Year-End Wrap

I think we go into the Japan scenario.
I think there's no escaping.

[A lost decade.]

Right.

--Charles Nenner,
interviewed by John Thomas, 12-10-2009
(Hedge Fund Radio)

Cycle analyst Charles Nenner (see website) predicts that stocks and bonds will sell off beginning the second week of January, leading to a painful double-digit correction. Longer term, he sees a low- to no-growth economy for the next decade, a baked-in consequence of the debt bubble created during the past two decades.

It would be a mistake to think that all that bad debt has disappeared. Some has made it onto the Federal Reserve's balance sheet (see the powder-blue slice in the graph below). As James Turk explains in his Free Gold Money Report, for the past year the Fed has been buying toxic debt that nobody else wants--with "money" that did not even exist a year ago:

The Federal Reserve now owns over $1 trillion of mortgage-backed securities...[and has become] very highly leveraged, much more than most banks. It is carrying $2,157.0 billion of debt on $52.8 billion of capital, giving it a leverage of 40.8-times more debt than capital. The mortgage-backed securities it owns are 19-times greater than the Federal Reserve’s capital, meaning that if the true value of these assets is 5.3% less than their book value, the Federal Reserve’s capital is depleted, effectively making it another insolvent institution...It remains liquid because banks continue to provide it with funding and because people continue to accept in commerce and use without question the Federal Reserve’s liabilities, i.e., the paper currency it issues. But for how much longer? (www.fgmr.com)

In addition to the $1 trillion in MBS purchased outright, there may be hundreds of billions more (a public audit would tell us for sure) offered as collateral for the loans pictured in green. This toxic brew is a ticking time bomb.

Happy New Year, indeed.

Monday Muse

Alison Krauss

Simple Gifts

Weekly Wrap

This work week is abbreviated, and so was the "recovery." This morning brought a double dose of bad news for the housing industry, which is being counted on to lead the U.S. out of recession. First, the Mortgage Bankers Association Purchase Index (above), tracking mortgage applications for planned home purchases, made a U-turn south last week, declining over 11% from the week before, seasonally adjusted. The raw index was down almost 33% from the same week last year.

Then came a report from the Commerce Department that annualized sales of new homes in November declined over 11% (to 355,000) from the month before--even after October's figure was revised downward from 430K to 400K (the five months ending in October were running at 404K). The back-to-back announcements of double-digit drops from already depressed bases brought a screeching halt (at least for now) to this week's rapid rise in bond yields. Such a rise generally signals a pick-up in economic activity.

GDP growth in the third quarter was revised downward again, to 2.2% (after an earlier revision from the initially reported 3.5% to 2.8%). It has been estimated that the now- defunct Cash for Clunkers program added 1.5% to Q3 GDP, and a replenishing of inventories accounted for the remaining growth. Otherwise, GDP was flat. Again, from a depressed precursor. Despite massive government stimulus. Take that to the bank, why don't you.

Intent on further crippling the economy, President Obama continued his full-court press on Capitol Hill for healthcare reform. Needing two votes to invoke cloture in the Senate, the prez larded the bill with the "Cornhusker Kickback" and the "Louisiana Purchase," exempting Nebraska and Louisiana from any cost-sharing for future Medicaid expansions. The other 48 states can go [abuse] themselves. It is just this kind of horse-[trading] that gets me thinking about secession.

In last week's pep talk at the White House, the Big O told Senate Democrats that they were "on the precipice" of an historic accomplishment. The President is known for his careful choice of words:

prec·i·pice

n.

1. An overhanging or extremely steep mass of rock, such as a crag or the face of a cliff.

2. The brink of a dangerous or disastrous situation: on the precipice of defeat.

Tomorrow at 7 a.m. the Senate will most likely pass its version of healthcare reform, taking us all one step closer to the edge.

Jobs will be hard to come by, with or without healthcare legislation. Late yesterday Cintas Corporation, the largest U.S. supplier of work uniforms, reported disappointing quarterly earnings. Today investors dumped the company's stock, sending the share price down by more than 11%. (What is it with this number eleven?) Clearly the company's fortunes are tied to job creation. When asked to provide guidance for upcoming quarters, CFO Bill Gale gave none, saying only that "we believe the current analysts' estimates are overly optimistic for the remainder of this fiscal year and into 2011." Get that? Two thousand eleven.

In other words, investors betting too soon on a recovery will lose their shirts.

History Harmonizes

[click to enlarge]

"History does not repeat itself, but it does rhyme."

--Mark Twain

Monday Muse

Linda Ronstadt

Blue Bayou

Weekly Wrap

The charade is over. Citigroup's busted stock offering late Wednesday has exposed the banking industry's game of "extend and pretend." Flash back to last March, when investors recognized that Citi and many other banks were hopelessly undercapitalized for a coming tsunami of loan defaults in commercial and residential real estate and in consumer credit-card debt. Citi was trading at a buck, Bank of America at three. Wells Fargo traded briefly at a hat size, and the two Morgans, Stanley and Chase, were teenagers.

Then ensued a seven-month rally that saw these stocks triple, quadruple, even quintuple. The rally was aided and abetted by the U.S. Treasury Department, which first injected tens of billions of TARP dollars directly into the banks, then certified their health with feeble "stress" tests. The Federal Reserve helped by bidding for toxic assets, taking some off the banks' balance sheets and enabling an artificial mark-up of what remained. Smitten investors bought the lipstick. New share offerings were snapped up as investment banks bulled (and underwrote) each other's stock. For two quarters, losses turned to profits, thanks largely to inflated asset prices. The government's pump-and-dump scheme seemed to be working.

Treasury actually got cocky. Earlier this month Treasury Secretary Timothy Geithner blithely announced that almost all of the $370 billion jettisoned by TARP in last year's bail-out frenzy would be recovered. Then the Department reached for $90 billion of it just in the past week, allowing Bank of America, Citigroup, and Wells Fargo to repay government loans. Mission accomplished? Not yet, according to bank regulators, who remain unconvinced that the Three Amigos (particularly Citi) are ready for prime time on their own.

Which may be precisely the point. With a flood of foreclosures coming after the new year, Geithner must have realized that zombie investors will soon wake up, closing the window for new capital raises. He therefore fired his starting pistol, and the race to the window was on. Bank of America got there first, followed quickly by Wells Fargo. By the time Citi got there, the window, while not completely shut, was on the way down. Citi had to discount its shares by 20% to clear the merchandise.

Citi's $20.5 billion offering is the largest in U.S. history. There are now enough Citi shares in circulation to allocate four to every human soul now walking the planet. To placate regulators, Treasury had stipulated that Citi repay the TARP loan entirely with fresh capital--in sharp contrast to BofA and Wells Fargo, required to raise only half of their TARP refunds. Treasury still owns an equity stake in Citi and was hoping to ditch some of it on the heels of the offering, but postponed those plans when the new share price put its investment--our investment as taxpayers--underwater. My expectation is that Citi's stock price retreats from here, that we'll be so far underwater in the next six months that we'll be feeling the bends.

The Federal Deposit Insurance Corporation's budget for 2010 was approved by its board earlier this week, expanding from $2.6 billion in 2009 to $4 billion. Why the 54% jump? Simple. Bank failures will accelerate in the coming year because of the above-mentioned tsunami of loan defaults. The FDIC's job is to clean up the mess, transferring assets to healthy banks and making depositors whole.

The FDIC is an independent agency, funded not by Congress, but by premiums paid by banks and thrift institutions for deposit insurance coverage. Established during the First Great Depression, it is not part of the federal budget process and has its own fiscal year. The agency expects to boost its staff by 1,600 (23%) to handle the coming workload. Its job is to protect $4 trillion (with a "T") of deposits, and right now its Deposit Insurance Fund stands at--could this be?--negative $18.6 billion.

That's the new balance after seven more banks folded late today, bringing the total for 2009 to 140 (with an overall hit to the DIF of over $30 billion). As these magnificent seven were deep-sixed, a new concern arose: there may not be enough healthy banks left to take over the casualties. For two failed banks in Michigan and Illinois, temporary "bridge" banks were set up to handle customer accounts. The affected Michigan depositors will have 45 days to get their money out before the temp closes. Depositors at a failed Georgia bank will simply be mailed checks.

The new mantra for orphaned clients of a damaged industry: What's in your mattress?

Fat Cats Put on Diet

Riddle: How do you get an insolvent company to pay back the money it owes you? Answer: Threaten to cut the CEO's pay.

That's what "special master" Kenneth Feinberg (a.k.a. the Pay Czar) is doing. Appointed by the President, Feinberg is reviewing the executive compensation paid by firms receiving "exceptional assistance" last year from the Troubled Asset Relief Program, or TARP. He wields the kind of power that Huey Long-ed for 75 years ago.

Quick history lesson. Huey Long (pictured above) was a fiery populist from Louisiana who managed to serve as governor and U.S. Senator simultaneously. How's that for clout! He had such a stranglehold on state politics that he became known as The Kingfish. His popularity with the voters arose from his conviction that wealth in the U.S. should be distributed more evenly. He wrote a book titled Every Man a King and promoted a "Share Our Wealth" plan, calling for a guaranteed personal income of $2,000 and a maximum allowable income of $1 million. Anything over that would be subject to a 100% tax rate. An individual's accumulated wealth would also be taxed--at a rate of 0% for the first million, rising geometrically until it reached 100% for anything over $8 million. For the mathematically challenged, 100% is spelled C-O-N-F-I-S-C-A-T-I-O-N. (Multiply dollar threshholds by 15 to get today's inflation-adjusted equivalents.)

In 1935 Long was positioning for a third-party run for President, but then got himself shot to death in the state capitol building in Baton Rouge. By a doctor. Administering what they call high-velocity trans-abdominal lead therapy. Actually, there was no forensic examination to determine conclusively that Long was killed by his assailant, and not accidentally by one of his bodyguards, of whom he had many. Anyway, Huey was way larger than life. An estimated 100,000 mourners filed past his open casket in the state capitol rotunda.

But I digress. Today Ken-fish gets to finish what The Kingfish yearned to start: a whittling down of Wall Street salaries. In Round One, Feinberg went after the 25 most highly paid executives at each target firm. The cuts, announced in October, average 50% for total compensation (salary, stock, and benefits) and 90% for cash compensation. This week brings the bad news for second-tier executives, numbers 26 through 100, who are capped at $500,000 annually (no more than 45% to be paid in cash). Feinberg apparently can exercise some discretion. Exemptions may be granted for the most deserving, and the least deserving (think AIG) get hammered down further to $200K.

Huey must be salivating in his grave.

Sean Penn as Gov. Willie Stark in All The King's Men

Monday Muse

Emmylou Harris

To Know Him Is To Love Him

Weekly Wrap

The Incredible Shrinking Paycheck. Last week's announcement by Bank of America that it would pay back $45 billion in TARP money doled out by the feds a year ago was a desperate move to clear a salary cap imposed by pay czar Kenneth Feinberg. The cap was crimping the company's ability to hire a suitable replacement for outgoing CEO Ken Lewis. To stay competitive, Citigroup said this week that it would follow suit, returning $20 billion to TARP (another $25 billion had been converted to common stock, which the government plans to sell "in an orderly fashion" in 2010). So are bank execs home free? Not quite. Under pressure from shareholders, Government Sachs...sorry, Goldman Sachs (the first bank to exit TARP) revealed yesterday that its top managers would not be receiving cash bonuses this year, but rain checks instead, in the form of "shares at risk" that cannot be sold for five years and may be revoked for poor performance.

Speaking of TARP, Treasury Secretary Timothy Geithner said yesterday that the program would cost taxpayers $200 billion less than earlier projected, thanks to the paybacks of principal, dividends on outstanding investments, and proceeds from the sale of warrants (JP Morgan Chase warrants held by the government were just auctioned off for nearly $1 billion). Still, the program may not break even, as tens of billions allocated to AIG, GM, and Chrysler will not be coming back. Moreover, the TARP kitty is now treated by the Obama Administration as a revolving slush fund for additional economic stimulus. In other words, money successfully recovered will be put back at risk until it gets vaporized, all to buy your vote.

What should the TARP balance be used for? How about, as bank analyst Richard Suttmeier suggests, for rebuilding the Deposit Insurance Fund, which has gone negative in the last month? Every time the FDIC closes a bank, the DIF takes a hit. FDIC Chair Sheila Bair wants prepayment of three years' worth of premiums from insured banks to put the DIF back in the black. But with hundreds more banks likely to fail in the next 12-18 months (including three announced tonight), that won't be enough. An unfortunate consequence of the ongoing credit crunch is the subordination of depositors to derivative counterparties whenever a bank must liquidate. Of all people, savers should be made whole. They're already getting punished enough with dollar devaluation. Why should they have to stand in line behind zombie investors?

Maine revenues may be stabilizing. Yesterday the Legislature's Appropriations Committee received a report that General Fund revenues came in slightly over budget in November, a welcome contrast to the first four months of the fiscal year, when revenues were 8.3% under budget and down 9.3% year-over-year. Of course, one month does not a trend make. Furthermore, it was exactly one year ago when the state's revenues went into cliff-drop mode, so merely matching year-ago revenues going forward will be no big accomplishment. Certainly not a victory, but maybe we can stop retreating.

Still out of control on the expenditure side. Maine's very own public option, Dirigo Health, continues to bleed cash, so much so that it has had to borrow $25 million from other state accounts to maintain service to 8,636 Dirigo Choice subscribers (new applicants not wanted). Yesterday members of the Appropriations Committee asked when the $25 million would be repaid. "Search me," said Dirigo's executive director, Karynlee Harrington. Wrong answer, said an exasperated Bill Diamond, Committee Chair. "All the projected good news never seems to materialize," complained Diamond, a Democrat no less who is no doubt embarrassed that his party has owned this one since way before it was broken.

Exercising damage control, the governor's office wrote up a clarifying statement for Ms. Harrington, who late today passed the cut-and-paste job on to the press. The cash advance, the Harried One now insists, will be repaid by the June 30 due date, and in her (boss's) view legislators need not treat the missing money as a new liability to be added to the state's growing shortfall. So what exactly is the reason for the cash crunch? "Members are not terminating" fast enough, said the director on Thursday. (Does that mean not dying fast enough?) "Lower attrition than forecasted," said today's statement. In other words, the lower the enrollment, the healthier the balance sheet. Some business plan. Logical next step: reduce the enrollment to zero (not by everyone dying, but by taking the money away). As Tarren Bragdon has said, Dirigo should be Diri-gone.

Monday Muse

Christine McVie of Fleetwood Mac

Warm Ways

Light At the End of the Tunnel?

Perhaps not an oncoming train after all. Employment figures released this morning by the Bureau of Labor Statistics have everyone excited. The U.S. economy shed only 11,000 jobs in November. One must go back to December 2007 to find a better number than that. Moreover, job losses for September and October were revised lower by 159,000. The average work-week rose from 33.0 to 33.2 hours last month, while the unemployment rate dropped from 10.2% to 10.0%. These are all good signs.

Caution is still warranted, however. David Rosenberg of Gluskin Sheff points out that the raw number (not seasonally adjusted) was 80,000 jobs lost, coming in a month when traditionally 300,000+ jobs are added (holiday hiring and all that). Private-sector jobs dipped by 18,000 last month (and 4.7 million year-over-year), more than offsetting a gain in government jobs of 7,000. Since the former ultimately pay for the latter, we can deduce that government borrowing (how sustainable is that?) mitigated the overall erosion. The adjusted household survey showed a bleaker number: 109,000 jobs lost. And remember, the true "break-even" number for employment is not zero, but roughly +100,000. The economy must add that many jobs monthly to accommodate the growing workforce. Any fewer reduce hours worked per capita and, presumably, our collective standard of living.

Bank of America to repay TARP loan. Yesterday's headline, at first glance, suggests that things in the financial sector are getting back to normal. Don't be fooled. Sure, taxpayers are getting their $45 billion back, plus interest, which is cool for them. But risk has not been eliminated, just transferred back to BofA creditors and shareholders. The latter face further dilution with a new $19.3 billion stock offering, which, if you do the math, is not enough to replace the cash going back to Uncle Sam. The reduced Tier I capital ratio is not comforting news to bondholders.

Let's face it, the company had to repay Uncle Sam in order to create some wiggle room for executive compensation. With the TARP overhang, BofA's Board was simply unable to hire a replacement for CEO Ken Lewis, who wants to leave at the end of this month. Remember, the Adminstration's pay czar docked Lewis his entire salary for 2009. Who wants to take a job sparring with regulators, bankrupt customers, antsy bondholders, and aggrieved shareholders--all represented by legions of lawyers--for no pay?

How about the FDIC's Q3 Banking Profile? Released last week, the report revealed that the number of "problem" banks rose by 136 in the third quarter to a 16-year high of 552, with total assets at risk rising by 15% to $345.9 billion. Additionally, 50 banks failed during the quarter and are no longer counted. Think about it. For every bank that failed, nearly four more were added to the "problem" list (kind of like that mythological serpent Hydra with the nine heads: cut one off, and two grow back). Today is Friday, so we'll get to see how many more heads roll.

[update, 8 p.m.--Six more banks bite the dust, three in Georgia, one each in Virginia, Ohio, and Illinois. That makes a total of 130 in 2009, with three weeks to go.]

Also reported by the FDIC was a 10.5% increase in noncurrent loans and leases (90 or more days past due) to $366.6 billion, or nearly 5% of all loans and leases--the highest noncurrent rate in the 26 years that insured institutions have reported. Data from other sources detail the tenuous state of the union:

One in 7: home mortgages that are 30 days past due or in foreclosure.

One in 3: home mortgages with negative equity.

One in 5: mall storefronts that are vacant.

One in 8: Americans receiving food stamps.

One in 6: workers who are unemployed or under-employed.

One in 5: Americans eligible for Medicaid.