Nuking the Nestegg

BREAKING: BAC sinks to a 52-week low.

Know when to hold 'em, know when to fold 'em. Last we knew, MainePERS was holding 'em--2,545,137 shares of Bank of America stock (as of September 30). At the end of today's trading, the stock (ticker symbol: BAC) closed at $10.94 a share. It has not traded this low since June 2009. It is down almost 9 bucks since a springtime high of $19.86. In other words, MainePERS has lost approximately $22.7 million on this sucker since it peaked.

The worst may be still to come. Julian Assange of the whistleblower website WikiLeaks promised in an interview earlier this month to release internal documents from one of the nation's biggest banks. The documents, Assange told Andy Greenberg of Forbes magazine, will uncover "flagrant violations, unethical practices." Mathematicians have put two and two together and fingered Bank of America.

From the Forbes interview:

[Greenberg:] These megaleaks, as you call them, we haven't seen any of those from the private sector.

[Assange:] No, not at the same scale as the military.

Will we?

Yes. We have one related to a bank coming up, that's a megaleak. It's not as big a scale as the Iraq material, but it's either tens or hundreds of thousands of documents depending on how you define it.

Is it a U.S. bank?

Yes, it's a U.S. bank.

One that still exists?

Yes, a big U.S. bank.

The biggest U.S. bank?

No comment.

When will it happen?

Early next year. I won't say more.

[Stay tuned.]

[update, 12-02-10:]

In a Bloomberg column this morning, Jonathan Weil explains how accounting irregularities at Bank of America may be disguising the company's exposure to toxic mortgage-backed securities. Bank officers thought they sold 'em; courts may decide that they still hold 'em. "The transfer of a financial asset," writes Weil, "may have to be treated as a secured borrowing" instead of a sale, absent a proper transfer of notes and documents. If courts determine that the dog ate the documents, the assets will come back to BofA--severely depreciated, I might add. Lesson for today: don't trust Wall Street's balance sheets.

Risk on.

[update, 12-06-10:]

Moody's analyst David Fanger published the following this morning:

"We still don’t know to what extent their [i.e. BofA/Countrywide's] documentation and transfer process was defective. Any such defects will increase foreclosure timelines and costs and in some cases may preclude the servicer from enforcing the mortgage altogether. We also believe the case will encourage other mortgage borrowers as well as investors in Countrywide securitizations to challenge BofA. We expect this will increase servicing and litigation costs for BofA, and could reveal defects in BofA’s mortgage servicing processes, exposing the bank to further unfavorable legal decisions."

Full comment viewable here.

Still want to own this bank?

Solution--or Dissolution?

All is not well in the Eurozone.

Will the Irish bailout plan fly? Cobbled together by European ministers over the weekend, the €85 billion financial rescue package is sure to rile the citizenry. For one thing, the first €17.5 billion is not external aid at all, but a transfer from other government accounts, most particularly Ireland's national pension reserve fund. That money amounts to half the €35 billion set aside for the country's struggling banks. The other €5o billion will go toward sustaining government expenditures.

The €67.5 billion in external loans (almost 90 billion in U.S. dollars) will carry an interest rate of 5.8%, less than the 9% currently demanded by private markets, but punishing nonetheless. This new debt comes to almost $20,000 per Irishman, woman, and child. Service on the debt could reach 20% of the Irish government's annual tax revenues by 2014.

There is still no demand that bank bondholders share in the pain. They will be fully protected until at least 2013, or so the powers-that-be proclaim. Ordinary folks have other ideas. The Irish electorate may have an opportunity as early as next year to vote out its present government, which now enjoys a 13% approval rating, according to recent polls. Prime Minister Brian Cowen, who insisted just weeks ago that Ireland did not need a bailout, now calls the new loan facility "the best deal available." But will it work? Read his lips (below).

Quote for the Week, Nov. 28-Dec. 4, 2010

Alexander Hamilton started the U.S. Treasury with nothing, and that was the closest our country has ever been to being even.

--Will Rogers

Edifice Complex

Telling It Like It is:

Nigel Farage upbraids the European Parliament,

predicts Eurozone collapse.

Bleak Friday

Lift-off:

Spanish-German bond spread soars to euro-era high.

"So what,"

says Spain's PM...

"Bring it on!"

While American shoppers were stampeding through store aisles like the bulls of Pamplona in the wee hours this morning, Spanish Prime Minister José Luis Rodríguez Zapatero (above) was trying to hold off the bond bears in Europe. Spain, you see, is the biggest of the Club Med deadbeats. Bond investors, wary of possible default, have driven the yield on Spain's ten-year bond up to 5.2%, or roughly double that of the rock-solid German bund. For holding such a risky asset, they rightly insist on getting paid accordingly.

Then there are the speculators who do not own Spanish bonds, but are selling them anyway, betting on still lower prices. Those notorious shortsellers are no better than wolves in the minds of many. They strike in packs and can do big damage. Zapatero challenged them in an interview earlier today. “I should warn those investors who are short selling Spain," said the Zap Man, "that they are going to be wrong and will go against their own interests.” So there.

History tells us that the bond vigilantes are not so easily intimidated. In fact, Zapatero's taunting is about like the South Koreans telling the North Koreans that they can't hit the broad side of a barn door. (That the North Koreans can we now know, because they just did.) Zapatero needs to understand that there are truckloads of testosterone coursing through the financial markets. You cannot thumb your nose at shortsellers with any expectation that they will slink away quietly into the night.

Greece (last spring) and Ireland (last week) have already applied for bailouts for their failing sovereign debts, and Portugal appears to be next. But Spain is the Big Daddy. Some question whether the European Financial Stability Facility, the the €750 billion rescue fund set up by the European Union and the International Monetary Fund, is even big enough to to save Spain. Right now it is all a confidence game. And the 8% hit to Spain's stock market just in the past week (along with sky-rocketing bond yields) suggests that confidence is waning rapidly.

Congress Choosing Well, Per Usual

[click to enlarge]

above: a slide from a presentation by

Douglas Elmendorf, Director

Congressional Budget Office

on November 19, 2010

to the National Tax Association

"The United States faces a fundamental disconnect between the services that people expect the federal government to provide, particularly in the form of benefits to older Americans, and the tax revenues that people are willing to send to the government to finance those services."

Quote for the Week, Nov. 21-27, 2010

The most significant characteristic of modern civilization is the sacrifice of the future for the present, and all the power of science has been prostituted to this purpose.
--William James

Falcons Rock On

credit: Derek Davis, staff photographer

Maine Sunday Telegram

Mountain Valley 20, Leavitt 0

Fourth state "B" championship in seven years.

Cassandra on Cue

Banking sector still under pressure,

says financial analyst Meredith Whitney

in this Financial Times interview

[6 min.]

80,000 layoffs coming.

(Not to mention a meltdown in the muni market.)

[postscript, 11-19-10:]

The Meredith Whitney Advisory Group, founded by Whitney in 2009, is seeking SEC approval to be licensed as a credit-rating agency, entering a field dominated by the Big Three--Moody's, Standard & Poor's, and Fitch. Her company evaluates credit risk for corporate bonds, U.S. municipal bonds, and global structured products. In her view, the Big Three did a poor job of this in the years leading up to the global financial crisis and have "lost all credibility on securitization" after consistently overrating toxic securities. Whitney outlines her challenge in this four-minute interview with Financial Times.

Whitney fills out another Big Three, joining Elizabeth Warren and Sheila Bair as arbiters of transparency in high finance. Warren has chaired the Congressional TARP Oversight Panel and is the President's special advisor on the newly created Consumer Financial Protection Bureau. Bair chairs the Federal Deposit Insurance Corporation and has been known to mix it up with the biggest Wall Street banks over their lack of disclosure and undue risk-taking.

Memo to MainePERS: It's Not Too Late To Sell

Market-Ticker's Karl Denninger

on Hedge Fund Radio:

"potential wipe-out" for TBTF banks

If you are a beneficiary, now or in the future, of Maine's Public Employees Retirement System, you may want to click away from this page. Go somewhere else, anywhere else. Keep having your nice day. Nothing to see here.

With that up-chuck alert out of the way, let's get down to business. You already know that the State of Maine's pension fund is over-exposed to stocks generally, and to bank stocks specifically. As discussed earlier, the MainePERS portfolio has lost $20 million since mid-April in share-price depreciation for two of its largest holdings, JPMorgan Chase and Bank of America. Our "passive" fund managers continue to hold one million shares of the former and 2.5 million shares of the latter, apparently under the assumption that what goes down must go back up.

Karl Denninger is here to remind you that what goes down in the stock market can go not up, but to zero. Denninger, in a radio interview with the Mad Hedge Fund Trader, John Thomas, points out that there are still real-estate losses out there, over $2.5 trillion worth, looking for a home. They will find one in the Too Big To Fail banks (aka JPMorgan, Bank of America, and others of their ilk). The banks' exposure to "put-backs" of defective mortgages and fraudulent securities is estimated at $200 billion. And their exposure to second mortgages (typically home-equity lines of credit, or HELOCs) may be even greater. So far the banks have been able to hide their exposure through creative accounting. Denninger gives them another three to six months "before it becomes impossible to hide anymore."

[If you cannot catch the whole 40-minute interview, slide ahead to the 12:00 mark and listen to the next eight minutes. All you need to know, right there.]

Other fund managers are bailing on the banks. Why not MainePERS? Listen to David Tepper, the hedge-fund manager who famously declared on CNBC in late September that the Fed's latest round of quantitative easing is a "win-win" for stock investors. Better yet, watch what he does. As of June 30, 2010, Bank of America was his largest holding, 27.3 million shares valued at over $360 million. At the same time that he was pumping equities on TV, he was dumping 18% of his BofA.

Ditto the legendary John Paulson. As of September 30, 2010, Paulson had nearly 8% of his $23 billion portfolio in Bank of America, his third largest holding. That was after trimming 18% of his BofA in the third quarter. A year ago Paulson had a 2012 price target of $30 a share for the stock. Now he's selling it in the low teens. What does he know that MainePERS managers do not?

In Denninger's view, 2011 will be a case of sugar-hits-fan. You've heard of 30/30 players in baseball. How about this one? Denninger is looking for a stock-market meltdown that takes the S&P 500 average to 300 and the Dow to 3,000. Those valuations, which are 75% lower than where we are today, will reveal the "embedded pension fund damage" that is already in place, though not yet recognized. Eventually the federal government will step in and try to stop the bleeding. Public pension funds will be allowed to redeem their beaten-down stocks for 30-year Treasuries yielding 2%. In Denninger's words, it will be "the ultimate screw job."

But if you have clicked away like I told you to, you are still having a nice day.

[update, 11-17-10:]

Christopher Whalen of Institutional Risk Analytics explains in this five-minute interview why the big banks are a Sell. To quote, "a lot of losses in the system investors haven't seen yet...we have a distressed sale going on with some of these larger banks."

James Grant,

"How To Make the Dollar Sound Again"

[excerpt:]

"The classical gold standard, the one that was in place from 1880 to 1914, is what the world needs now....

For a convertible currency is a sophisticated, self-contained information system. By choosing to hold it, or instead the gold that stands behind it, the people tell the central bank if it has issued too much money or too little. It's democracy in money, rather than mandarin rule.

Today, it's the mandarins at the Federal Reserve who decide what interest rate to impose, and what volume of currency to conjure."

Grant's op-ed is viewable at NYTimes.com.

Mohamed El-Erian

CEO, PIMCO:

"Advanced economies are not wired to operate at elevated levels of sovereign risk, be it Portugal’s 5 percentage points spread over German five-year bonds,

Ireland’s 7 percentage points,

or Greece’s 11 percentage points.

The longer these spreads persist, the greater the decline in investment activity and employment."

Complete commentary viewable at FT.com.

Our Next President?

"The Federal Reserve will self-destruct."

--Congressman Ron Paul (R-TX)

on CNBC's SquawkBox

earlier this morning

No Respect Here

Germany's Finance Minister, Wolfgang Schäuble,
has one word for the U.S. Federal Reserve:

"Clueless."

Plus a few more...

"It is not consistent when the Americans accuse the Chinese of exchange rate manipulation and then steer the dollar exchange rate artificially lower with the help of their printing press...the American growth model is in a deep crisis. The Americans have lived for too long on credit, overblown their financial sector and neglected their industrial base."

We DO Get Fooled Again

John B. Judis, "A Lost Generation"

[excerpt:]

"When America finally recovers, it is likely to re-create the older economic structure that got the country in trouble in the first place: dependence on foreign oil to run cars; a bloated and unstable financial sector that primarily feeds upon itself and upon a credit-hungry public; boarded-up factories; and huge and growing trade deficits with Asia. These continuing trade deficits, combined with budget deficits, will finally reduce confidence in the dollar to the point where it ceases to be a viable international currency....

If I am right about the fundamental problems that this nation suffers from at home and overseas, then any politician’s or political party’s victory is likely to prove short-lived. If you want to imagine what American politics will be like, think about Japan...like Japan, we’ve had a succession of false dawns, or what Walter Dean Burnham once called an 'unstable equilibrium.' That’s not good for party loyalists, but it’s also not good for the country. America needs bold and consistent leadership to get us out of the impasse we are in, but if this election says anything, it’s that we’re not going to get it over the next two or maybe even ten years."

Complete commentary viewable here.

"Monetary Heroin"

Former OMB Director David Stockman disses QE2:

No Double Dip...Yet

The Commerce Department on Friday released its preliminary estimate for third-quarter Gross Domestic Product, which grew 2.0% from the quarter before. The good news was that it was a positive number. The not-so-good news was that most of that statistical increase was due to the build-up of unsold goods. Real final sales grew just 0.6%. Unless inventories move faster, production in Q4 will likely slow.

"This goes down as the weakest recovery in real final sales on record, despite the fact the economy has been on the receiving end of the most pronounced dose of fiscal, monetary and bailout stimulus ever," says David Rosenberg at Gluskin Sheff. "At 60 basis points above zero, real final sales are just a shock away from double-dipping — a shock like looming tax hikes, accelerating fiscal cutbacks at the state/local government level or the millions of '99ers' about to fall off the extended jobless benefit rolls at the end of November."

According to figures released by the Bureau of Economic Analysis this morning, personal incomes were declining by the end of the third quarter. September's drop of 0.1% was the first since the current recovery began in July 2009. Disposable (after-tax) personal income was down 0.2%; inflation-adjusted DPI was down 0.3%. These numbers do not suggest that American consumers will be buying up inventories anytime soon.

Personal income ex transfer payments:

no gain since the recession "ended"

Trick? Or Treat?

Portfolio performance through 09-30-2010:

+9.6% for the third quarter,

but negative over the past three years.

Maine state employees and retirees got some good news earlier this month when MainePERS trustees reported a gain of 9.6% in the pension fund's market value from June 30 to September 30. A string of quarters like that will go a long way toward closing the gap (estimated at over $4.4 billion) between the projected benefits due future retirees and the resources currently expected to be available.

But the state's investment in the financial sector continues to diminish returns. Two large equity holdings, JPMorgan Chase and Bank of America, have dropped out of the portfolio's Top Ten, not because shares have been sold, but because the shares held (over a million shares of JPM and 2.5 million shares of BAC) have underperformed relative to other investments. Since financial-sector stocks peaked on April 15, JPM's stock price has fallen by 21.9% (as of last Friday's close) and BAC's by twice that, 42.4%. That's over $20 million up in smoke.

According to a MainePERS spokeswoman, MainePERS domestic equities are "100% passively managed." In other words, fund managers are not in the business of picking winners and losers. They buy the entire market and hope for protection through diversification. That's fine if the market goes up, not so fine otherwise. With the broad economy working its way through a painful transition, what we are left with is not a stock market, but a market of stocks. Some will advance, but most will stagnate.

How are the Ivy Leaguers doing it? This is how:

Notice that Harvard allocates 33% of its endowment portfolio (as of June 30, 2010) to publicly traded stocks. MainePERS, by contrast, has over 63% in stocks. MainePERS knows that it is overexposed to equities and aims to reduce its allocation to 55% eventually, still two-thirds higher than Harvard's. Harvard has also gone to 2% cash as a way of improving the "flexibility of the portfolio we are managing today," part of its renewed commitment to "attend closely over the last two years to liquidity, capital commitments, and risk management." MainePERS? 0.5% cash on the way to zero. Voilà some of the differences between active and passive management. "De-risking," Harvard calls it. Yale's exposure to public equities is even less--16% on June 30, down from 34% the year before.

In an environment which calls for sharpshooters with rifles, not shotguns, MainePERS may have the wrong weaponry.

[update, 11-04-10:]

Check out this piece on Bank of America. Remember, if you are a Maine taxpayer or MainePERS enrollee, you own this company.


[update, 11-07-10:]

According to former bank regulator William K. Black, "putting Bank of America into receivership is the proper remedy for its substantial violations of the law and for its continuing reliance on unsafe and unsound practices. Outside reviews have documented the most extensive and financially harmful violations of law and unsafe banking practices and conditions in history." Black further states that "demands by investors that Bank of America repurchase loans and securities sold under false 'reps and warranties' may cause exceptional losses." I repeat, Mainers own 2.5 million shares of of this zombie.

Dressed To Kill

Jeremy Grantham,

Chief Investment Strategist, Grantham Mayo Van Otterloo & Co.

October 2010 Quarterly Letter

[excerpt:]

"If I were a benevolent dictator, I would strip the Fed of its obligation to worry about the economy and ask it to limit its meddling to attempting to manage inflation. Better yet, I would limit its activities to making sure that the economy had a suitable amount of liquidity to function normally. Further, I would force it to swear off manipulating asset prices through artificially low rates and asymmetric promises of help in tough times – the Greenspan/Bernanke put. It would be a better, simpler, and less dangerous world, although one much less exciting for us students of bubbles. Only by hammering away at its giant past mistakes as well as its dangerous current policy can we hope to generate enough awareness by 2014: Bernanke’s next scheduled reappointment hearing."

Complete commentary viewable here.

Doing the Math

[click to enlarge]

Regular readers of this blog know that I am no fan of the banksters on Wall Street. They are the ones who securitized subslime mortgage loans (worth hundreds of billions of dollars in face value) and sold them to inattentive investors, thereby fueling a housing bubble and stunting the productive economy. Despite this malfeasance, they were bailed out by Congress in 2008 with direct injections of taxpayers' money. They benefited further when they were allowed to offload toxic assets onto the Federal Reserve's balance sheet. Investors, assured by such machinations that the banks had backup, plowed even more money into the sector by buying up new stock issued by the banks.

I have said all along that such investments are risky, and I have been taking the other side of that trade (explained here). The banks, facing declining revenues, have been generating "profits" by drawing down their loan-loss reserves even as loan delinquencies accelerate. To make matters worse, they may have to buy back tens of billions in subslime securities because of faulty documentation. Write-downs and write-offs will follow. The banks are insolvent; once investors figure this out, there will be a rush to the exits.

Bringing investors into the light is Branch Hill Capital, which has compiled a Power Point about to go viral. The slide show picks on Bank of America (as have I, many times--try that Search bar above), but could have selected any one of the Too Big To Fail banks. Branch Hill's advice? Go long the monoline insurers, go short the banks.

There. I just made your week.

Fed Continuing Down Dangerous Path

John Hussman,

"The Recklessness of Quantitative Easing"

[excerpt:]

"Businesses and consumers now see their debt burdens as too high in relation to their prospective income. The result is a continuing effort to deleverage, in order to improve their long-term financial stability. This is rational behavior. Does the Fed actually believe that the act of reducing interest rates from already low levels, or driving real interest rates to negative levels, will provoke consumers and businesses from acting in their best interests to improve their balance sheets?...

Despite the probable lack of measureable benefits, further QE poses significant risks. It has already triggered a steep decline in the exchange value of the U.S. dollar, and threatens a destabilization of international economic activity, a loss of confidence, and the creation of a "boom-bust" cycle threatening to choke off any economic recovery that does emerge....

One critical question deserves far more attention. After the Fed engages in another round of QE, how will it unwind that position?...It is unlikely that QE will result in a significantly greater use of existing slack capacity and labor in the U.S. economy. But several years from now, as the U.S. economy recovers (no thanks to the Fed, but simply by the emergence of new technologies and markets through innovation), the Fed will have no easy choices. Attempting to sell massive amounts of debt into an expanding economy will risk pressuring interest rates higher and choking off the recovery...."

Complete commentary viewable here.

Eleven Days Remaining

Candidate interview

Lewiston Sun Journal

10-22-2010

Thursday Threesome

The Long Way Around

Pushing On a String

Richard W. Fisher, President

Federal Reserve Bank of Dallas

on the need for more quantitative easing:

"Given that we at the Fed are mandated to maintain price stability and create the monetary conditions to encourage maximum employment growth―at a time when inflation is 'somewhat below' what the Committee as a whole judges appropriate―I instinctively understand the impulse to put the monetary pedal to the metal to try to move the needle on employment growth. And yet the efficacy of further accommodation at this point has yet to be established....

Of course, if the fiscal and regulatory authorities are able to dispel the angst that businesses are reporting, further accommodation might not even be needed. If job-creating businesses are more certain about future policy and are satisfactorily incentivized, they are more likely to take advantage of low interest rates, release the liquidity they are hoarding and invest it robustly in hiring and training a workforce that will propel the American economy to new levels of prosperity, rendering moot the argument for QE2. The key is to remove or reduce the tax and regulatory uncertainties that act as an impediment to businesses responding to an increase in final demand. I think most all would consider this to be a far more desirable outcome than being saddled with a bloated Fed balance sheet....

There is a great deal of legitimate debate still to take place within the FOMC on the subject of quantitative easing and the pros and cons and costs and benefits of further monetary accommodation. Whatever we might do, if anything, must be consistent with long-term price stability and not add to the nightmare of confusing signals already being sent to job creators."

[Entire speech viewable here.]

Tuesday Twosome

Paul Simon and Art Garfunkel

The Boxer

Competing for Students

"This shows the enormous demand for school choice. The competition really injects a level of accountability into the system."

--Jamie Gass, director of the Center for School Reform at the Pioneer Institute

Under a Massachusetts law enacted in 1991, students can attend public schools in any district that accepts outside students and has seats available. Host districts are often enticed by the $5,000-per-student subsidy they typically receive from the students’ home districts.

Complete Boston GLOBE story here.

The Road to Stagnation

Take this 60-second ride, see where you end up:

[Click on the yellow stripe once it starts moving for a wider view.]

"The regulatory impact on the business community is pervasive, insidious, and needs to be exposed," said U.S. Chamber of Commerce President Tom Donohue (below) in Des Moines last night. "It is suffocating the entrepreneurial spirit." The Chamber will spend $75 million backing pro-business candidates in the November elections.

Curing Our Addiction to Growth

Sustainability expert Tim Jackson talks about how to evolve from "spending money we don't have on things we don't need to create impressions that won't last on people we don't care about." [20 minutes]

Race To Debase, Take 3

Dominique Strauss-Kahn

Managing Director, International Monetary Fund:

"There is clearly the idea beginning to circulate that currencies can be used as a policy weapon. Translated into action, such an idea would represent a very serious risk to the global recovery . . . Any such approach would have a negative and very damaging longer-run impact."

Financial Times, 10-05-10

Tuesday Twosome

Graham Parsons and Emmylou Harris

Love Hurts