Friday, February 26, 2010

Weekly Wrap

States are scrambling to fill budget gaps stemming from the Greater Depression. Nationwide, revenues for fiscal years 2010 and 2011 are now expected to fall short of budgeted expenditures by a combined $375 billion. That may sound like a big number--heck, it is a big number--but it is only half the amount that Congress set aside in 2008 to rescue banks in the private sector. That was the TARP bill that passed despite a public outcry. First things first.

But Congress did not stop there. Fully trained in spending money it doesn't have, it then went ahead and, a few months later, passed the American Recovery and Reinvestment Act (ARRA), the so-called stimulus bill. For the states, that meant about $140 billion in new federal aid to help balance their budgets. Not as much as the banksters got, but hey, every little bit helps. The only problem is that the money (light blue in the graph above) will run out by July 2011. If we don't hurry up and have a recovery by then, states will have to find other ways to manage their shortfalls.

Lord knows they are trying. Some are biting the bullet and raising taxes. Others are borrowing; most are cutting spending. Maine, looking at a shortfall of $438 million for its biennial budget ending June 30, 2011, is trying every trick in the book to avoid tax increases. First out of the toolbox is the McKernan Maneuver, named after the former governor who balanced budgets by pushing payments from one fiscal year to the next. Unfortunately, that one does not actually remove the obligation. We still need real money. So earlier this week we learned of a proposal to add new games to the state lottery. Now there's a winner!

Or how about this: on Wednesday the Revenue Forecasting Committee simply revised its revenue projections upward by $51 million. Problem solved, or at least mitigated. You see, the RFC detected a bump in income-tax receipts during December and January and decided to extrapolate that over the remaining sixteen months of the fiscal period. To which I say, Good luck. Those little green shoots are about to get roto-tilled.

What makes me say this? All week the economic news has been dismal. Home sales, both new and existing, were seriously southbound in January, despite the extended First Time Homebuyer's Credit. Auto sales are in the breakdown lane. Durable-goods orders disappointed. Initial unemployment claims are ratcheting back up toward the half-million mark. Bank credit continues to contract (over 10% since the recession began), and "problem" banks, according to the FDIC, are breeding like rabbits.

Option adjustable-rate mortgages are resetting, raising monthly payments for borrowers already struggling to pay the bills. New foreclosure filings are expected on three, four, perhaps even five million homes before the year is out. President Obama is toying with the idea of prohibiting banks from foreclosing on home loans that have not first been screened and rejected by the government’s Home Affordable Modification Program. This will allow borrowers to live rent-free for a few more months, but only delays the inevitable. This shadow inventory of homes in default hangs over the market like the sword of Damocles. Home-builders will not be hiring.

One more thing: at the same time as Maine's revenue estimates for individual and corporate income-tax receipts were revised upward, estimates for sales-tax receipts were revised downward by $30.8 million for the biennium. Someone please explain that one. I remain skeptical that a continued downward spiral in consumer spending, which accounts for 70% of U.S. GDP, will lead to higher incomes.

And it's not just me. Jamie Dimon, CEO of JPMorgan Chase, who makes way more than I do, agrees that the economic outlook is sketchy at best. At his bank's annual Investor Day yesterday, Dimon described his company as "cautious" about the immediate future. "We don't mind holding extra capital right now," he said, "because we don't know what's going to happen. There are huge potential negatives out there." Dimon reiterated that his firm, which currently pays a quarterly dividend to stockholders of a nickel a share, would like to raise it to as much as a dollar, but will do so only when the worst of the global financial crisis is over.

He's still waiting.

Wednesday, February 24, 2010

Home Loans Tanking

Not since May 1997 has the Mortgage Bankers Association's Purchase Index (updated this morning to reflect last week's lending activity) dropped so low. "Housing demand remains relatively weak,” said Michael Fratantoni, MBA's Vice President of Research and Economics. “With home prices continuing to drift amid an abundant inventory of homes on the market, potential homebuyers do not see any urgency to lock in purchases.” Mr. Fratantoni does not even address the shadow inventory of homes entering foreclosure, a number variously estimated at between 3 and 5 million before year's end. So, yeah, a super-supply will undoubtedly pressure prices.

But it's not simply a case of cagey consumers waiting for a better deal. Many do not have the means to pull the trigger. With interest rates at historic lows (and about to explode higher?) and the federal government's First Time Homebuyer's Credit about to expire in a few months, now is a good time to buy for those who qualify. But it ain't happening. The inescapable conclusion is that a double-dip recession is at hand.

Need more data? Two hours after the MBA release came this from the Commerce Department: sales of new homes in the U.S. in January were down 11.2% compared to December and down 6.1% year-over-year. New homes sold at an annualized rate of 309,000, the lowest rate since record-keeping began in 1963.

[click to enlarge]

Monday, February 22, 2010

Friday, February 19, 2010

Weekly Wrap

One-armed economists are in short supply, as President Harry Truman ruefully observed. When prognosticating, economists typically hedge their bets. On the one hand, they begin, before eventually backtracking. But then, on the other hand....

Drove Truman crazy. Notice in the photo above that Fed Chairman Ben Bernanke is using both hands, and with good reason. He remains unsure which way the U.S. economy is heading. Anticipating a weak, protracted recovery, Bernanke has signalled that interest rates will remain low for "an extended period." On the other hand, the Federal Reserve announced last night that it was raising its discount rate a quarter of a percentage point to 0.75%. The discount rate is the interest charged by the Fed, as lender of last resort, to banks needing quick cash.

Technically, this move does not amount to a tightening. The federal funds rate, the rate at which one bank lends funds deposited at the Fed to another bank, remains at 0.25%. The Fed used to keep the spread between the two rates at a full percentage point, but that spread was compressed during the credit-market turmoil of late 2008. With the spread now widening, does Bernanke think that things are getting back to normal?

If he does, hit-and-run trader Jeff Cooper thinks the opposite. The recent tranquillity in the financial markets may be just the calm before the storm. "If the 2008 global meltdown was not just bad subprime loans going belly up," says Coops, "but [instead] a warning sign that the entire world financial structure was overextended and about to unravel, then this is the eye of the hurricane." The widespread concern this week about the sovereign debts of the so-called PIGS may be the first freshening breezes of the back side of the storm.

Whether or not he himself sees the storm coming, Bernanke may be responding to public pressure to rein in the big banks on Wall Street. "Remember," Cooper reminds us, "the Fed isn't a federal agency at all but a cartel of big banks that does the bidding of big banks." And those big banks have been coining money under the Fed's Zero Interest Rate Policy (ZIRP), borrowing low and lending high. But continued high unemployment and credit contraction show that the "flow" is not making it to the real economy. As Christopher Whalen of Institutional Risk Analytics explains, "to date the entire focus of Fed policy efforts [including quantitative easing] has been to temporarily spare the largest dealer banks from losses on securities and not helping the real economy."

Whalen believes that gradually rising interest rates will actually help the economy. "In a fiat money system, ZIRP implies that paper assets have no value. If the Fed wants to break the deflationary cycle that now threatens the global economy and truly restore investor confidence, then it is time to let interest rates start to rise." But there will be losers. The price discovery accompanying higher rates will negatively impact the holders of all those toxic mortgage-backed securities, including the Fed itself, which brought a trillion or two dollars worth of said MBS onto its own balance sheet.

Maybe, in that picture above, Bernanke is weighing his choices. On the one hand, he could save the banksters. Or, on the other hand, he could take the shackles off the broad economy. Let's hope he makes the right choice.

Thursday, February 18, 2010

The Total Package

Lindsey Vonn victorious at Vancouver

Tuesday, February 16, 2010

Mainer Two-peats at Winter Olympics

Seth Wescott

two-time gold medalist from Carrabassett Valley

Monday, February 15, 2010

Friday, February 12, 2010

Weekly Wrap

Judge Still Not Satisfied

Regulators lectured;
Bank execs sweating bullets.

Lawyers, the ones who get all the flak for adding costly friction to the system, will end up the heroes once the Global Financial Crisis runs its course. That's because they are taking names and assigning blame. Foremost among them is Federal District Judge Jed Rakoff (above), who is being petitioned to approve a settlement between the Securities Exchange Commission and the Bank of America over claims that the company withheld material information prior to a shareholder vote in December 2008 to corral the wounded bull, Merrill Lynch. In the weeks after the merger vote, Merrill reported a disastrous fourth-quarter loss while handing out hefty year-end bonuses to top-tier executives. BofA shareholders felt ripped off. After settling their stomachs with meds, they reached for their phones and speed-dialed their attorneys.

The SEC, established after the Crash of '29 to supervise the rascals playing in the Wall Street sandbox, swung into action. O.K., you got me--it slept through the alarm, rolling out of bed only after the New York State Attorney General had started his own investigation and only after a House panel told it to wake the hell up. The Commission puttered around for a few months, then offered Bank of America a $33 million wrist-slap, payable to the federal government. That was less than the janitor's bonus.

Rakoff was outraged. He found two things wrong with the settlement: one, it punished the wrong party (i.e. the shareholders, who were, like, the VICTIMS?!) and two, it failed to identify the perpetrators of the fraud. Other than that, it was a slick piece of work by the gub'mint. Rakoff threw out the settlement and told the commission to do the job right this time.

Five months later the SEC is back with a new settlement. The price tag has been increased to $150 million, and the proceeds now go to the shareholders. The Judge is still not happy. He thinks the payout should be doubled--and maybe doubled again--and should come out of the hides of the over-compensated executives who were so lax with due diligence and disclosure in the first place. Otherwise, shareholders would simply be paying themselves. In an order issued yesterday, Rakoff insisted that "the entire distribution be made to Bank of America shareholders who were harmed by the alleged non-disclosures, and that no distribution be made to to so-called 'legacy Merrill Lynch' shareholders of Bank of America, nor to Bank of America officers and directors who had access to the undisclosed information."

Moreover, the Judge wants further documentation concerning the dismissal by Bank of America of general counsel Timothy Mayopoulos prior to the December 2008 shareholder meeting. The New York AG alleges that Mayopoulos was fired for questioning the company's disclosure, or lack thereof. Rakoff wants to know what's up with that. If he does not get answers, the case will go to trial next month. Memo to BofA: courtrooms are all about disclosure. Of any and all wrongdoing.

Remember all those toxic securities that Congress was so eager to buy through TARP? You know, the ones no one else wanted? Well, there is a whole legion of lawyers trying to sort out exactly to whom those rightfully belong. Thankfully, they do not (yet) belong to us taxpayers. That's because then-Treasury Secretary Hank Paulson, having forced TARP through Congress, took a second look at the merchandise and had a brief moment of clarity: You know what? No one, not even we, can in good conscience push this crap onto the taxpayer. Instead, Hank opted for preferred stock in the banks holding the assets, giving us at least one degree of separation from the ooze.

Stuck with unwanted inventory--and knowing just how bad these mortgage-backed securities are--Wall Street lenders bought default insurance, just in case. Sure enough, distressed homeowners became delinquent on their mortgage payments. Now the insurers, as well as federally chartered guarantors Fannie Mae and Freddie Mac (yeah, we pretty much own them now), are pushing back in court. They claim that the loans were defective by design and were bundled into securities sold without proper--here's that word again--disclosure. The banks are being forced to take many of the loans back. In the words of Christopher Whalen of Institutional Risk Analytics, "The wave of loan repurchase demands on securitization sponsors is the next area of fun in the zombie dance party, namely the part where different zombies start to eat each other." When it comes to cannibalism, nobody does it better than lawyers.

Now let's enter the shadowy netherworld of credit default swaps. This is a whole 'nother universe parallel to the real one in which we live. Here you can buy default insurance for credit instruments that you do not actually own. And you can sell insurance without maintaining any reserves to indemnify buyers should a "credit event" actually occur. You can do these things because you are not regulated, thanks to the Commodities Futures Modernization Act of 2000, the act by which Congress essentially put the SEC into a Rip Van Winkle deep sleep (at least until Congressman Kucinich rang the alarm). You do all these things over the counter, without adult supervision.

By the end of 2007 the CDS market had a notional value of $45 trillion, and the biggest seller of this ghost protection was AIG. In 2008 "credit events" started happening in a big way, triggering massive liabilities at AIG. Unable to pay all the contract holders that came knocking (including Wall Street's biggest dealer banks), AIG tried to negotiate discounted payouts. That's when Timothy Geithner, then head of the New York Federal Reserve, stepped in, suspended negotiations, and ordered payouts at par for all his banking brethren. For that alone he should never have been confirmed as President Obama's Treasury Secretary.

Geithner and Paulson operated under the impression that CDS counterparties were at the top of the food chain in bankruptcy proceedings, senior to all other creditors and shareholders. But New York Bankruptcy Judge James Peck, handling the Lehman Brothers estate, has consigned counterparty risk back to the limbo world from whence it came. This delights Whalen, who views the judge's conduct as "the starkest condemnation possible of the AIG bailout, a hideous political contrivance that ranks with the great acts of political corruption and thievery in the history of the United States." As well, the Peck ruling will further embolden bond insurers and guarantors to seek relief from the sponsor banks who originated shoddy loans, then tried to lay off the risk by selling shady derivatives.

At least one profession has job security these days.

[ Peter Atwater of Minyanville summarizes in this posting, 02-16-2010:]

Where the securitization market once facilitated the movement of loan assets away from originators, the legal system is now moving financial claims the other way -- from investor to asset manager to underwriter or guarantor -- to “bundler” all the way back to the originator. And while we're just at the beginning stages of the litigation/warranty repurchase daisy chain, if the “settlements” so far are any indication, the final figures will be enormous.

Tuesday, February 9, 2010

Middle Class Is MIA

Depth & Duration of Past Recessions
[click to enlarge]

Productivity is killing the middle class....

How long will it take for that job-bleeding red line to get back to zero? Look at the brown 2001 line. It took 24 months for that recession to recover the 2% jobs contraction. If we assume that we're now at the start of the turn, then using the same recovery slope as 2001, it will take 72 months (six full years!) to get back to the previous peak employment at the end of 2007, just in time for the 2016 presidential campaign. If the Democrats think that the mid-term elections will be tough this November, wait until 2012 if the recovery is only to -4% on this chart. At least the start of the Obama Presidential Library in 2013 will generate some construction jobs.

--James Anderson, Minyanville

Click on
to watch the lights go out on the middle class

Monday, February 8, 2010

Friday, February 5, 2010

Weekly Wrap

The number that spooked Wall Street yesterday was the figure released by the U.S. Labor Department showing initial claims for state unemployment benefits. The 480,000 reported was up from the week earlier and higher than the four-week moving average (plotted above). After a peak approaching 700K a year ago, job turnover has lessened considerably since. Still, as John Thomas (a.k.a. the Mad Hedge Fund Trader) points out, there is room for improvement:

Someone once asked PIMCO’s bond king, Bill Gross, if he were stranded on a desert island and could get only one statistic on which to base investment decisions, what would it be? He didn’t hesitate. Initial claims for unemployment insurance, released by the Labor Department every Thursday at 8:30 am EST, gives the best real time snapshot of economic activity... During the first half of 2009, more than 600,000 new claims a week were common. Since then, they have dropped to a still serious 450,000/week, indicating, at best, a tepid recovery. When claims drop below 400,000, the unemployment rate will stop rising, below 350,000 a recovery is in progress, and below 300,000 the boom times are back.

This "morning after" the mini-meltdown in the markets brought the monthly unemployment report from the Bureau of Labor Statistics, and investors are having a hard time grappling with the data. The report gave mixed signals as to whether jobs were added or lost in January. The Establishment Survey says we lost 20K. The Population Survey says we gained 785K, a number that, if believed, should be igniting a rally in stocks. But the report cautions that, effective January 2010, the latter survey uses "updated population estimates" and may be overstating the job gain by 243K. The apples-to-oranges comparison is apparently confusing not just me. As of 10:55 a.m. the Dow is unchanged.

Nobody is talking about the Adjusted Household Survey number, a series that attempts to reconcile the CES and CPS numbers. That one is +841K! Maybe we should take these preliminary numbers with a wheelbarrow of salt; they will just get revised again (and again) anyway. For example, December's CES figure got changed from -85K to -150K. An annual benchmark revision moved up the job-loss figure for all of 2009 another 617K, bringing the two-year recession total to 8.4 million. As Benjamin Disraeli once said, there are three kinds of untruths: lies, damn lies, and statistics.

Channeling Disraeli, Mike Mish Shedlock points out that the BLS massages the unemployment data even more than usual in the month of January. And he has a graph to prove it:

[click to enlarge]

The rest of every year is spent reverting to the mean. All this suggests that the 9.7% unemployment rate reported for January is a myth and that we could easily see 11% by summer. TrimTabs, working backwards from tax-collection data, calculates that the number of jobs lost in January likely exceeded 100K, or five times more than the "official" number.

On the bright side, the average work week inched up in January another six minutes, which, believe it or not, is the wage equivalent of tens of thousands of jobs. State governments, obliged to balance their budgets, cut 41,000 jobs last month. The federal government, under no such budget constraint (more on that below), added 33,000 jobs. You can thank our creditors (China et al.) for those. All in all, the BLS report was a wash. But whatever the real job numbers are, they need to improve dramatically, and soon. Adjustable-rate mortgages across the land are ready to explode. Disarming them will require millions of new jobs, not thousands.

President Obama's FY2011 budget was greeted with angst when it was rolled out to the press on Monday. You got the heads-up here last Friday that the headline number on the expenditure side was going to tickle $4 trillion, 40% to be funded by new debt. I'll say it again--four trillion dollars. Hopefully by now I have trained you to look for the REAL number.

Before we can find that one, we must review how the federal government keeps its books. Unlike all the banks it regulates, it uses the cash method of accounting, tracking only current expenditures. The Citigroups, the JPMorgans--all those financial institutions that we love to hate--use the accrual method. They attempt to project costs beyond the present and will reserve some of their earnings to meet those future liabilities. The global financial crisis that has been brewing since the summer of 2007 can be blamed on the failure of the banks to reserve enough for the future in light of the high degree of risk that they were undertaking with subprime and subslime lending.

Federal regulators are now (a bit late, I would say) tightening up on the banks, raising capital requirements. But who is overseeing the federal government, which has been piling up liabilities within its entitlement programs (primarily Medicare and Social Security)? It is supposed to be holding monies in trust for future pay-outs, monies paid into the system by employers and employees under one of the government's original mandates. But since the days of hey-hey-LBJ, the government has been raiding the trust accounts to fund current operations, creating future liabilities without tracking them in annual budget statements. If we were properly reserving for future pay-outs, we would be showing much higher deficits.

On Christmas Eve, Treasury Secretary Timothy Geithner gifted taxpayers with the announcement that the federal government would backstop all home mortgages held by GSEs Fannie Mae and Freddie Mac. Presto! Trillions in new liabilities added to our collective balance sheet, all without congressional approval. Which brings us back to the question, what is the real annual federal deficit? Answer: no one knows. But the number must come from a certified public accountant (any of those in DC, or are they all attorneys?) and is assuredly some multiple of the $1.556 trillion that the Big O is proposing for 2011. The Government Accountability Office, which audits the books, will not even hazard a guess, offering this disclaimer:

Because of the federal government's inability to demonstrate the reliability of significant portions of the U.S. government's accompanying accrual basis consolidated financial statements for fiscal years 2008 and 2007, principally resulting from certain material weaknesses, and other limitations on the scope of our work, described in this report, we are unable to, and we do not, express an opinion on such accrual basis consolidated financial statements.

"No opinion" means the numbers are worthless. As the debt rolls forward to our children and grandchildren, I will whisper in their ears the magic words. Strategic default. That's right, it's time to repudiate the national debt. It is not morally defensible for one generation to sell another one (or more) into slavery. And what would I say to the creditors, the ones holding all those Treasuries? Tough noogies. You took on the risk, you suffer the consequences. In the Mother of All Workouts, you bondholders, as always, will have to take a haircut.

There, glad I solved that one.

[update, 02-08-10: In this Bloomberg interview, Marc Faber calls U.S. debt "junk."]

[Niall Ferguson in a
Financial Times column, 02-11-10:

US government debt is a safe haven the way Pearl Harbor was a safe haven in 1941. Even according to the White House’s new budget projections, the gross federal debt in public hands will exceed 100 per cent of GDP in just two years’ time. This year, like last year, the federal deficit will be around 10 per cent of GDP. The long-run projections of the Congressional Budget Office suggest that the US will never again run a balanced budget. That’s right, never.]

Monday, February 1, 2010