit was down 39% ($ 0.6 billion to $1.7 billion) in October (more than expected) as exports of copper and precious metals rose.
French industrial production was down 0.8% in October, which was more than expected; Italy's was down 0.1% (down 2.1% in September); Germany's was up 2.9%.
Spain began a 5 year $111 billion program to make its industries more competitive.
Print Page
Subscribe to:
Posts (Atom)
Posts
