NEWS #85

From December 16, 2008 to February 14, 2009

http://www.minyanville.com/gazette/newsviews/?id=21141 Americans to More Debt: Talk to the Hand by Andrew Jeffrey of Minyanville.Com

"Bloomberg cites Midsouth Bancorp (MSL) president C.R 'Rusty' Cloutier, who says that, despite aggressive marketing, town hall meetings, and $20 million in TARP money, Midsouth's customers just aren’t taking out new loans.

This is the rejection of debt Professor Depew speaks of when discussing the structural deflation we’re currently experiencing.

Credit is based on trust. And while conventionally we view this relationship as one in which the lender must trust the borrower to repay his debt -- at least to an extent that’s commensurate with the interest rate -- it does go both ways.

As lenders like Citigroup (C), Bank of America (BAC) and Wells Fargo (WFC) are increasingly being painted as corporate marauders out to rape and pillage the American public, would-be borrowers are wary of putting their financial future in the hands of these men of questionable repute. And with credit-card companies rushing to alter terms, it’s no surprise consumers are reluctant to extend themselves further.

Still, lawmakers are pushing through an economic stimulus package that depends, in part, on a willingness on the part of consumers to keep spending. Their delusion is only outmatched by their hubris - the belief that a bunch of self-interested politicos can coerce the average American into making ruinous financial decisions for the betterment of the country.



February 13, 2009

Who will buy this wonderful morning?...the musical Oliver Vegas sends this link to 'How Banks Are Worsening the Foreclosure Crisis', by Brian Grow, Keith Epstein and Robert Berner. I quote the article extensively below.

"The Obama Administration is expected within the next few weeks to announce an initiative of $50 billion or more to help strapped homeowners. But with 1 million residences having fallen into foreclosure since 2006, and an additional 5.9 million expected over the next four years, the Obama plan -- whatever its details -- can't possibly do the job by itself. Lenders and investors will have to acknowledge huge losses and figure out how to keep recession-wracked borrowers making at least some monthly payments.

...However the skirmish ends, the industry's contention that it has done as much as possible to limit foreclosures seems hollow. Some statistics it cites appear to be exaggerated. Even pro-industry figures such as Steven C. Preston, a Republican businessman who headed the Housing & Urban Development Dept. late in the Bush Administration, concede that many lenders have dragged their heels. 'The industry still has not stepped up to the volume of the problem,' Preston says. One program, Hope for Homeowners -- which Bush officials and banks promised last fall would shield 400,000 families from foreclosure -- has so far produced only 25 refinanced loans.

...A major reason financial institutions and investors are so determined to avoid modifying loan terms more aggressively has to do with accounting nuances, say industry lobbyists. If, for example, a bank lowered the balance of a certain mortgage, there would be a strong argument that it would have to reduce the value on its balance sheet of all similar mortgages in the same geographic area to reflect the danger that the region had hit an economic slump. Under this stringent approach, financial industry mortgage-related losses could far surpass even the grim $1.1 trillion estimated by Goldman Sachs (NYSE:GS - News) in January.

...In a press release last Dec. 22, Hope Now said it had prevented 2.2 million foreclosures in 2008 by arranging for borrowers to catch up on delinquent payments and, in some cases, easing terms. But the data don't reveal how many borrowers are falling back into default because many modifications don't, in fact, reduce monthly payments. The alliance doesn't receive this information from banks, says Schwartz.

There's reason for skepticism. Federal banking regulators reported in December 2008 that fully 53% of consumers receiving loan modifications were again delinquent on their mortgages after six months. Alan M. White, a law professor at Valparaiso University, says the redefault rates are high because modifications often lead to higher rather than lower payments. An analysis White did of a sample of 21,219 largely subprime mortgages modified in November 2008 found that only 35% of the cases resulted in lower payments. In 18%, payments stayed the same; in the remaining 47%, they rose. The reason for this strange result: Lenders and loan servicers are tacking on missed payments, taxes, and big fees to borrowers' monthly bills."

One thing that strikes me when I read this article is how much campaign money the principal congressional players are getting from the financial industry that they supposedly regulate, many hundreds of thousands of dollars. That can not be a good thing for the rest of us.

The other thing that strikes me is the fact that banks don't want to reduce mortgage amounts because that would lower the assets on their balance sheets, the old 'mark to market' accounting rule that is biting them all in the ass right now.

I think a solution needs to be imposed upon the big banks. They must be forced to abondon 'mark to market'. They must be made to value assets within a historical frame work, perhaps the ten-year average value of homes. Further, to avoid what happened in Japan, the big banks must be forced to take some hits now. I would favor a program where they were forced to write off 20 percent of their mortage losses each year for the next five years. They need to take the hit and move on. Bill Seedman, a former FED governor, favors dismantling some of the big and essentially bankrupt banks like Citi. Just chop them up and sell off the pieces. Sounds like a plan to me. If borrowers and banks are taking hits, shareholders should take some too.

Meanwhile, who has enough money to make all the banks and all the mortgagees whole? Who can buy this wonderful morning? I estimate that it would take, untimately, another six to ten trillion dollars to do that. That's more money than the world has.



February 8, 2009

Rich Kolon sends this link to 'Commodity Shipping Index Advances the Most Since at Least 1985'. It seems that the Chinese are buying iron ore again.

Here is a link to 'Bill to curb speculation could kill CDS: analyst', by Laura Mandaro & Ronald D. Orol of MarketWatch.Com. I quote it below.

"Starting Tuesday afternoon, the House Committee on Agriculture, led by Chairman Collin Peterson, D-Minn., plans two days of hearings in Washington, D.C. to discuss legislation that would impose severe curbs on credit derivatives. Representatives of trade groups representing farmers and gasoline-station operators and the major futures exchanges are scheduled to testify.

Peterson's bill would make it a violation of the Commodity Exchange Act to enter into a type of credit derivative known as a 'naked' credit default swap. In other words, the only buyers of those securities, which act as protection against the risk that an underlying corporate or sovereign borrower will default on its debt, would be those investors who must have 'direct exposure to financial loss' on the underlying entity."

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Why interest rates should be higher

Dear Alan,

You thought you could control the world with just one tool. You're one of those 'give me a lever long enough and I will move the world' kind of guys. And by golly several Presidents did give you just that. But that interest lever has its limitations and we are now seeing the dark side of its use.

I remember the 1950s. People saved. Why? Because they could make 3 and 4 percent on their money. Banks made money too at those rates. Banks actually relied on deposits for capital to lend. What a concept!

Alan, when you lower interest rates below 4 percent you killed the incentive for millions of Americans to save. When they quit saving banks were forced to look elsewhere for capital. As bank profits dwindled they looked at riskier and riskier business. First they got into full scale brokeraging, then they got into credit default swaps.

So now I ask the question: wouldn't we all be better off if the FED kept interest rates between 4 and 6 percent? Isn't cheap money from the FED what got us into this mess in the first place? And why should banks be able to borrow money at what is essentially no cost? If we're going to stay on that track, why shouldn't the Federal Government start paying individuals (a true negative interest rate) to take out loans?

February 6, 2009

February 1, 2009

Here is a link sent by Red and White D to a wonderful lesson in Economics 101. What I particularly like is how it illustrates visually just how big the problem of unwinding inflation is, and how relatively little we are able to throw at the problem. Your government was lying to you all along about how bad inflation really was. Now there is nothing for the government to do except to stand on the sidelines and watch the unwinding process.

Here is a link to 'Currency Destruction', by Mr. Practical on Minyanville.Com. I quote it below.

"The details of the good bank/ bad bank plan have yet to be revealed, but it's important to remember one important point: Any program initiated by the government is a zero sum game, at best. The government can't create wealth/productivity; it can only transfer wealth from one entity to another.

...The plan is a derivation of all the previous plans, with a new name and a new sponsor - the FDIC. Does anyone believe the FDIC can manage bad assets any better than the private market did? What the FDIC can do, with the help of the government, is create money (debt) to buy bad debt (I'm not going to call them 'assets'). But what price do they pay the banks for it?

If a bad loan has a 50% chance of being paid back, perhaps its market value is $0.60 on the dollar. If the government pays $0.40 on the dollar for it they have a reasonable chance of getting the value back (as long as the situation does not deteriorate further).

But if the government buys the bad debts at $0.40 from banks, banks will have to take huge losses and possible go bankrupt. This is because they have no capital left to absorb those losses. I would guess the government would have to pay $0.75 on the dollar for banks to be able to transfer/break-even. This is probably what the government is thinking. So the chances of getting that money back for taxpayers is very poor.

...This is what the government plan is: To further destroy the value of the currency to try to help people and the economy. But remember: An economy is based on production, not the ability to borrow. The standard of living is based on wealth, which is created by production or income generation, not the ability to borrow that wealth from someone else.

We were borrowing from the rest of the world to keep our standard of living high. Now we're increasingly borrowing from our children, who will eventually experience either much higher taxes or a much lower dollar; either will lower their standard of living.

But my words will fall on deaf ears. Policy is settling in. We just confirmed a Secretary of the Treasury who was directly responsible, as head of the New York Federal Reserve, for monitoring proper capital at all of our money center banks. They failed, because they didn't have enough capital to support the vast lending they were doing. Geithner isn't going to change his tune."

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The folks at Minyanville.com believe that we are witnessing a watershed moment in our financial history. They believe that individual Americans will emerge from this with a very different, and more conservative view of both debt and savings. Average Americans will be much less likely to borrow as much as they did before. Savings will grow. While I agree with much of what they say, I would contend that savings may take new forms, and old forms may be revived. Just throwing money into a bank account and earning one percent is not going to get it. Throwing money willy nilly at mutual funds may not get it either, not with recent history as a guide. And this leads me to another point.

Many pundits over the years have bemoaned the 'fact' that Americans don't save. With savings accounts paying one percent, is it any wonder? Yet the statement that Americans don't save is, in the truest sense, a bald faced lie. We have these things called 401Ks and each month those 401Ks throw Billions at the markets. We are saving. The problem is HOW we are saving.

401Ks SUCK! If Congress was forced to use them they would be modified, literally, overnight. The idea of the 401K is that it is self directed. In practice that just does not happen. 'Self directed' implies a choice. Where is the choice? The typical company 401K offers the employees of a company their choice between eight (count 'em, eight) funds. Whoopee. There are ten thousand different funds out there, and you, the employee, get to choose between eight. The choices are abreviated because the company has struck a deal with The Principal, or J P Morgan, or such. The Principal/J P Morgan throw together some of their dogs of mutual funds - or the funds of some 'friends' - and that is what thousands of employees get to choose from. This is a thoroughly corrupt system which robs millions of working Americans every year. In my crystal ball I see a lawsuit coming. It will be a class action suit against some major U.S. corporation. It will seek damages for employees from the 401K system and the suit will win. This will be followed by a rash of 'me-too' class action suits. Once juries get their teeth into that one, there will be hell to pay.

My friend Lar believes that not only is this financial crisis a watershed event for individuals, it is one for corporations as well. Many of the concepts that corporations nurtured for the past 25 years are being held up to a new light and are found wanting.

One such idea is economies of scale. If you own four newspapers and you buy four more you should reap some economies of scale right? Not so. Now instead of four different types of presses, you own eight different types, you use different paper and different inks. Where is the economy? Each newspaper has unique problems whose solutions have already been worked out by some relatively smart people. Imposing new solutions just creates new problems, and may profoundly bother readers, employees, and ad buyers. No, economy of scale is often just not there. Companies should not buy more than they can effectively manage. The emphasis should be on EFFECTIVELY.

Another idea is leverage. It is a sword that cuts both ways. On the way up leverage is your friend. With it, you can create more profit. When the economy is moving down leverage is your enemy because now you lose money at an even greater rate that you otherwise would have done. Companies should not engage in more leverage than they can handle in a downturn. And that turns out to be a very conservative number.

January 30, 2009

Regular readers will note that I am into long positions here. I am trading what some would call 'singles' or 'chip shots'. I am not going for a long ball here. I am taking small profits and running. Richard Ney was fond of saying: "He who sells and runs away lives to buy another day."

There is a lot of fine reading out there. Here is a link to 'Minyan Mailbag: What Paradox of Thrift?',by Kevin Depew. I quote it below.

"Good thoughts, but the paradox of thrift is different from what i was referring to. Yes, if no one ever consumes anything, that creates the paradox you're referring to. but there are 2 separate considerations here: 1. Why is there a lack of consumption, and 2. What constitutes 'real' demand and wealth creation?

If everyone decides they're going to hoard cash and stop spending because they just want to watch their pile of twenties grow, that creates the paradox you're talking about.

But in our case, that isn't what's happening. In the aggregate, burdened by debt that's increasingly difficult to service, people are choosing not to take on more debt. And, if we have a certain amount of savings and choose to deploy that into the economy, that can create real economic growth.

In this case, however, the government is attempting to offer credit, and encouraging everyone to take on more debt to 'save the economy.' But that is neither 'real' demand nor 'real' growth, and is precisely the paradigm we've operated under for the past 15 to 20 years. Consequently, we have arrived at the stage of consumer and business "balance sheet repair,' fueled by what i believe are 2 things: 1. an unserviceable debt load, and 2. a social mood shift which influences how people interpret the idea of 'serviceable debt load' in the first place."

Here is another article from the same source: 'Why Should I Care: Nationalization',on Minyanville.Com. I quote it below.

"We may never know, as the current course of action seems to be a bastardized version of nationalization, in which government offers up tens of billions of dollars in cheap loans in exchange for some miracle turnaround strategy that may or may not materialize. Meanwhile, it offers gentle suggestions of exactly what kind of cars these 'private' corporations should make.

The banking system, which some say has already been effectively nationalized, is even trickier."

Here are comments sent by Rich Kolon

"This article is a few months old, but the message is clear.

http://henryckliu.com/page173.html

This is a biggie. The stock market lost over 30% last year, and it's not doing well this month. Pension funds were also a buyer of these mortgage backed securities that still are toxically valued near 0.

James Cramer just said on his show that the Democratic stimulus plan passed today is "meaningless" and has too much "pork". That won't be a long term help to the economy.

Add this all up, and pension funds are in big trouble.

Let's look at one pension fund at a large company: Boeing.

http://www.boeing.com/news/releases/2009/q1/090128a_nr.pdf

On page 11, under liabilities, the "Accrued pension plan liability, net" at the end of 2008 at Boeing was $8.383 billion vs $1.115 billion at the end of 2007.

That's a whopper of a deficit. How bad is it? I had an old article from 2005 that talked about underfunded pension funds. Out of all the companies in the S&P 500 back then, Boeing was listed as having the 4th largest underfunding at over $6+ billion. A good stock market thru 2007 helped reduce that to $1+ billion. But now it stands at $8+ billion shortfall at the end of 2008.

The shortfall comes from the fact that their obligations for payments from the fund are theoretically higher than the value of the assets in the fund.

How bad is the latest number? On page 6 it says "At year-end, Boeing's pension plans were funded at 83 percent of the projected benefit obligation resulting in a reduction of $8.2 billion to shareholders' equity."

In fact it was the TOP factor in reducing shareholder equity.

Back in 2005, the article (no link, sorry) said that companies had plenty of cash on hand to reduce these deficits.

Well let's look at Boeing's numbers now.

On page 11, cash on hand at the end of 2008 is $3.268 billion. Accounts receivables is $5.506 billion. Subtotal is $8.774 billion. That would be enough to cover the pension funding deficit, but then all of Boeing's money would be practically gone.

What is Boeing going to do? Page 7 says on the bottom, they plan to add $0.5 billion to the fund in 2009.

Well I guess they are hoping for a big stock market and economic comeback some time in the future!

Theoretically, if Boeing were to layoff 8383 employees with a total cost saving of $100,000 per employee EVERY YEAR FOR 10 YEARS, they could use the money to pay down the current pension fund deficit. However that would mean the company would downsize to HALF its current staff.

Boeing plans 10,000 job reductions this year. Warn notices go out tomorrow.

Now what if Roubini is somewhat accurate, and a worldwide recession hits us for several years? Will pension funds lose more money? Will the government really have enough money to take over the pension funds that run out of money? Will the Fed just print the money up and hand it over? Will massive inflation occur when the velocity of money starts trading faster?

Pension fund shortages will likely be major headline news by 2010.

Rich"

Here are some more recent comments by Rich Kolon.

"Here is the latest words on a video from Professor Roubini, who predicted the financial crisis under way.

Rich Kolon http://www.cnbc.com/id/15840232?video=1015456793&play=1

Essentially, he thinks we are in for a U shape recession at best, provided the government forces banks to write down their toxic assets. This would make some banks insolvent and they would go bust. But then a cleanup is possible with government stimulus.

A bank is insolvent when it looks like its salable assets, reserves, and income would not be able to cover its liabilities (e.g. what they owe depositors) if depositors started to freak out. In other words, if there were a run on the bank, the bank would be unable to pay off those depositors who want their money immediately.

The problem of insolvency with banks stems from the government permiting them to loan out most of their money, while keeping a small amount on hand (reserves) to stem any theoretical temporary bank run by some of their depositors. If a lot of depositors want their money back at the same time, that makes a "problem" for a bank, unless they have enough money in reserves. Else they have to sell assets to get the money. And if their assets are "toxic", they would be UNABLE to pay these depositors without bailout money, and their depositors would become scared that they cannot get to their own money.

Without the cleanup of write downs, Roubini expects a L shape recession leading to depression to occur. Basically we would be like Japan in 1990's, except the problem is worldwide."

Here is a link sent by Ben Smith. It is so good that I am going to make it semi-permanent on this front page.

Market Bottoms

January 21, 2009

Red and White D sent this link to 'Scary Banks', by John Durie of TheAustralian.Com. I quote it below.

"The issues are twofold: it is becoming clearer by the day no-one knows just when the extent of the banking crisis will be known and the policy responses are even more frightening than the unknowns.

Somehow everyone is trying to equate the offshore attempts to prevent the global financial system from collapsing as the same as actually repairing it, which it plainly isn’t.

If this whole mess started because of loose lending policies by fee-hungry banks, then forcing banks to lend now is hardly going to help.

Nor is the prospect of more nationalisations, because ultimately banks have to be seen as attractive to the market and there is nothing more unattractive than a bank headed for public ownership."

Keith sends along three links. The first is to 'Omnipotent Property Depression: History's Ominous Precedent', by Michael White on SeekingAlpha.Com. I quote it below.

"Painting with a broad brush, assume a 40% loss in property values throughout the entire United States in a period ending in 2010 or 2011. This means eight trillion dollars of equity disappears. That's a boatload of money to take away from somebody, but turns to catastrophe when you recognize borrowed money purchased this loss.

Assume mortgages of half of the eight trillion disappear. So four trillion dollars of mortgages burn and go away and are never paid and are a complete loss and write off.

This means the banks and other mortgage owners are bankrupt to the tune of $4 trillion dollars. So the owners of the mortgages need $4 trillion dollars of new capital to get back to square one."

The second of Keith's links is 'Contemplating the Demise of Bank of America, Citi and JPMorgan', on SeekingAlpha.Com. I quote it below.

"While losses associated with Bank of America’s, Citigroup’s and J.P. Morgan's exposure to securities tied to the credit market has likely peaked, each of these banks still face enormous pressures from the rapid economic deterioration that has engulfed the United States and the world. In essence, the banks that toiled in credit market sensitive instruments are facing a double blow; as they must now deal with deterioration in the core of their balance sheets as loans to consumer across the United States begin to deteriorate in quality.

What began with subprime mortgage backed securities and spread to the credit market and its alphabet soup of credit derivative products is on the verge of engulfing Main St. U.S.A. and the bread and butter of these institutions' productive assets. Whereas the regional banks received TARP money to bolster their balance sheets for what was widely viewed as a coming storm, it is painfully apparent that the TARP money received by Bank of America, Citigroup and J.P. Morgan was only used to help the companies recover partially from the implosion of the credit markets. This has left them acutely exposed to a worsening U.S. economy.

As it stands now, the big three U.S. money center banks are clearly unprepared to deal with a severe and deep recession."

The third of Keith's links is 'Inflation vs. Deflation: The Quantity Theory of Money - M & V', on EastCoastEconomics.com. I quote it below.

"The above charts suggest that we are currently seeing deflation concerns because banks are increasing their excess reserves faster than the Fed is expanding the monetary base; in other words, all the additional money printed by the Fed is getting soaked up by banks and the consumer is seeing decelerating inflation. This trend is bound to reverse suddenly and drastically once credit thaws, though. At that point do you think the Fed will be able to drain excess cash from the system fast enough to prevent massive inflation?"

January 18, 2009

Ben Smith sent this link to 'Crude Oil Inventories: I Can Tango, Can You?', by Brian Kelly on SeekingAlpha.Com. I quote it below.

"Prior to the ginormous price move from 2004 to 2008, OPEC's spare capacity dropped precipitously. From April to August of 2004, spare capacity dropped from 2.29 to 0.71 million barrels per day. The average price of oil subsequently rose from $34b/bbl to over $130/bbl. Between July and November 2008, OPEC spare capacity surged from 1.22 million barrels per day to 2.54 million barrels per day, and oil dropped like a stone from $130/bbl to below $40/bbl, without a hint of resistance.

The bottom line - even if the global economy begins to expand (a huge assumption given recent data) there is plenty of oil in storage and in the ground to supply the market. It is unlikely that a new bull market in oil will begin any time soon."

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What would a Reasonable Person do?

I dare say that if folks think banks are the only ones freezing up, they should take another look around. There is a whole lot going on throughout all the segments of the economy that are, or should be, disturbing. Banks are simply the poster child for the symptoms being suffered by all. A lot of what is wrong is a foreshortening of future perceptions combined with a really scary view into the rearview mirror.

Eighteen months have altered all of our perceptions. Eighteen months ago hordes of investors thought housing stocks were all the rage. Eighteen months ago a prudent investor may have considered buying GM bonds and stock. What pray tell is truely prudent now? Are U.S. Treasuries a prudent investment? Really? You should go to the PIMCO site and see what the experts have to say. If a prudent investor would have purchased GM's bonds eighteen months ago, what would he buy today...and would he be any better off eighteen months from now than the buyer of GM bonds in the past is today? That is the problem.

So if you make steel, or drill for oil, or make paper, or provide accounting services to businesses, or make appliances, or produce chemicals, or mine copper and zinc, what do you do? If you build toys, or airplanes, or computer gear, or mill lumber, or grow grain, or rent cars, or own a chain of restaurants, what do you do? What does a reasonable person do in this economic climate do that has a chance of being right eighteen months from now? You see, when you look in the rear view mirror your vision 20/20. But the future is awfully foggy right now and that has to limit the amount of risk taking going on. People at the top of organizations like to be able to plan. Who can plan right now?

And that 20/20 hindsight is really scarry because millions of prudent people made what they thought were careful decisions eighteen months ago, and today those decisions look insane. That tends to feed the paralysis at the top of every organization. Lack of the ability to plan is a killer for our economy. It is Jack the Ripper stalking our darkened economic thoughts.

January 12, 2009

There is a lot a fine reading on the internet right now. Red and White D sends this link to 'The failure of our 401(k)s', by Tim Rutten on LATimes.Com. I quote it below.

"As a consequence, there's been little discussion of the way in which this economic implosion has exposed the utter failure of the now-ubiquitous 401(k) retirement accounts. In fact, the entire 401(k) system looks increasingly like the sort of bait-and-switch con relished by the Bernie Madoff's of the world.

...Nobody bothered to ask employees whether they wanted to swap their pensions for choice or ownership, nor did anybody stop to notice that very few people are suited by background, ability or temperament to actively manage investments.

If there is such a thing as lethal social poison, it is avarice cloaked in political piety.

Companies seized the opportunity to abandon their defined-benefit pension plans. Today, more than 60% of all U.S. workers rely on 401(k)s as their primary retirement fund. They're not eager to "choose" their own retirement program, nor are they enthusiastic "owners" of American business. They're draftees."

Here is a link to 'Five Things You Need to Know: The Newest Conundrum', by Kevin Depew on Minyanville.com. I quote it below.

"So what is everyone missing? Simple: a structural deflationary debt unwind compounded by a lack of savings and a glut of production and inventory. There are no quick, easy re-flationary [Inflationary] answers to this cocktail of excess.

Only time will resolve these imbalances and, as was the case with Japan's structural deflation, as the recovery unfolds bond yields will remain at unimaginably low levels."

Here is a link to 'Lies, Damn Lies and Value-at-Risk', by Eugene Linden on Minyanville.com. I quote it below.

"The New York Times Magazine weighed in on January 2nd with a cover story on Value-at-Risk by Joe Nocera, a business columnist for the newspaper. Value-at-Risk (VaR, for short) describes various metrics that supposedly provide a hard number for the expected probability of losses as markets and prices change. VaR is accused of giving Wall Street a false sense of confidence about true risk, leaving the financial-services industry vastly more exposed to calamity than investors and regulators realized.

...The VIX, popularly known as the 'fear index.' The VIX is based on the pricing of future options on the S&P 500. If traders are willing to pay more to insure against movements in the market, that means they expect more volatility in the future. The catch: the VIX tends to rise only when markets go down, and to drop when markets are going up.

...What good is an index that tells you of danger ahead only after you've hit the iceberg? Or, to put it another way, what good is a 'fear index' that's blind to emerging bubbles, when fear is most needed?

...Flawed risk metrics and greed brought the financial system to the brink of collapse, but there are 2 final reasons why the crisis became a calamity. One is leverage; the other is Wall Street's inherent herd instinct. Risk metrics gave the green light for living dangerously, and greed supplied the motivation. Leverage provided the rocket fuel and made statistically improbable events fatal.

Perhaps most importantly, what made these fatal but supposedly rare events likely was Wall Street's tendency to say 'me too' when anyone finds a money-making strategy. If Wall Street was a football league, the teams would only play offense, every coach would run up the score, and everybody would use the same set of plays."

Keith sends along this link to 'The End of the Financial World as We Know It', by Michael Lewis and David Einhorn of the New York Times. I quote it below.

"Everyone now knows that Moody's and Standard & Poor's botched their analyses of bonds backed by home mortgages. But their most costly mistake - one that deserves a lot more attention than it has received - lies in their area of putative expertise: measuring corporate risk.

Over the last 20 years American financial institutions have taken on more and more risk, with the blessing of regulators, with hardly a word from the rating agencies, which, incidentally, are paid by the issuers of the bonds they rate. Seldom if ever did Moody's or Standard & Poor's say, 'If you put one more risky asset on your balance sheet, you will face a serious downgrade.'

...But this should come as no surprise, for the S.E.C. itself is plagued by similarly wacky incentives. Indeed, one of the great social benefits of the Madoff scandal may be to finally reveal the S.E.C. for what it has become.

Created to protect investors from financial predators, the commission has somehow evolved into a mechanism for protecting financial predators with political clout from investors. (The task it has performed most diligently during this crisis has been to question, intimidate and impose rules on short-sellers - the only market players who have a financial incentive to expose fraud and abuse.)"

Vegas sends along this link to 'Obamanomics vs. Reaganomics: Let's rumble!', by Paul B. Farrell on MarketWatch.Com.

And finally, Rich Kolon sends this note:

"First a background on the coming events related to the multi-trillion dollar debts that the US government plan.

http://www.financialsense.com/fsu/editorials/schiff/2009/0109.html

Now let's think this thru.

Let's say the government raises the budget deficit to $2 trillion a year. Now that's close to maybe 15% of the entire GDP of the US per year.

There is no way they can tax the people to pay off this amount. It would destroy the ability of private demand to buy the goods and services we produce, and cede it all to the government.

http://www.taxpolicycenter.org/taxfacts/displayafact.cfm?Docid=200

In 2007, the government collected $2.5682 trillion in taxes. Imagine needing $2 trillion more per year on top of it? To pay that extra debt off, taxes (etc.) would have to increase by 80%. There's no way to pay this debt off EXCEPT ultimately by PRINTING MONEY with no intention to repay it (eventual default). And that is what the Fed is likely to now do.

I doubt the world will give any kind of real money (gold, silver) to us to fund this.

Only the Fed can afford to do this - print money to loan the government, and then eat the loss on t-bond defaults. But individuals will see their standard of living go down as the government outspends them for limited resources. Either that, or hyperinflation printing of money will eventually occur until no one accepts dollar bills. (My guess is barter will return.)

The great default on treasury bonds is inevitable.

Rich"

I am comfortable with assuming that the FED and the Feds will just print money to 'borrow' the extra Trillions needed. If all other governments 'borrow' the same way and at the same rate, what will the net effect be?

The U.S. Dollar will neither gain nor lose in relation to other currencies. But no currency will then be worth what it was before, or buy as much as it did. Long term, all commodity prices are going up, by a large amount.

Rich is right, treasuries will be paid back in dollars that are worth fractions of what they were before. What a con.

January 7, 2009

Rich Kolon sent me this link to 'Don't buy Wall Street's latest con', by Paul B. Farrell on MarketWatch.Com. I quote it below.

"But look closely at who's hyping those 'predictions.' You guessed it: Economists, pundits and strategists on the payrolls of the same Wall Street banks (J.P. Morgan Chase, Citigroup and my old firm, Morgan Stanley) that our clueless Washington politicos gave tens of billions of our taxpayers dollars after those banks failed America's investors with their excessive greed, arrogance and incompetence.

Worse yet, last January those same banks 'were also bullish heading into 2008.' Folks, you'd be a fool to believe them. Yet they keep conning us because they know many Americans will buy into the scam again."

In a related vein, here is a link to 'Stock Market Roadmap for 2009',by William Fleckenstein on Minyanville.Com. I quote this below.

"There are massive forces working against each other: Enormous fiscal and monetary stimulus, on the one hand; the undertow of the collapsed housing/credit bubble, on the other. Were it not for the imagination of Paulson and Bernanke, the financial system would have been vaporized.

In any case, the fear of what that undertow will lead to, combined with the damage that's already been done, is spurring the creation of ever-larger government stimulus packages as these 2 forces continue to thrash it out.

My opinion: At some point, it will be clear which force has the upper hand, and we can then decide whether (and how aggressively) to be long or short. But at this juncture, it's difficult to ferret out how and when those opportunities will set themselves up. This is one of those moments where it may really pay to be more liquid and flexible. I prefer to react more and predict less this year - at least until the roadmap becomes clearer."

I still think the Bears will win this one. But Fleckenstein does make a good point about staying flexible.

January 4, 2009

Turn the Machines Back On

Toward the end of the movie Trading Places, the Duke brothers, having lost their fortunes, want to turn back the hands of time, want to go back to the times when money was flowing their way and times were good.

Congress, amongst others, wants to turn the machines back on. The fools in Congress simply do not know what they are talking about when they envision the Federal Government handing out enough money to prop up all the housing prices in the U.S. Between them and Bernanke nearly 1.7 Trillion has already been passed out and not one dime has gone to support house prices. Does this not seem strange when the purpose of the TARP was supposedly to give home owners some relief? Actually, it is not strange at all when you look at the size, the true size, of the problem.

When you talk about house prices, you are talking about real inflation, a real bubble, some real money. This bubble is many many times the size of the Dot-Com bubble. Dot-Com money that was lost was money we actually had, that we had already earned, extra money the average person had in his retirement account. Losses on houses is money nobody ever really had, but money they all still owe, both lenders and borrowers. To bail out home owners we're not talking Billions, we're talking Trillions. I just don't think we, as a people, have the ability to borrow, or even to print, that many dollars. I think the wise in Congress will vote against any such efforts, and also against any more handouts to banks. 2009 will be the year of Consumer Failure.

As for markets, I think we are currently witnessing denial at its worst. The consumer, (remember him?) is not coming back any time soon. We are going to see double digit unemployment before the year is over. We are going to see foreclosures at a rate not seen in a generation at least. Industries of all kinds are going to be shrinking their workforces and their orders. 2009 is when the chickens come home to roost. Brawwk!

But there is always a beacon of hope being held out, isn't there? Right now there are a couple: the January Effect, and the Giant Pool of Money on the Sidelines (Here is a relevant link sent by Red and White D). The January effect will be over, then what will late January look like? We should start getting reports late in this month about the fourth quarter. Hopeful? I am not. Those are going to be grim numbers. When those numbers come out, the DJIA could go from the 10,000s to the 7,000s easily. Money on the sidelines can simply stay there. Most people think the sheep have to emerge from the cave. But, they don't. As the scared sheep watch 2009 play out, they will be less and less inclined to leave the safety of the cave. And the sheep logic will go something like this:

Perfectly wonderful funds have lost twenty or thirty percent in the past year. Badly managed ones have fared worse. Comparatively, I can make twenty or thirty percent on my money simply by not losing it! I think I'll ride out 2009 in the cave, thank you.

The inflation stored away in housing is a huge problem, it is a huge bubble and it will take more than one year (2009) to deflate. The real silver lining will be that house prices will fall, and people who have been saving to build up a 20% downpayment will find that prices will have fallen down into ranges they can afford.

To reinforce what I have just said, here is a link sent by Rich Kolon to the Marc Faber Blog. I quote it below:

"Many investors argue it's dangerous to buy Treasuries with such low yields. While a holder can expect to get repaid in full at maturity, the price of longer-term Treasuries could fall sharply in the interim if yields rise. The 30-year T-bond, for instance, would drop 25% in price if its yield rose to 4.35%, where it stood as recently as Nov. 13. The bear market may have begun Wednesday, when prices of 30-year Treasuries fell 3%. They lost another 3% Friday. - "Get out of Treasuries. They are very, very expensive," Mohamed El-Erian, chief investment officer of Pacific Investment Management Co., warned recently. Pimco runs the country's largest bond fund, Pimco Total Return (ticker: PTTPX)." in Barron`s Online.

...2009 will be a write-off in terms of economic activity.

...Faber thinks the best trade for 2009 is to short US treasuries. That can be done by shorting US 30 Year Government Bond Futures in the CBOT or buying the ProShares UltraShort Lehman 20+ Yr(TBT) ETF. (This might force some sheep from the caves.)

...Given the expansionary fiscal and monetary policy of the United States, 'there will be a time when inflation accelerates along with a weak dollar,' Faber says.

'When that happens, central banks will have to increases interest rates, which will be difficult to implement.'

Red and White D should think seriously about selling into the January Effect. He knows what I am talking about. Remember what the Duke Brothers were saying just before the Machines were turned off? Sell, sell, sell!

December 16, 2008

Here is a link to 'Op-Ed: Ponzi, Ponzi Everywhere' from the Minyanville.Com site. I quote from it:

"This begs the question: If this scam has been in progress for decades, how many of its kind are still out there?"

Here is a link to another in their series on the Madoff scandal:

'Deregulation to Blame for Madoff Fiasco', by Guy Bennett of Minyanville.Com. I quote it below.

"Every financial system requires rules and regulations to function. The PR coup of the 'free-market economists' is that they managed to convince the American public that only little people need rules.

Hogwash. In the late 1990s, when Bill Clinton was president, the financial industry spent $300 million lobbying Congress to deregulate. Astonishingly, Congress went along with it - despite the fact that deregulation of the savings-and-loan industry a decade earlier triggered an orgy of plundering that eventually cost the federal government more than $500 billion.

...In corporate and commercial law, there’s a legal requirement that every contract be negotiated in 'good faith.' Good faith is defined as 'the observance of honorable intent and the avoidance of any attempt to deceive.'

So how is a major bank allowed to go into a poor neighborhood and sell mortgages to people with 'teaser rates' that triple a year later? Why is a guy like Madoff allowed to shuffle around tens of billions of dollars without any branch of the government glancing over his shoulder to see what he's up to?"

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