Friday, June 18, 2010

Financial Reform is a Dirty, Corrupt Process

While many, including myself, labor and desire financial regulatory reform in the United States which will protect the American public, defuse systemically risky financial companies, provide a practical liquidating process of multiple financial companies during a financial crisis, and enter the 21st Century with respect to the need for fiduciary duty and how that is distinct from a watered down wolf in sheep's clothing fiduciary standard.

What can be said of a country that will not even debate the need for fiduciary duty and the ethically incompatible functions of selling financial products?  In the United Kingdom, Canada, and Australia is illegal to provide financial advice and sell financial products.  Period.  Are they more civilized or more democratic or just more pro consumer protection oriented than regulators and congressmen in the United States?  Are their regulatory agencies more conflict free and less corrupt than the United States?  In the United States not even the main line bloggers think fiduciary duty is worth discussing.  I have made my position very clearly and I have not minced words.

It is more popular to talk about "too big to fail" when the topic should actually be the "systemically dangerous".  Obviously, a Volcker Rule which addresses financial companies of any size which are systemically dangerous is necessary.  The fight for an independent consumer financial protection agency is lost with its imprisonment in the Federal Reserve.  Stripping commercial banks of derivatives, private equity, and hedge fund trading and product development is fundamentally necessary.  Taxing financial companies for excessively risky behavior is perceived as too much to ask; after all, it might actually curtail excessive risky behavior and limit the compensation of investment bankers/traders who live to devour the competition much less the unsophisticated.  If, during a financial crisis multiple financial companies need to liquidated or restructured simultaneously, we are doomed, because the resolution process proposed in the United States addresses single companies and will not work if initiated. 

Stiglitz has recently listed what financial reform should do and what it is not doing in a recent article.  He shows that the House and Senate versions are both inadequate, the pressures of the financial lobbyists, and the need for a resolution process, and reforms to prevent another financial crisis like one we continue to experience.  He falls into the "too big to fail" myth while he has written about systemically dangerous as the proper term, because it is not about size; it is about excessive risk and being a systemic threat.  But, then, he also falls into the fiduciary standard trap.  Perhaps he is just trying to be inclusive in an attempt to promote reason.  His article covers a lot of territory with little substantive argument in an attempt to show the problem and the need for solution.

Exemplifying the extreme focus on what many consider "the" important issues, Rortybomb compared the House and Senate versions of resolution authority, bank capitalization, derivatives, and auditing the Fed only.  He does mention he is also concerned at the loss of the ratings companies being subject to an independent agency which assigns raters to debt issuances and auto dealers exempt from consumer protection disclosures.  What he does not mention is fiduciary duty, the consumer financial protection agency, the exemption of many small banks, and the provisions which make the largest banks more powerful than before the current crisis. 

The inadequacy of the Orderly Liquidation Fund is well discussed in this article by Jennifer Taub on The Baseline Scenario.  The proponents of the financial elite want no part of any law which would actually make the financial elite pay for their mistakes, when the losses can be so conveniently dumped on the American public in a pious contrition towards the unspoken state of corporate socialism.  The Baseline Scenario has many other posts on financial reform.

The attack upon any type of Volcker Rule which addresses the issue of systemically dangerous financial behavior is unrelenting.  Rortybomb, which is an excellent source on financial reform, recently wrote about how any form of the Volcker Rule is not being taken seriously in the Conference process.  Some congressmen are concerned that stripping private equity, derivatives, and hedge fund activities from banks will put them in unregulated entities.  Are they being obstructionist?  Without divorcing commercial banks from trading excesses, we will be primed for the next financial crisis and nothing will stop it.

Do we live in a corrupt society?  Do we desire a society feudalistically dominated by financial corporations?  Is the general welfare of the people a dominant concern or just a phrase which money from financial lobbyists allow congressmen to ignore?  Do we need to go back to the Constitutional mandate of a U. S. Representative for every 30,000 citizens and have a larger lower House like other developed democracies, like the United Kingdom?

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Thursday, June 17, 2010

Leftovers --- Radio Show 5/15/2010

We discussed the use of stop loss orders and stop loss limit orders.  In liquid markets, stop loss orders are usually sufficient, but on May 6th we saw how stop loss orders would have been more appropriate given high frequency and computer program trading gone awry.  A stop loss order is a market order after the stop loss is reached.  A normal stop loss is 8% from either the original basis or a higher gained level after purchase.  In a stop loss limit, you might have a stop of 4% with no execution below an 8% loss.  This would save you from a precipitous drop from which the market then recovers; if the market does not recover your loss is even greater, because there was no execution.  Those people, who followed my consistent advice, would have been completely out of stocks and stand alone ETF positions by May 5th, because the market went into correction on the 4th and they would have sold any positions in which there stop loss orders had not yet executed.  You do not stay in stocks and stand alone ETF positions in a correcting market.

The major securities exchanges agreed to create a uniform system of circuit breakers to slow trading during intense market volatility.  Part of the problem on the 6th of May was a slow down on the NYSE and trades routed to electronic exchanges.

U.S. Senate voted to force credit card companies to cut transaction fees to businesses that accept debit card transactions.  This will help businesses more than the public as the cost of the cuts is passed on by the credit card companies to the card holders.  The Senate also stripped the right of banks to directly engage ratings agencies to rate bonds.  The Senate wants the SEC to set up an independent board to decide which ratings agency provides ratings for a bond issue.  The New York Attorney General has subpoenaed eight banks for information on their dealings with ratings agencies: Goldman Sachs, Morgan Stanley, Deutsche Bank, Merrill Lynch, UBS, Citigroup, Credit Suisse, and Credit Agricole.  Moody's received a Wells notice from the SEC, because there is concern Moody's 2007 initial application to become a nationally Recognized Statistical Ratings Organization (NRSRO) was misleading.  Morgan Stanley is being investigated by the Justice Department to determine if they misled investors on mortgage derivatives it helped create, market, and sometimes bet against.  The New York Attorney General is suing a unit, Ivy Assets, of NY Mellon alleging they kept clients in the dark about problems with Bernie Madoff of which they had knowledge.

The U. S. Senate approved an audit of the Fed, but only of the emergency actions since December 2007.  It is not a full audit.

FHA commissioner David Stevens urges private mortgage insurers to not ease standards.  They have seen a massive drop in business, but prices are falling and the mortgage insurers want to do more business and the bailout of Fannie and Freddie, with their higher costs, is pushing private mortgage insurers out.  The FHA intends to maintain lending volume until capital comes back.

The ECB is committed to the survival of the euro and is buying sovereign bonds in the secondary market with a $1 trillion fund.  While this is portrayed as necessary steps to strengthen the eurozone, the bond purchases will primarily help European banks by taking the sovereign bonds off their balance sheets while increasing their liquidity.  The ECB pledged to keep the bonds for their full maturity.

There is a fake SEC being operated by con artists under the name of "U.S. Securities and Equities Administration", "U.S. Securities Administration", and the U.S. Securities Bureau enticing investors with offers to remove supposed restrictions on stocks they own or release funds being held by the government for a fee.  They had a global counterpart, an address shared with Deutsche Bank and Standard and Poor's in Boston.  They even set up a website with detailed investor alerts and warnings.

Parallel criminal and civil probes have been launched by DOJ and CFTC into whether JPMorgan through its trading activities actively suppressed the price of silver.  There has also been some speculation that big bullion dealers and ETFs do not have the physical bullion they claim to possess.

According to a study from the Center for Retirement Research at Boston College, if a couple turned 65 last year and at least one spouse suffered from a chronic disease, they would face lifetime health cost of $220,000.  A healthy couple without any chronic diseases would have lifetime health care costs of $260,000.  For 5% of the unhealthy couples, the cost can be as high as $465,000 compared to $570,000 for 5% of healthy couples, because a healthier couple will live significantly longer lives.

In the past we have said several times that a sustainable recovery is usually preceded by a strengthening dollar.  Since 2008, commentators have been extolling the export benefits of a weak dollar as the road to recovery.  The increase in exports and a significantly declining trade deficit has not been happening.  A strong dollar encourages foreign investors to invest in the U.S., bring money into the United States.  A stronger dollar makes imports cheaper and helps control inflation.  Services and production outsourced to other countries may find economic reason to return to the United States.  The strength or weakness of the dollar is always a double edged sword.

Lacker, Richmond Fed President, again said the Fed must not wait too long to raise rates given public inflation expectations despite low inflation.  Economy is slowly improving but it will take some time to make substantive progress in high unemployment, although he sees progress.

Kohn, Fed vice-chairman, said economic rebalancing prevents turmoil. in addressing the problem of global financial imbalances in the emergence of global financial crises.  In my opinion this is exactly the problem within the eurozone.  It is unfortunate that Germany and China are not interested in global rebalancing.

Hoenig, Kansas City Fed President, who also wants the Fed to raise interest rates and to move back to a more neutral policy, was profiled with a explanation of his monetary beliefs by The Wall Street Journal online.

Elizabeth Warren of the Congressional TARP Oversight Panel said she remains infuriated that TARP has failed to funnel some of the $700 billion to small businesses.  Big bank lending to small businesses actually dropped 9% from 2008 to 2009.  Small banks still remain constrained by exposure to commercial real estate.  In my opinion the banks which have profited the most from the government bailout are lending the least to promote economic recovery.  A study by the Panel found that several TARP initiatives were ineffective in getting money for small business.

The National Federation of Independent Business monthly economic trends survey showed more optimism but still weak economy with spending at record low levels.

FINRA is focusing its enforcement priorities on selling-away cases, municipal disclosures, structured products, and leveraged exchange-traded funds.

John Hussman in his weekly commentary is of the opinion that no repetition of game theory will produce a result that will keep Greece from needing to restructure its debt despite the EU/IMF bailout, which was designed to last three years.  In his opinion it might give Greece only 18 months relief from seeking capital in the open market.  Unfortunately, he appears to be to focused on deficits and not enough on the current account imbalances among the eurozone countries.

Rob Parenteau of the Levy Economics Institute, for whom I have been doing economic research on the eurozone crisis and European and U.S. bank exposure as well as hedge fund investment opportunities, wrote that the Greek bailout will fail for three reasons: 1) higher taxes and lower public worker wages create discontent, 2) Greeks have borrowed from French, German, and Swiss banks not just Greek banks compounding the problem, and 3) Greeks will have less money to spend and countries and businesses with business ties to Greece, like Germany and the Netherlands, will also suffer.  He also indicated the euro will fall at least 20-30% this year.


The IRS has issued average premiums by state for the new small group tax credit.
Chinese prices were up 2.8% for the year to April; industrial output was down 17.8% vs year ago; bank lending is still pumping despite monetary tightening at $113.4 billion in April.

French economy may see a .4% growth in Q1 and .5% in Q2 according to the Bank of France (the forecast is 1.4% and is now in doubt).

China April trade surplus is $1.7 billion after a March trade deficit of <$7.2 billion>.

Keeping children until age 26 on parent's insurance will raise employer premium costs by 1%.

UK production was up 2% in March; output was up 2% vs year ago.

US retail sales, ex autos, were down 2% in April with all sales up .4% in April; all sales were up 8.8% vs year ago.  March was revised up to 2.1% from 1.9%.  US trade deficit was up to 19% in March.  It grew by 2.5%, $40.4 billion, in March.  Imports were up 3.1% led by oil.

US industrial output was up .8% in April with capacity utilization up to 73.7%, which is still 6.9 below the average.

China April producer prices were up 6.8% and property prices were up 12.8%.

Hong Kong GDP Q1 was 8.2%.

U.S. Treasury auctions:

3 year Treasury, $38 billion, yield 1.414%, bid-to-cover 3.28, foreign 51%, direct 16.5%.

10 year Treasury, $24 billion, yield 3.548%, bid-to-cover 2.97, foreign 59.6%, direct 24.96.

30 year Treasury, $16 billion, yield 4.49% (higher than current market which means this yield is "tail"), bid-to-cover 2.60, foreign 32.5%, direct 17.5%.  This was a weak 30 year auction.


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Tuesday, June 8, 2010

Illinois Has No Political Will; Fiscally and Ethically Bankrupt

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

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

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

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

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

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

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

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

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


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

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

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

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

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

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

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Friday, June 4, 2010

Leftovers -- Radio Show 5/8/2010

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Indian consumer prices are projected to rise 7.5%.

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

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

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

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

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

ECB held its interest rate to 1%.

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

Vanguard ETFs are now commission free at Vanguard.

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

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

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

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

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



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Friday, May 28, 2010

Leftovers -- Radio Show 5/1/2010

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Spanish unemployment is at 20.1%

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

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

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

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

HP will buy Palm for 41.2 billion.

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

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

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

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

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

U.S. Treasury Auctions:

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


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Thursday, May 20, 2010

Financial Reform in an Age of Unavoidable Corruption

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

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

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

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Goldman Sachs Fraud & CDOs

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

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

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


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