Follow the Money

Hoffman and Redford as Watergate sleuths Bernstein and Woodward,

All the President's Men

The advice of Deep Throat, the legendary Watergate informant, to "follow the money" is useful in any era and particularly at this time, when European financial ministers ("fin mins" in insider parlance) are loudly proclaiming that the region's sovereign debt crisis is under control. Earlier this morning, officials in debt-strapped Greece announced that government bonds maturing later this month--bonds with zero chance of face-value redemption--will be swapped for long-dated bonds and warrants in a kick-the-can restructuring. Losses finally will be taken. Private creditors are looking at a haircut of about 70%, which would send €100 billion to money heaven.

But that may not be the end of the destruction. The new Greek bonds have no more chance of paying interest than the old ones did, and in the grey market this morning they are bid at 20 percent of face value. Moreover, the warrants, or "sweeteners," attached to the new bonds will add value only if Greece can return to GDP growth. But how likely is that? The Greek economy has been shrinking for the past five years and shows no sign of a turnaround. Capital flight has afflicted all the PIIGS, as the chart below shows:

Money is leaving the periphery.

Today's debt swap is a precondition for a second bailout of Greece. But most of that bailout dough will pass GO (Greece does not collect the $200) and proceed directly to senior holders of the maturing sovereign debt. Meanwhile, the short-dated debt next in line is still priced for default. Stuck with this crapola, European banks have engaged in a different kind of swap--call it trash-for-cash--as part of a Long Term Refinancing Operation (LTRO). The distressed debt gets posted as collateral with the European Central Bank, which lends cash to the banks, which use some of it to roll over their own corporate debt. Any remainder appears to be getting redeposited back to the ECB:

Money is being parked here.

The lending facility is not being used for investment in the regional economy, which bodes ill both for Eurozone GDP growth and Greece's ultimate rescue. In fact, the lendable "remainder" is getting called back by the ECB, as collateral continues to lose value. ZeroHedge, which has been all over this story, describes it this way:

"The rapid deterioration in collateral asset quality is extremely worrisome...as it forces the banks who took the collateralized loans to come up with more 'precious' cash or assets (unwind existing profitable trades such as sovereign carry, delever further by selling assets, or subordinate more of the capital structure via pledging more assets - to cover these collateral shortfalls) or pay-down the loan in part. This could very quickly become a self-fulfilling vicious circle...."

Money is needed for margin calls.

Where is the money going exactly? How about around and around, then down. Flush job.

[update, 03-12-12--]

Barclays has a research note out (via ZeroHedge) explaining how the ECB's lending liquidity facilities are merely a short-term fix for Europe's banking system. By cannibalizing available collateral and subordinating other bondholders, they drive up the banks' borrowing costs:

"Bondholders face increasing subordination from this balance sheet encumbrance, reinforced by depositor preference laws (in some countries) and imminent legislation on bail-in bonds. Combining these factors suggests that unsecured funding cost for banks will remain high – potentially too high for some business models to make economic sense."

[update, 03-15-12--]

Bloomberg explains in a story today how the serial bailouts of Greece have gradually (and, shall we say, insidiously) shifted exposure from private-sector banks and insurers to European taxpayers. As one economist is quoted, "the longer we wait for these restructurings, the worse the deal gets for the public." The reckless lenders who should be taking the losses use the delay to wriggle off the hook--extend and escape, if you will. Minyanville's Peter Atwater calls it the re-syndication of risk.

Quote for the Week, Mar. 4-10, 2012

Unfortunately, I do not expect the partisanship of recent years in the Senate to change over the short term...I see a vital need for the political center in order for our democracy to flourish and to find solutions that unite rather than divide us. It is time for a change in the way we govern.
--U.S. Senator Olympia Snowe (R-ME)

"Going Down"

I am old enough to remember when an elevator was typically operated by a real person--the lift man--who rode the car up and down all day and opened and closed the door manually. If you were waiting for an elevator, a soft "ding" would signal that the elevator had just arrived at your floor. Then the door would slide open. Getting on depended on whether the lift man behind the door said "going up" or "going down."

Numbers cruncher David Trainer is saying "Going down," and it's not an elevator that he is talking about. It is Bank of America's common stock (ticker symbol: BAC). BAC has had a doozer of a Dow Dog rally, levitating by 60% since the December doldrums. The stock has spent most of February flatlining at $8 a share. As explained here, Trainer expects a return trip to $5, and maybe all the way to the basement. He is telling investors to get off now.

Trainer has developed a construct called economic book value (EBV), "which measures the equity value of the business based on its actual operating cash flow after tax net of all liabilities," including off-balance-sheet debt, pensions, preferred stock, and outstanding stock options. He considers EBV a more useful indicator than reported earnings, which are massively massaged by clever accountants. According to Trainer, Bank of America's EBV is negative (and, you guessed it, going down).

Sources: New Con­structs, LLC and com­pany filings

Last we checked, the MainePERS portfolio was holding steady at 2.6 million shares of BAC and seemingly intent on checking out the basement. BAC used to be a top-ten holding, but no more, thanks to the erosion in share price. Now appearing in the Top Ten (as of 12-31-11) are Johnson & Johnson and Pfizer, amounting to $90 million worth of high-priced pharmaceuticals. Once considered among the bluest of blue chips, Big Pharma stocks will soon be subjected to earnings risks of their own. According to Casey Research, several blockbuster drugs are coming off patent in 2012. Combined, these babies add up to $35 billion in annual sales. New competition from generics will certainly eat into those revenues. 58% of J & J's revenues will be at risk, 66% of Pfizer's. MainePERS portfolio managers are reaching for Tums as we speak.

Back to Bank of America. Not only is the company going down; it is leaving town altogether. Mainers found that out Monday when BofA announced that it was closing a call center in Orono and shedding as many as 200 employees. The company may be shedding customers as well. The Wall Street Journal this morning reports that BofA is contemplating new service fees for basic checking accounts. Must do something about that negative EBV.

[update, 03-05-12--]

John Hussman's weekly commentary highlights the biggest reason not to own bank stocks:

"A good amount of bad debt has been written down, but the remaining bad debt still needs restructuring. Notably, non-current assets and bank-owned non-foreclosed property ("other real estate owned" or OREO) is actually a larger percentage of bank assets today than in 2008. Restructuring generally means reducing the interest spread or writing down a portion of the principal, and this process is likely to siphon off earnings in the financial sector for years. Despite their preferred status as 'risk on' speculative assets, I continue to view financials as a minefield."

"Grandchildren Do Have Value"

Jeremy Grantham's quarterly investment letter:

[excerpts:]

"Capitalism has gone through a Darwinistic series of trails and errors, which still continues. For the time being, capitalism has tuned itself to rapid growth at almost any cost. Circumstances such as the hydrocarbon revolution and the ensuing population explosion have allowed for both high growth and high profit margins to sustain the growth. Sustained high margins have in turn trained capitalists--or corporate executives if you prefer--to set high hurdles for all investments....

"Of all the technical weakness in capitalism, though, probably the most immediately dangerous is its absolute inability to process the finiteness of resources and the mathematical impossibility of maintaining rapid growth in physical output. You can have steady increases in the quality of goods and services and, I hope, the quality of life, but you can't have sustainable growth in physical output. You can have 'growth'--for now--or you can have 'sustainable' forever, but not both. This is a message brought to you by the laws of compound interest and the laws of nature."

Complete commentary here.

Quote for the Week, Feb. 26-Mar. 3, 2012

The world owes all its onward impulses to men ill at ease. The happy man inevitably confines himself within ancient limits.
--Nathaniel Hawthorne

"The Bubble Is Everywhere"

Bob "The Bear" Janjuah

Forget the Blob. Worry instead about the Bubble. In his latest analysis, Bob Janjuah of Nomura International gives his view from the Bear Cave:

[excerpts:]

"Greece (and the whole eurozone story) continues to lurch about, seemingly perpetually, from Farce to Tragedy. Policy seems to be focused on protecting and preserving vested interests, with little consideration given to the dreadful conditions the people of Greece and other "peripherals" are being forced to live with....

"I am staggered at how easily the concepts of Democracy and the Rule of Law – two of the pillars of the modern world – have been brushed aside in the interests of political expediency. This is not just a eurozone phenomenon but of course the removal of elected governments and the instalment of "insider"technocrats who simply serve the interests of the elite has become a specialisation in Europe. Many will think this kind of development is not a big deal and is instead may be what is needed. Personally I am absolutely certain that the kind of totalitarianism being pushed on us by our leaders will – if allowed to persist and fester – end with consequences which are way beyond anything the printing presses of our central banks could ever hope to contain....

"[I]n this current cycle, where central bank balance sheets are at the core, the bubble is everywhere – in stocks, in bonds, in growth expectation, in credit spreads, in currencies, in commodity prices, in most real asset prices – you name it! This is why I think that this current bubble, if it is allowed to fester and develop into 2013, will have such widespread consequences when it bursts that it will make 2008 feel, relatively speaking, like a bull market.

More here.

The Pink Lady and The Trickster

Helen Gahagan Douglas vs. Richard Milhous Nixon

for U.S. Senator from California

1950

She was, all by herself,

"10 of the 12 most beautiful women in the world."

And wicked smart to boot.

Sarah Palin, returning from Oz with both heart and brains,

might come close.

JFK: "the biggest damnfool mistake I ever made."

What if?

Don't worry about people stealing an idea. If it's original, you will have to ram it down their throats.
--Howard Aiken

Back to the Past

Sawin gives the bad news.

Maine's Finance Commissioner Sawin Millet has always been a fiscal conservative. So it came as a bit of a surprise that in November he tolerated upward revisions to revenue projections coming from the Legislature's Revenue Forecast Committee. That committee, it turns out, may have been overly optimistic about how the rest of the State's fiscal year, ending June 30, will turn out.

Millett now reports that revenues in January lagged projections by almost $40 million, a huge miss. $15 million of the shortfall was due to higher-than-normal income-tax refunds, meaning that filers ended up making a lot less in 2011 than they had the year before. We know also that federal payroll withholdings took a nose-dive in mid-January. Further evidence of an economic slowdown comes from the chart below, showing deliveries of gasoline to retailers. Can you say Cliff Drop?

The fall-off in gas sales is consistent with Sawin's observation that sales-tax revenues are softening in Maine. It may be time to crank those revenue projections back to pre-November levels.

[update, February 14--]

The State of Maine is getting sued over alterations made earlier this year by the Legislature to benefit plans for state retirees. If the plaintiffs prevail--and their defined-benefit retirement plans are kept intact by the courts--the State will be in a world of hurt. Poor returns in the MainePERS investment portfolio over the past five years, with more of the same likely over the next five years, mean that the General Fund will have to cover the shortfall.

[update, February 23--]

Speaking of shortfall, Commissioner Millett is now penciling in a $14 million shortfall in the state budget for this fiscal year. Notice I said pencil. Revenue forecasters will be surprised at the blow-up just around the corner. Interestingly, $5.7 million from the recently announced 49-state mortgage settlement with the biggest banks on Wall Street will get thrown into the $14-million hole like so much silly putty. That money was supposed to go for relief to distressed home borrowers. The settlement, by the way, still awaits court approval. Knowing Sawin, I'll bet he has a big fat eraser on the end of his pencil.

Quote for the Week, Feb. 12-18, 2012

Too often we... enjoy the comfort of opinion without the discomfort of thought.
--John F. Kennedy, U.S. President [1961-63]

Happy Days Are NOT Here Again

The employment gap persists.

Employment figures released on Friday by the Bureau of Labor Statistics seemed, on the surface, to indicate that the U.S. economy is on the mend. On cue, the stock market rallied. But the January numbers are always difficult to interpret. For starters, the "seasonal adjustment" used by bureaucrats to "smooth" the trend is far bigger in January than any other month of the year:

The reason? Temporary jobs added in the retail sector during the prior three months (the annual bump for holiday shopping) all go away in January. On an unadjusted basis, we actually lost almost 2.7 million jobs in January. But the BLS estimated that the "normal" seasonal decline should have exceeded 2.9 million. So after seasoning and stirring, presto!--the cooked number was +243K. Rally on!

As John Hussman observes wryly in his weekly commentary, "the enthusiasm over that number is almost certainly excessive." Further complicating the January report is an annual "benchmark" adjustment applied to each of the twelve monthly numbers from the prior year. Finally, we know that the January 2012 figure itself will undergo multiple revisions, ending with next year's annual benchmark adjustment. As Yogi Berra might have said, it ain't final till it's final.

So let's take a step back from the January mess and look at some longer-term trends. From January 2011 to January 2012, the U.S. economy added about 2.3 million jobs, but this still leaves us about 7 million shy of the cycle peak four years ago:

As former U.S. Labor Secretary Robert Reich points out in his blog, the working-age population has increased by 10 million since January 2008. So job creation is not keeping up with population growth (NILF stands for Not In Labor Force):

What's more, of the 2.3 million jobs added during the past year, only 1.5 million were full-time jobs (see Table A-9 here). Total real disposable income has stagnated...

...meaning that the same-sized pie is being shared by more people, leaving smaller pieces for each. Further evidence of the economy's flat-lining is the recent downturn in payroll withholdings:

Bottom line: January's phantom surge in employment must be followed by real increases in the months ahead before we can get too excited.

Quote for the Week, Feb. 5-11, 2012

That men do not learn very much from the lessons of history is the most important of all the lessons of history.
--Aldous Huxley

Going Back To Where We Came From

PIMCO's Bill Gross nails it.

[excerpt:]

"A 30-50 year virtuous cycle of credit expansion which has produced outsize paranormal returns for financial assets--bonds, stocks, real estate and commodities alike--is now delevering because of excessive 'risk' and the 'price' of money at the zero-bound. We are witnessing the death of abundance and the borning of austerity, for what may be a long, long time."

Complete commentary here.

Euro Spring for 2012?

Telling chart from ZeroHedge.

Picture this: hoards of idle youth roaming the streets of Europe as buds begin to bloom. And there may be more layoffs coming if overnight credit freezes even as the snow melts. Don't think it can happen?

Then read this. European banks will have to hunker down as their collateral loses value, thanks to the European Central Bank's determination to subordinate all distressed sovereign debt held by private-sector lenders. Rates will rise, countries will default, and credit-dependent employers will run out of cash. It will be oog-ly.

Quote for the Week, Jan. 29-Feb. 4, 2012

In economics, hope and faith coexist with great scientific pretension.
--John Kenneth Galbraith

Dr. Doom Looks Through the Gloom

Nouriel Roubini thinks he sees a way to avoid the coming collapse of the Eurozone...

...but we may be past the point where Keynesian intervention can work. Deficit spending by sovereign governments can sometimes create a hothouse environment for economic growth, but not after future growth has already been pulled forward through over-borrowing. Fiscal stimulus now would just add to the debt overhang, further damaging long-term prosperity. Doug Casey proposes instead that government spending be drastically curtailed and sovereign debts repudiated. "Those debts," says Casey [interview here], "constitute an unethical mortgage without consent on the next two or three generations of people as yet unborn as a result of the excess consumption of their parents and grandparents."

Meanwhile, the European Central Bank's attempt at monetary stimulus is coming up dry. As Bloomberg reports, cash that might otherwise go for private-sector investment is being used instead to refinance sovereign debt, effectively starving the economy. When companies run out of cash, companies default. Companies default, workers are laid off. Workers are laid off....

You get the picture.

The State of the Union--Unvarnished

Karl Denninger gives his.

[excerpts:]

"The simple fact of the matter is that we are borrowing more than one third of every dollar the federal government spends. This will double the national debt in less than a decade -- again. We have added more than 50% to our federal debt in three years, and we cannot continue on this path. Eventually, foreign and domestic creditors who have lent the government that money will go on strike, dramatically raising the cost of financing. When this occurs we will be forced to cut the size of government by more than 50% in an afternoon, instantly collapsing all of our federal social programs....

"The tax system at the corporate and personal level favors debt instead of equity, leverage over thrift and industry. This must end. The Fair Tax is one such way to do so; by zeroing the corporate tax and rendering all taxes on consumption it removes the preference for debt over equity, makes lobbying for special preferences impossible and makes the cost of government instantly visible and transparent to everyone in the nation. The Internal Revenue Code should be burned to ash and replaced with The Fair Tax tomorrow morning....

"...today America is not a bastion of capitalism. Many have claimed that we now have 'crony capitalism' but that too is a misnomer. Capitalism is the premise that one succeeds or fails through the wisdom of one's investment, predicated on capital formation (that is, the investment of economic surplus into various economic activities.) While the vestiges of this system remain in America, what has replaced it is a feudalistic system of scams, frauds, allegedly 'lent' funds that do not in fact exist and bribery of various forms, both legal and not."

Complete address here.

Quote for the Week, Jan. 22-28, 2012

My opinion is that there would never have been an infidel, if there had never been a priest.
Thomas Jefferson, U.S. President [1801-1809]

Be Like Mitt

"What did I do?"

Republican presidential candidate Mitt Romney came under fire this week for some of the things he had done in a previous life as a venture capitalist with Bain Capital. Let it be noted that his antagonists did not call him a venture capitalist. They said vulture capitalist. According to them, Romney and his fellow raptors made a habit of swooping down on struggling companies, gutting them, and leaving carcasses. It was creative destruction writ large, very large, with "destruction" italicized, capitalized, bolded, underlined, and color-fonted. Pretty coldhearted, but also very American.

Now you, too, can be a vulture capitalist. And you don't even need Mitt's millions. For the price of two cappuccinos, you can buy a share of Bank of America's common stock and rub wings with other shareholders of a similar feather. You see, there is a fire sale going on at BofA, where management is converting to cash anything not nailed down. During 2011's fourth quarter, the company (as we learned from this morning's earnings release) sold an equity stake in China Construction Bank for $2.9 billion and assorted securities for another $2.4 billion. After all that, pre-tax income came to $2.7 billion, which suggests to me that the rest of the business, the part that stays, was losing money.

As Mitt will tell you, timing is everything. If you do decide to fly in for some warm flesh, make sure you are not the last to leave. When they start selling the furniture, you want to be gone already. Just like Mitt.

[update, 01-23-12--]

Go here to see how Mitt and his minions benefit twice from preferential tax treatment.

Quote for the Week, Jan. 15-21, 2012

Human nature cannot bear prosperity. It invariably intoxicates individuals and nations. Adversity is the great reformer. Affliction is the purifying furnace.
--John Adams, U.S. President [1797-1801]

BAC From the Dead?

BAC, 6-month chart

You can see it, without squinting even. Bank of America's common stock (ticker symbol: BAC) has risen in price per share by nearly one-third since mid-December. Last Thursday's up-thrust on heavy volume (over a half-billion shares traded out of ten billion outstanding) was a technical signal to just go long, baby. Pension-fund managers and Congress critters everywhere are breathing sighs of relief. The bottom, they hope, is in.

If BofA actually had a viable business model, with neither legacy liabilities nor regulatory repression, I would be buying the shares with both hands myself. But it doesn't, and I won't. Let me suggest instead that this is a heaven-sent opportunity to divest. This is actually the fourth such opportunity in the past thirteen months, starting with the Santa Claus rally of 2010 and running through the Saint Warren rally, the Big Bazooka rally, and now the Dow Dog rally. That's right, traders are piling into the worst performer of the 30 Dow Jones Industrials in 2011 (when BAC was down 58%) according to the knee-jerk, brain-dead theory that such a dog deserves a dead-cat bounce. Although they won't call it a dead-cat bounce. They'll call it a reversion to the mean, as if there were some sort of mathematical inevitability to it.

When I do the math, I still see declining organic revenues, ballooning legal liabilities, and unquantifiable derivatives exposure. BofA may have a random profitable quarter in the near future, but only through divestitures, draconian cost-cutting, and courtroom dallying. One suspects from the power of the recent rally that short-sellers are covering. But the scalloped pattern in the chart above shows that the shorts do re-load, kicking off another scoop down in price. Each rally high is lower than the one prior.

JP Morgan Chase reports Q4 earnings on Friday, and the other banks will follow next week. Let us see if the news is sold. "Friday the 13th will live up to its name when it comes to bank earnings," bank analyst Mike Mayo tells Bloomberg. "You're going to see all sorts of revenue and margin pressure."

Picture of Fear

Cash in Europe has nowhere else to go.

[chart from ZeroHedge--click to enlarge]

When the economy is running smoothly, banks lend to each other readily and willingly. Conversely, a curtailment in inter-bank lending is a sign that the economy is stalling. Or, in the current instance, seizing. The chart above shows that European banks with money to spare are parking it with the European Central Bank, not lending it out. Deposits at the ECB have reached a record €464 billion, higher than the peaks seen following the Lehman failure of 2008 and the flash crash of 2010.

These deposits have soared by €200 billion since December 21, when the ECB released a flood of fresh three-year loans through its Long-Term Refinancing Operation (LTRO). The operation is a desperate attempt to sop up impaired collateral held by stressed Eurozone banks, such collateral consisting of either discounted sovereign bonds or their own junk-rated debt. Collateral is the grease that makes the whole Rube Goldberg machinery run. When it goes bad, the machinery grinds to a halt. As the Wall Street Journal explains, "banks favor using the ECB as a safe haven for excess cash rather than lend it out to other banks...due to concerns about their counterparties' exposure to risky euro-zone sovereign debt."

Bond expert Marc Chandler, at his niftily named blog (www. marctomarket.com), points out that Eurozone banks need to re-fund, or roll over, €230 billion of their own maturing debt and expects that "the bulk of the ECB's liquidity provision will not be used to buy sovereign bonds, but to address the banks' own needs." Charles Smith, Chief Investment Officer at Fort Pitt Capital Group, uses more colorful language to describe this shell game:

These “refinancings” are nothing more than the (panicked) banks dumping their very worst collateral on the ECB to cover immediate withdrawals/maturities. And these withdrawals/maturities will keep on coming! And if they run out of pledgeable collateral, no worries. They simply issue new bonds, get a government guarantee on those bonds, and then post them as collateral for cash at the ECB. Italian banks issued 40 billion euros worth of such bonds yesterday! There’s a very vulgar term for this sort of behavior…”circle jerk”.

ZeroHedge insists that much of the LTRO liquidity is coming right back to the ECB as overnight deposits. The depositing banks no longer have a sufficient collateral cushion to recycle the 1% LTRO debt into higher-interest loans (e.g. short-term sovereign notes), thereby earning a positive "carry." Instead, they park the cash for 0.25%, effectively earning a negative return. Such is the price of impaired collateral, which itself is the end-product of risky lending.

Negative interest rates are a harbinger of impending deflation. Bloomberg Businessweek reports that earlier today Germany sold a six-month bill yielding -0.01%, "the first time a national money market instrument offered a negative yield" at issuance. Secondary markets have been marking yields on Germany's one-year debt below zero since November 30 [FT]. Before this is all over, we shall hear of many more "first evers."

[update, 11:30 a.m.--]

Reuters has an article just posted on how private-sector non-banks, and not just the ECB, are becoming sources of cash for struggling banks. These non-banks are familiar names--Johnson & Johnson, Pfizer, Peugot, etc. They are cash-rich multinationals looking to put their money to work (but not, it should be pointed out, by investing in their own businesses). They are the "shadow" bankers. They lend to the banks through so-called "repo" transactions, in which they buy collateral from the banks, then sell it back later at a discount, pocketing the "haircut." Lehman Brothers, you'll recall, used repos to hide the firm's leverage from investors and regulators. Remember how that turned out?

Quote for the Week, Jan. 8-14, 2012

Beyond a critical point within a finite space, freedom diminishes as numbers increase.
Frank Herbert

David Collum's Year in Review

This chemist gives it to you straight.

David Collum, professor of chemistry and chemical biology at Cornell University, surveys the global economic landscape--and does not like what he sees. In his review of 2011, Collum describes both the trouble in which we find ourselves and the opportunity to set things straight. Included is a list of books and links that will get you up to speed. Here are two nuggets to whet your appetite, the first pertaining to the Federal Reserve, which, you may be surprised to learn, does not exist to serve ordinary taxpayers...

Here's my biggest gripe in a nutshell. The Fed, whether it's a wholly owned subsidiary of the banking cartel or not, is charged with protecting the banking system. Period/full stop. The banking system is global. Period/full stop. Ergo, one does not even know if the Fed's actions are in the best interest of the United States. Period/full stop. What is to prevent them from sending trillions to Europe, Asia, or any faraway place because bankers got themselves in trouble? Absolutely nothing; they do it relentlessly...We keep hearing that we made money on the bailouts, including from General Motors! That's an OMG/LOL/WTF all rolled into one. The $700 billion TARP was put on display for public consumption. It was designed to be paid back in the light of day. The rest of the money [at least ten times as much] entered the system covertly.

...and the federal government, which (now you've got it!) does not exist to serve ordinary taxpayers:

Government is a living, breathing organism that exists to perpetuate itself. There is nothing that says evolution must create a pleasing government better suited to individual liberties. History paints an altogether different picture. Possibly the single largest selection pressure is money. It has always bought political favor. When our government was a few percent of GDP and the industrialists were buying favors while building a nation, government had little power to wield. When money commandeers the machinery of a huge government, however, you have a monstrously expensive and intractable problem.

Quote for the Week, Jan. 1-7, 2012

Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one.
--Charles Mackay

The Devils Are (Still) Here

Kyle Bass said it was a must read, and that was good enough for me. All the Devils Are Here, by Bethany McLean and Joe Nocera, offers a chronological account of how Wall Street executives created, and then abused, the instruments that led to the global financial crisis of 2008. The whole alphabet soup is explained--ABCP, CDO, RMBS, SIV, etc.--as well as the motivations of the chefs cooking this toxic brew.

The scary part is this. Time and again, smart men and women (O.K., men mostly) suspended their better judgment, allowing risk to metastasize. The dereliction was so pervasive as to appear inevitable. The story told here strongly suggests, furthermore, that the dereliction is ongoing. It comes from human nature. Character breeds success, which then undermines character.

So much for the villains. How 'bout them victims? There was a veritable tsunami of dumb money sloshing through global markets in the mid-aughts. There probably still is. We know that in August 2007 some of that dumb money, about $20 million worth, leaked from the State of Maine's Cash Pool into an SIV-Lite called MainSail II, which was heavily invested in residential mortgage-backed securities (RMBS). Maine bought at the exact top of the market for such securities--the very definition of "dumb money." Within weeks MainSail II was downgraded by Moody's from Prime-1 to junk, and the vehicle's assets were frozen. By the end of August, Maine could not be sure that it would get any of its money back.

According to UMaine's Richard Borgman (who gives the blow-by-blow account here), this was not a prudent investment by the Treasurer's office. For months defaults on home loans had been rising, home prices falling, and subprime lenders failing. In July 2010 (before Maine invested in MainSail II) Standard & Poor's and Moody's had each placed hundreds of tranches of RMBS on review for possible downgrade. The handwriting was on the wall, and Treasurer David Lemoine failed to see it. In Borgman's opinion, "there was a lack of understanding of the investment and an over-reliance on ratings and the broker." One year later Lemoine made a stick-save by putting the investment back to the broker, Merrill Lynch. But for a whole year the $20 million was dead money.

Fair question: if Maine's Treasurer was in over his head in 2007, are MainePERS fund managers, with their "passive" investment style, in over their heads now? If so, a lot more than $20 million is at risk.

Toward the end of their book, the Devils authors lift a trenchant passage from Alan "Ace" Greenberg's The Rise and Fall of Bear Stearns. Greenberg was formerly CEO (until 1993) and Chairman of the Board (until 2001) at Bear Stearns and was 80 years old when the firm that he helped build went belly up in 2008. Reading this, one cannot help but think that the money is getting ready to stop one more time:

The interdependent relationships between banks and brokerages and institutional investors strike most laymen as impenetrably complex, but a simple ingredient lubricates the engine: trust. Without reciprocal trust between the parties to any securities transaction, the money stops. Doubt fills the vacuum, and credit and liquidity are the chief casualties. Bad news, whether it derives from false rumor or verifiable fact, then has an alarming capacity to become contagious and self-perpetuating.

Quote for the Week, Dec. 25-31, 2011

Credit is suspicion asleep.
--William Gladstone

Queue It Up

"The Wind That Shakes the Barley"


The Emerald Isle seen shimmering.
And simmering.
Pragmatists debate fanatics in barroom brogues.
Andrea Corr sings the credits.
Trailer here.

Quote for the Week, Dec. 18-24, 2011

This is how government grows--by claiming to correct the mistakes it earlier created, all the while constantly shaking down the taxpayer.
--Congressman Ron Paul

The Beginning of the End

If you have not gotten enough of Kyle Bass about the capital flight from Europe, go here for an interview two days ago on CNBC.

Now speaks another voice, Michael Platt, founder of BlueCrest Capital Management, a $30 billion hedge fund. Over the past eleven years, BlueCrest has returned nearly 14% on an average annual basis and has never had a down year. John Paulson, eat your heart out! Platt tells Bloomberg [below] about the sovereign debt crisis and the serial insolvency of most European banks:

Late yesterday one of the Big Three ratings agencies, Fitch, issued downgrades for eight global banks, including our beloved Bank of America. BofA's Viability Rating was dropped from a- ("strong") to bbb ("good") and its long-term Issuer Default Rating from A+ to A, still a couple of notches above Johnny B (Goode). The calls follow similar moves from Standard and Poor's last month and Moody's in September, thus completing a tricky trifecta for BofA. Such downgrades can trigger collateral calls, reducing a firm's liquidity. In extreme cases a downgrade can put a company out of business (witness MF Global).

Go here for a refresher from Gary Shilling on why all these banks are such a miserable investment.

Fed Head MIA

Hilarious. From ZeroHedge.

Quote for the Week, Dec. 11-17, 2011

He knows nothing; and he thinks he knows everything. That points clearly to a political career.
--George Bernard Shaw

Now You See It, Now You Don't

"I simply do not know where the money is."

This is what former MF Global CEO Jon Corzine will tell the House Agriculture Committee on Capitol Hill in his testimony today. Corzine was forced to resign last month amid allegations that his firm improperly commingled clients' funds with its own investment capital. All the money went out the door in some highly leveraged speculation. And never came back.

How can this happen? Reuters correspondent Christopher Elias describes how in a must-read article, MF Global and the Great Wall Street Re-hypothecation Scandal. Now, if "re-hypothecation" sounds to you like something sinister and best not tried at home, you would be absolutely right. But the big banks and brokers do it all the time. In fact MF Global, before it collapsed, warned its customers in its Customer Agreement as follows (and where you see the world "collateral," think anything of yours with cash value):

7. Consent To Loan Or Pledge

You hereby grant us the right, in accordance with Applicable Law, to borrow, pledge, repledge, transfer, hypothecate, rehypothecate, loan, or invest any of the Collateral, including, without limitation, utilizing the Collateral to purchase or sell securities pursuant to repurchase agreements [repos] or reverse repurchase agreements with any party, in each case without notice to you, and we shall have no obligation to retain a like amount of similar Collateral in our possession and control.

In other words, Mr. Client, we are going to pledge to someone else what rightfully belongs to you. And you can't opt out. If you want to do business with us, you have to play along. The problem, explains Elias, is that the same collateral gets pledged over and over, from one counterparty to the next:

With collateral being re-hypothecated to a factor of four (according to IMF estimates), the actual capital backing banks' re-hypothecation transactions may be as little as 25%. This churning of collateral means that re-hypothecation transactions have been creating enormous amounts of liquidity, much of which has no real asset backing...Considering that re-hypothecation may have increased the financial footprint of Eurozone bonds by at least four fold, then a Eurozone sovereign default could be apocalyptic. [emphasis mine]

Expounding on the Elias piece, Zero Hedge uses a familiar metaphor to describe the risk to the global economy:

The collapse of the weakest link in the daisy-chain sets off a house of cards that eventually will crash even the biggest entity due to exponentially soaring counterparty risk: an escalation best comparable to an avalanche - where one simple snowflake can result in a deadly tsunami of snow that wipes out everything in its path. Only this time it is not something as innocuous as snow: it is the compounded effect of trillions and trillions of insolvent banks all collapsing at the same time, and wiping out the developed world and the associated 150 years of the welfare state as we know it.

Hyperbole? We shall see.

What's That Smell?

I love the smell of napalm in the morning, says Robert Duvall's character in Apocalypse Now. We are getting a whiff of that on the morning after this CBS 60 Minutes piece on alleged fraud at Countrywide Financial (now a division of Bank of America):

Now, none of this is really news. If you have been following this blog, you know that Bank of America is freighted with huge successor liabilities inherited not just from Countrywide, but from Merrill Lynch as well. Consumer fraud, investor fraud, breach of fiduciary duty, obstruction of justice--you name it. That the Obama Administration has done so little to hold these companies accountable is a sure sign of whose shed has the biggest Tool.

Maybe, if the feds don't do it, the states will. The Attorneys General of the fifty states have been trying for a year or more to reach a settlement with BofA and other Wall Street lenders over foreclosure abuses. But the dollar figure being floated around for the industry to buy immunity is, in the eyes of at least one AG, too small. So last week Martha Coakley of Massachusetts announced that her office is striking off on its own and suing BofA, Wells Fargo, JP Morgan Chase, Citigroup, and GMAC. To her chagrin, Martha will be forever remembered as the heavily favored Senatorial candidate who lost Ted Kennedy's seat to a little-known Republican runt, Scott Brown. But she has been a crackerjack AG, going after some of the big banks in 2008 when few others did.

The news flow on Bank of America continues to, um, reek. Aside from this latest legal attack, there was the credit downgrade announced by Standard & Poor's late Tuesday of BofA and 36 other global banks. Indeed, the share price of BAC common was headed for a toilet spin until a gang of central banks injected a stiff dose of monetary heroin the very next morning. And how's business, you ask? BAC's share of mortgage loan originations in the U.S. has declined from about 25% to around 10% in Q3 2011. That's in a market that is expected to soften by 25% in 2012. Hmm, wonder what that combo is going to do to revenues.

But faithful shareholder MainePERS is hanging tough, I tell ya. HANGING TOUGH!

[update, 12-07-11--]

Mississippi PERS just reached a settlement with BofA, recovering $315 million from a soured investment in toxic mortgage-backed securities peddled by Merrill Lynch in 2006 and 2007. The settlement awaits approval by Federal District Judge Jed Rakoff. Yup, that Judge Rakoff.

Quote for the Week, Dec. 4-10, 2011

Long ago I proposed that unsuccessful candidates for the Presidency be quietly hanged, as a matter of public sanitation and decorum. The sight of their grief must have a very evil effect upon the young.
--H.L. Mencken