Leftovers - Radio Show 1/16/2010

The Baseline Scenario had a post in which Kevin Drum is asking why President Obama has not, with respect to financial regulatory reform, let us know what side he is on.  James Kwak notes there is no powerful lobbyist support for financial regulatory reform, unless you count Elizabeth Warren who is the Chairperson of the TARP Congressional Oversight panel.  Drum cites FDR's 1936 gauntlet to the bankers and Kwak says it is not too late for Obama to pick up the mantle.

President Obama has three problems in seeking financial regulatory reform and a sustainable economic recovery in which there is job creation: Tim Geithner, Larry Summer, and the people who recommended them.  The economist, Randall Wray, is calling for Geithner to be replaced and a new economic team installed which recognizes: 1) banks are not facing a liquidity crisis, but are insolvent, 2) saving financial systems does not save the economy, 3) all bailouts and guarantees to financial institutions need to be unwound, and 4) a need to understand government finance.

Bill Black, who is a professor of economics and law at the same University as Wray and who has regulatory experience with the unwinding of the Savings and Loan bubble of the 90's, has an article delineating the history of the Federal Reserve's opposition to regulation despite Bernanke's recent statements.  He particularly concentrates on the Greenspan and Bernanke periods, including Bernanke's appointing an economist, Patrick Parkinson,  with no regulatory experience and who has publicly stated derivatives do not need regulation as the Fed's top regulator.

Prior to President Obama announcing a 15 basis points tax on banks liabilities if they have assets of $50 billion or more and accepted TARP money, The Baseline Scenario put forward the argument for a supertax on bank bonuses.  It is expected to raise $90 billion dollars over 10 years, but TARP losses are approximately $117 billion.  While banks call it unconstitutional, others say it does not go far enough.  Some Congressmen have proposed a 50% tax on bank bonuses.  The UK and France already have a tax on bank bonuses but they assessed it wrong by making the banks pay the tax rather than the bankers.

What has not been disclosed in the vast majority of stories about the proposed bank tax is that the tax is deductible on corporate tax returns, consequently reducing the economic impact to the banks by approximately 35%.

Bernanke has been arguing that the housing bubble was not caused by low interest rates but a lack of regulation.  To that end Bernanke has engaged in a direct argument with John Taylor over the effectiveness of the Taylor Rule, which is designed to indicate the appropriate Fed target interest rate. Tyler Cowan has written on the Taylor-Bernanke argument and the failure of the Fed to critique its monetary policy. Taylor has an op-ed piece which is direct reply to Bernanke in which he criticizes the Fed's inflation forecasts and failure to develop a vigilant program for detecting bubbles.  Taylor also has his own blog.

Richard Alford, who is a former NY Fed economist, wrote an article, "Why Bernanke's Defense of Super Low Interest Rates Does Not Hold Up", argues Bernanke's definition of deflation does not hold with Bernanke's favorite  favorite inflation indicator, the PCE.  Alford believes that between 1996 and 2006, there was a fundamental mismatch between the causes of disinflation, unemployment, and the policy steps taken in response with undesirable domestic side effects.  He holds that the Fed should have listened to the many voices after 2002 warning about trade imbalances and decline in private savings.

Tom Duy in his Fed Watch says "It's Not About Interest Rates Yet" and the Fed will hold interest rates at low, rock bottom levels.  Consumers have failed to resume spending,, retail activity remains well below the trend expected in 2007, and there has been no offsetting improvements in trade balances.  The underlying rate of growth is doubtful, industrial production is improving, the reversal of unemployment is elusive, households are hobbled, and the trade imbalance is not turning around.  There is little likelihood interest rates will be raised and the possibility of future asset purchases may be resumed is not unlikely.  I have been saying for some time that, historically, the Fed does not raise interest rates until 12-18 months after the end of a recession.

Hussman still remains concerned about the over valuation of the stock market and the weak recovery.  Consequently, he still expects an abrupt market decline within the next few months.

John Prestbo has written that it appears the stock market inflation adjusted return for 12/31/1999 to 12/31/2009 was actually negative.

John Mauldin still believes in the V-shaped recovery and cites a variety of minor improvements, but still sees 2010 as a year of uncertainty and believes that a tax cut is necessary.  However, I would disagree, because tax cuts have seen growth in unemployment, while tax increases have seen growth in employment.  Government spending spurs employment more than private spending.  I think we need to target creating jobs now with government programs and creating more credit availability for small businesses if we are to see job creation in the foreseeable future.

Nouriel Roubini is saying that the second half of 2010 may bring downside surprises with the possibility of a double dip recession.  The stimulus has not spurred top line revenue growth fast enough and thinks US GDP will be anemic at 2%-3%, which is not enough to drive GDP growth or job creation.

The CFTC has announced proposals to limit big energy traders, but they would apply to only the ten biggest position holders.

ECB Governing Council member, Nowotny, warned that US banks need to curb risk taking.

US banks are lifting executive salaries as they but bonuses just as many have predicted.  They want their cake whatever frosting it has on it.

China's $1.2 trillion 2009 exports edged out Germany's $1.17 trillion to become the world's top exporter.

Central banks in South Korea, Indonesia, India, and Singapore bought US dollars to curb the gains in their currencies.  There was also speculation China would let its yuan rise.

Bullard, St. Louis Fed President, said global growth, particularly in Asia, is driving the US recovery.  I have been saying and publishing in my blog and in nationally published articles that China has a spending bubble, real estate bubble, and increasing use of leverage.  As China tightens its monetary policy, how will that braking effect the global recovery.  I think the stock market showed us an advertisement for what might happen on 1/12.

UK trade deficit decreased November from $11.4 to 11.0 billion; the Canadian trade deficit was $331 million in November, but it was the 4th monthly deficit in five months.

The German economy was down 5% in 2009 as exports fell 14.7% in Q4 and is estimated to grow 1.2%-1.5% in 2010.

China renewed vows to curb real estate speculation amid concerns over a possible asset bubble and said it will keep an eye on excessive lending.

California's credit rating was reduced another level by S&P, which said the state will run out of cash in April.

Foxwoods Casino (owned by The Pequots tribe) is in financial difficulty.  Since the casino is owned by a sovereign tribe, only they can own the casino.  Where does this leave lenders who have no legal right to foreclose?  Why did the lenders provide credit without addressing this issue in the loan contract?

Heineken is to acquire FEMSA in a $7.7 billion deal.

Treasury auctions:
10 yr TIPS, $10 billion, yield 1.43%, bid-to-cover 2.69, foreign 40.7%.
3yr Treasury, $40 billion, yield 1.49%, bid-to-cover 2.98, foreign 38.0%.
10yr Treasury, $21 billion, yield 3.754% (lower than expected), bid-to-cover 3.01 (strong), foreign 29.02% (Primary Dealers took over 50%).
30yr Treasury, $13 billion, yield 4.640%, bid-to-cover 2.69, foreign 40.7%.


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Yield Curve & Bank Profits

Rolfe Winkler published a post in which he showed the banks are not profiting from the steep yield curve.  One reason is the banks are not lending; they are plowing their cash into more liquid securities.  He argues banks need to lend at higher rates, because the curve is steep at low rates and they cannot capture the whole spread based on what they actually have to pay for more deposits.  The banks also carry floating assets in the form of credit card and corporate loans and ARMs that key off indices.  Higher rates would would in turn mean lower real estate prices and higher default rates.

Tyler Durden had a post in which he demonstrated that foreign investors (indirect bidders) were fleeing the short bond.  Contrary to conventional wisdom, foreign investors are buying the longer bonds with steeper yields.  Yet, each auction is seeing high Primary Dealer (US banks and bond broker-dealers) purchases.  With the expectation of inflation around the corner, how are investors going to be persuaded to leave the short-term bills and buy the "riskier" long-term bills?

Karl Denninger observed that the Primary Dealers (banks) are heavy buyers (crowding out?) of the 13 week and 26 week bills with near zero yield.  This means they are not only not lending, but, in my opinion, they are hoarding cash.  The question becomes what do they know?  What makes them afraid to lend and make money?  Who does the steep yield curve benefit?

Econbrowser has published a post breaking down the Fed's recent profit of $46.1 billion given to the Treasury,  Besides finding the number is coincidentally the same as the revenue from US Treasuries and MBS, James Hamilton found the profits were from a strategy of borrowing short and lending long.  The Fed may be funding the purchase of MBS with near zero interest Treasuries.  This means the Fed must be able to continue to rollover the short term debt (continue to convince banks to keep holding excess reserves) or liquidate the long position (sell the MBS) without a loss or uncontrolled impact on interest rates.

We have been commenting for many months that the Fed appears to be encouraging banks to deposit excess reserves rather than lend.  Meanwhile, unemployment will stay high for years, consumer credit and spending will remain low, and small business credit availability will remain unusually low.  For whose benefit is this "recovery"?

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Leftovers - Radio Show 1/9/2010

Paul Krugman had two articles during this week.  His "That 1937 Feeling" warns us of blips, which are statistical illusions, that appear to convey good news and are often caused by inventory bumps, which is when inventory levels have been reduced to the point that they must be at least minimally replenished in order to continue to do business.  He indicates the housing and employment problems are not coming back yet in this recovery, which is something I have been saying for some time.  He indicates a boom in business investment would be very helpful right now, but I have been observing that business lending is down and the Fed appears to be discouraging bank lending by accepting excess reserve deposits without penalty to the depositors.  Krugaman indicates that the current stimulus will have played itself out economically by the middle of 2010 and any attempts by the Fed to exit by ceasing to purchase long-term debt and mortgaged backed securities will amount to monetary tightening without raising interest rates.

Krugman.s "Bubble and the Banks" asserts that the bursting of the housing bubble brought the financial system to a grinding halt with the significant reduction of liquidity in the financial system.  However, the banks got themselves in this plight by raising their leverage ratios in order to maximize short-term profits which directly affected the size of their bonuses.  While their is every need for transparency and regulatory reform, there is every incentive for bankers to engage in a repeat performance as they are now doing.  There needs to be a limit on bank leverage and a tax on excessive risk taking activities.

Karl Denninger of The Market Ticker had a post entitled, "Here It Comes (You Were Just warned Folks)" in which he argues that the only direction for interest rates to go is up, that P/E ratios are at record highs, and investors are piling in to the financial sector which needs regulation from the tech sector which has been on a tear.  He references the BIS warnings on Central Banks low interest rate policies and the China real estate bubble.  He indicates that we are presently worse off than in early 2007.  He ends with regulators warning of liquidity and interest rate risk at the same time it is preparing an exit from the liquidity programs put in place to seal the dam.

Marshall Auerbach published an article entitled, "Spain and the EU: Deficit Terrorism in Action" in which he criticizes the EU arbitrary fiscal rules with respect to the 3% of GDP limitation of deficit spending, because it is significantly deterring the ability of some EU member nations to adequately respond to their economic conditions during this period of global financial crisis.  The need for targeted government spending to increase employment and spur GDP growth is in direct conflict with the EU fiscal rules.  This is posing a a particular problem for Spain which adheres to the EU rules and is also a looming problem for Portugal and Ireland.  This conflict can also be seen in the friction between Greece and the EU over Greece's attempts to reduce its budget deficit.  There have been polite but harsh words on both sides as we have seen in several stories this week.

The Chicago Board Options Exchange intends to wait until the second half of this year to start a new platform for high-speed, high  frequency traders.  The SEC has not yet announced any decision yet on its proposals on regulating flash orders.  The CBOE is just going to keep muddling on as usual until it gets firm directions.  The process of regulatory reform is very slow when there is no one making it happen.

China raised the rate on its 3 month bills at the most recent auction and this is seen a a tightening of monetary policy.

FDIC is considering a plan to tie banks payment for deposit insurance  to risks involved in their pay structures.  Also, after a receiver of failed bank distressed CRE loans, the FDIC set up a LLC to hold these distressed loans with unpaid principal of $1.02 billion and sold 40% of the LLC to Colony Capital for $90.5 million net of working capital.

Bill Gross of PIMCO said that when the Fed stops buying MBA's the Fed will be unable to sell them and it will put pressure on interest rates.  PIMCO is also cutting it exposure  to US and UK debt.

Meredith Whitney, the banking analyst, lowered Goldman Sachs earnings estimates for 2010 through 2012 for the second time in less than a month.

The Illinois pension fund, Central laborer's Pension Fund, is suing  Goldman Sachs over bonuses citing the compensation system as a complete breakdown of corporate oversight.  $17 billion has been set aside for bonuses through Q3 and may approach $22 billion for year on what the Pension Fund calls government  bailout inflated revenues.

The ISM Manufacturing Index is up to 55.9 in December from 53.6; new orders up to 656.5 from 60.3; production  up to 61.8 from 59.9; employment up to 52.0 from 50.8; supplies deliveries up to 56.6 from 55.7; inventories up to 43.4 from 41.3; prices up to 61.5 from 55.0; exports down and imports up; customer inventory still contracting.

Construction spending down .6% in November.

ISM Service Sector up to 50.1 in December from 48.7 with 12 of 18 industries reporting a decrease and 2 reporting no change.

US durable goods factory orders up 1.1% in December; shipment up 1.0%; unfilled orders down .7%; inventory up .2%.

Mortgage demand at a 6 month low.

Pending home sales down 16% November but up year on year.

HAMP 2nd lien modification program is on hold with no listed servicers.

US apartment vacancy rate hits 3 year high; office vacancy rates hit  15 year high; and strip mall vacancy rate at 10.6%.

Small and medium size business loans, leases, and lines of credit more than 180 days behind are up to .91 from .87 for a 22nd monthly increase.

2009 personal bankruptcy at 1.41 million which is up 32% from 2008.

The Euro 16 nation unemployment at 11 year high of 10% and it is estimated it will continue to rise into Q3 2010.  Eurozone factory activity rose to 51.6 from 51.2 at the fastest rate in 21 months of 4/10ths of a percent.

German exports are up 1.6% in November.

Canadian unemployment is 8%.





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Leftovers - Radio Show 1/2/2010

Goldman Sachs was deceptive in its marketing of synthetic CDO products according to Yves Smith of naked capitalism. Any company should bear responsibility for their products, but the sellers of synthetic CDO's have access to hidden information, which even the most sophisticated buyers using modeling software cannot reasonably access for evaluation. Other banks such as Morgan Stanley also profited with the assistance of the rating agencies which would assign high investment credit ratings to these synthetic CDO's.  Even more ominous is that banks, such as Goldman Sachs, were on both sides of the transaction by shorting the very products it was packaging and selling.  It has become very hard to get information on the AIG bailout, because the Treasury and the Fed does not want to release information relative to that bailout and the 100 cents on the dollar payments made to Goldman Sachs and other banks to cover CDS positions.  Yves Smith also points to senior advisors to Secretary of the Treasury Geithner who came from firms directly involved in CDO marketing.

The Chinese premier pledged to cool property prices and keep inflation reasonable, while also saying China should anticipate inflation.  He indicated the government will maintain a moderately loose monetary policy and a proactive fiscal position.  Bllomberg.com also had another article indicating China's manufacturing production is cementing recovery.  This substantially begs china's spending bubble, real estate bubble, leverage growth, export tax incentives, peg of the yuan to the US dollar, internal consumption, and the growing rift between the coastal elite and the internal population as I have detailed in the my China's Spending Bubble and Double Dip Probability posts below.

Yves Smith also had a post on ten reasons to kill the Senate Health care bill. I have mixed thought on this issue.  I firmly believe that the United States as the only developed democracy in the world which does not have universal health care needs to provide universal health care to every citizen.  I do not understand why Congress and the the health insurance industry lobbyists are so intent on recreating the wheel and recreating it inefficiently and incompetently.  The present health care bills will not cover everyone, but the are being pushed to establish a program that can be perfected in the future.  If the Administration had had a real plan, the process would not have been so corrupt and incompetent.  The Swiss, Netherlands, and France all have universal health care with private insurance.  France has one of the lowest individual health care costs with the highest rated quality of service in the world while the United States has one of the most expensive health care systems with one of the poorer levels of  quality of care in the world.  Without universal participation, the age bands for insurance, as used in Switzerland, with no discrimination would not be economically sustainable.  If universal health care met or exceeded Medicare services, there be no need for Medicare, Medicaid, or veteran's hospitals.  The three countries I mentioned have accomplished this with private insurance in slightly different ways.  The only real wrinkle in the United States is that the States have the legal right to regulate insurance companies within their borders.  The United States does not need to usurp that State responsibility, but it can require any insurance company which wants to participate in universal health care to be licensed to do business in all fifty states and territories and to meet the Federal minimum requirements or higher State requirements.  Insurance companies want to continue denying health care procedures, denying insurance availability, and practicing medicine while cherry picking which states they want to do business in.

In France, you choose your doctor, the primary care doctor must to go to your home if you cannot see them, the doctor and patient decide what medical procedures and methods are appropriate (no medical procedure or therapy can be denied if recommended by the doctor and agreed to by the patient), there are no waiting lists like Canada, and the government has an active anti-fraud program.  All of this for 1/3 the cost of health care in the United States and with the #1 rating for quality of health care in the world.

The fastest growing part of the municipal debt market is Build America bonds, but the yields demanded by investors are higher than corporate debt with similar ratings. You have to be in the highest tax brackets to gain the most from these tax exempt securities.  They are expected to increase 46.6% in 2010 to $85 billion from an estimated $58 billion in 2009.

Tax free municipal debt issuance  is expected to rise 7.9% to $450.5 billion in 2010 from $418 billion in 2009.

sales taxes nationally are down 9% in Q3.

Credit card write-offs rose to 10.56% in November and is likely to go to 12-13% according to Moody's in 2010.  30 day delinquencies are up to 6.2%

The Chicago Fed Midwest Factory Index is up 1.2% to 84.2 which is the highest since 12/2008; the Automobile component  is up 1.1% within that.

Treasury auctions:
2yr $44 billion  yield 1.089%, bid-to-cover 2,91, foreign 34.8%; large Primary Dealer purchases.
5yr $42 billion yield 2.665, bid-to-cover 2.59, foreign 44.0%.
7yr $32 billion yield 3.345%, bid-to-cover 2.72; foreign 44.7%.






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Big Banks Short Sell Fraud

Diana Olick, in her blog Realty Check today , disclosed how big banks are coercing real estate agents to pay them money on the side off the official settlement statement to get the banks, as second lien holders, to agree to a short sell (below the value of the mortgage). This is not just a questionable pattern of conduct, it is specifically illegal.  You should read her complete post in the link above.

Interestingly, although we have been very vocal for many months on the exceedingly inaccurate balance sheets banks are now allowed to publicly present, today's reaction to J. P. Morgan's earnings show a closer inspection of the information being provided.  While J. P. Morgan had $3.3 billion in "profits" this last Quarter, analysts were disturbed by credit costs. Its mortgage and credit card business has seen rising costs.  It set aside $4.2 billion in Q4 to cover mortgage losses which are up from $653 million vs a year ago.  It increased its commercial loan loss reserve to $494 million from $190 million.  Prime mortgage net charge-offs (what it expects to never be paid) increased to $568 million from $195 million a year ago.  It wrote off loans at an annualized rate of 9.33%.

Continuing his critique, Joseph Stiglitz, has written a new book, "Freefall: America, Free Markets, and the Sinking of the World", and just published an article entitled, "Moral Bankruptcy", in which he argues that the current financial system has created a moral hazard which is a direct threat, not just to a free market but to society.  As long as the systemically dangerous financial institutions are allowed to privately profit and disgorge their losses onto the public, they have no fear of failure and no reason to fear the law as long as they are considered "too big to fail".


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Leftovers - 12/26/2009

We are still trying to catch up from the  Google Blogger hiccup with three Leftovers we need to post as well as several other posts we have been planning.

The Leftovers from 12/26 are:

The Chicago Fed President, Evans, said the economy will continue to grow  over the next five years, but unemployment will remain high and inflation tame.  Consequently, there will be no need for the Fed to change its low interest rate policy.  He said, "I think the focus is going to be on how the economy is playing out, how unemployment is coming down and whether or not inflationary pressures remain as as they currently are."

Federal estate tax changes remain pending in Congress with a bill in the Senate and a bill in the House with different provisions. Both maintain a $3.5 million exemption but one indexes for inflation (Senate) and the other does not. Both maintain a 45% top tax rate.  The Senate bill unifies the gift tax and estate tax exemption and offers portability of federal estate tax exemption between spouses.  The House bill prevents the switch from step-up basis to carryover basis.

Financial reform with respect to  fiduciary responsibility continues to be watered down by lobbyists who have been able to have broker dealer representatives not held responsible for their firms limited product line (does this also excuse the firms preference for products?) and this is consistent with the position of the CFP Board, which has been actively recruiting financial salespeople.  They are attempting to also have fiduciary responsibility limited to each transaction and not a an entire client relationship.  The CFP Board has wanted to be named the regulatory body, despite no one financial planning association being a dominant designation and the CFP requiring the least course work, experience, or education.  It appears FINRA may be the default regulator.  It needs to be the proposed Consumer Financial Protection Agency, but the lobbyists may be successful in getting it killed.

Small business bankruptcies in California are up 81%.

Geithner says banks need to lend to business for the economy to grow and strengthen.  Treasury wants TARP rules relaxed to allow small business lending -- wants to commit $30-40 billion -- but he wants it to go to large banks when it should go to local banks.  Geithner also said a double dip (he refused to use the actual phrase) is not going to happen, that it is completely within the capacity of the government  to revent, and the the government will do what is necessary to prevent it from happening..

Greece budget cuts will reduce their deficit in 2010 to 9.1% of GDP from 12.7%.

Russia's economy is estimated to grow 2.5-5.0% in 2010, but it is estimated to shrink 8.7% in 2009.

Latvia warned Sweden to resume lending to Latvia or risk choking off recovery in Latvia.

Japan's exports are up 4.9% November - the most is 7 years -- but down 6.2% vs year ago.  The jobless rate is up to 5.2% from 5.1%; consumer prices down 1.7% vs year ago (9th month down); household spending up 2.2% (4th month).

GMAC is reported to be in talks with Buffet to sell its residential mortgage company, Residential capital, which needs $250 million net worth to maintain loan compliance.

The 3rd largest radio company with 224 stations, Citadel Broadcasting, filed bankruptcy to restructure its hefty debt load.

Food prices in India rose 19% through mid-December.  It could boost inflation as overall growth accelerates.  A Central Bank interest rate hike is expected in April.

Lloyd's (45% UK owned) agreed to pay 3.6 billion over 15 years to raise 2 billion in capital by selling hybrid Tier 1 securities on December 15th.

AIG's CEO stopped the public offering of its worldwide casualty unit, Chartis, calling it a central holding for future growth of AIG.  Goldman Sach's selling of mortgage backed CDO's while shorting the same securities over a two year period is becoming more documented as investigators pry into the AIG bailout.

Upton Sinclair: "It is difficult to get a man to understand something, when his story depends upon his not understanding it."


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German Bonds vs. U. S Treasuries & Inflation

A recent Bloomberg.com article entitled, "Bernanke Bond Spread Most Since 2007 Shows Decoupling", exemplifies the constant need to apply critical analysis when reading any article, book, or information from any source.  The article begins, "The correlation between Treasuries and German bunds that has prevailed since credit markets started freezing in 2007 is breaking down as U.S. economic growth leaves Europe behind." It immediately continues with "Yields on U.S. 10-year Treasury notes rose twice as fast as German debt with a similar maturity since the start of December ...".

Reading that one would think the US is tromping Germany, but why would Pimco be selling US Treasuries and buying German bonds (Bunds)?  The decoupling is actually the investor view that the German Bund is a safer investment and they are willing to pay for it while investors apparently believe U. S. Treasuries are a riskier investment demanding a lower purchase price to face value.  While investors generally seek higher yields, the perception appears to be that the ECB has been setting its interest rate policy not only to provide liquidity but with a constant eye on inflation (a dual focus).  Consequently, the Fed, which lowered interest faster and to near zero (zero to 25 basis points while the ECB is at 1%), will have a more difficult time shifting its focus from liquidity to inflation with inflation expectations already stoked and heating up.

As we said last month on the radio show, CPI going forward from this past January will show increasing inflation, because it will be comparing year to year with a past period of declining inflation.  With oil prices continuing to go up despite 26 miles of full oil tankers sitting offshore in the oceans around the world, because there is not enough storage on shore given the lower demand, it will be even more aggravated.  If there are food shortages as the result of growing conditions, as some have predicted (rice, soybeans, sugar), the price of food will be going up.  We are already starting to see a variety of commodity prices going up.

The recovery is fragile.  What is going to happen when China starts tightening its economic, monetary, and fiscal policies to fight its real estate/housing bubble, spending bubble, increased use of leverage, and the threat of inflation?



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