Weekly Wrap

"I'm doing God's work," said Goldman Sachs CEO Lloyd Blankfein in a newspaper interview last November. Today the Securities and Exchange Commission begs to differ, charging Goldman with defrauding investors in (pick a year, any year!) 2007. Specifically, the SEC alleges that the firm peddled a collateralized debt obligation (CDO) structured, and then shorted, by one of its own clients.

The client, hedge fund Paulson & Co., packed the CDO portfolio with residential mortgage-backed securities of the subslime variety, the kind built to fail during the mortgage frenzy of the mid-aughts. Then Paulson paid Goldman $15 million to market the ticking time bomb to well-heeled suckers. Goldman did so, failing to disclose to investors how or by whom the securities were selected. Meanwhile, Paulson purchased credit default swaps from Goldman as a bet that the portfolio would blow up. Which it did. Paulson made about a billion on the deal. The CDO investors were out the same amount.

MIT's Simon Johnson, blogging at baselinescenario.com, calls today's disclosure a watershed moment, the "Ferdinand Pecora moment" for which he has been waiting. He suggests that Blankfein has some explaining to do:

Either Blankfein knew what was going on – and is therefore liable before the law – or he was clueless and therefore incompetent. Either way, the much vaunted risk management and control systems of Goldman, i.e., what is supposed to prevent this kind of thing from happening, are exposed to be what we have long here claimed: bunk.

And don't think Goldman was the only one playing fast and loose. In the words of Minyanville's Jeff Macke: "if Goldman is dirty, Citi is Pig Pen from Peanuts." The selling of financial dark matter was (still is?) an industry-wide problem with consequences yet to be fully suffered.

I wish the SEC had made its announcement 48 hours earlier. Since July I have been trading around a bearish position on the U.S. financial sector, using an inverse exchange-traded fund. The sector nearly imploded in September 2008 before the TARP bailout bought the big banks some time. But with a new wave of mortgage defaults expected this year, I figured that time was about to run out. Silly me. When JP Morgan Chase reported boffo first-quarter earnings on Wednesday and sent bank stocks en fuego, the pain became too great. I sold my ETF shares and started looking for tech longs instead.

Now the bank trade is back on. The SEC announcement comes after a relentless stock-market rally that has left even the bulls scratching their heads. In other words, we were due for a correction anyway. Add to the mix the risk of sovereign debt default (don't forget, Greece cooked its books with interest-rate swaps sold by Goldman Sachs, another piece of God's work) and a broken circle of trust, and we could have a rout on our hands. Options expiration may help prop the market today. Monday, though, could get interesting.

The stock market has been discounting a narrow slice of reality, the relative prosperity of a castle economy. Those inside the walls get to share the free money printed by the Federal Reserve and build their wealth on inflated paper assets. The unemployed and underemployed stranded outside the moat cannot understand what the party is all about. Could it be that the retail-sales boomlet in March was merely an artifact of transitory stimuli? I'm thinking of higher-than-normal tax refunds, redirected mortgage payments by strategic defaulters (the so-called "squatters' stimulus"), extended (for how long?) unemployment benefits, deep auto discounts (the Toyota-defect stimulus), an early Easter, summer-like weather, and temporary census hiring. Take those away, and what do you get?

A double dip.

Monday Muse

Grace Slick

Jefferson Airplane

White Rabbit

Quote for the Week, April 11-17, 2010

A patriot must always be ready to defend his country against his government.
--Edward Abbey

Weekly Wrap

Barack Obama is leaning on Governor Deval Patrick for a very good reason. Massachusetts, you see, is providing a test run for the kind of healthcare reform that the President envisions on a national scale. If universal health coverage can be made to work in the Bay State, then perhaps it can work in the other 49 states as well. ObamaCare needs CommonwealthCare to succeed.

But Massachusetts is struggling with costs. It has some of the best hospitals in the country--and some of the most expensive. It spends more per capita on healthcare than any other state. Insurance premiums continue to skyrocket. Campaigning for re-election in November, Patrick figures he has to do something to soothe voters. So when insurance carriers filed last month for hefty increases in rates for small-group coverage, Patrick said no.

That's when the sugar hit the fan. The insurers, caught in the same death spiral plaguing small-group pools all across the nation, need the higher premiums to break even. Since April 1 they have stopped enrolling new applicants in Massachusetts until they get a rate structure that makes sense. Patrick's insurance commissioner, on the other hand, has directed them to offer coverage at the old rates. The industry's response: we'll meet you in court.

Yesterday Suffolk Superior Court Judge Stephen E. Neel heard from counsel for the insurers that 2009 base rates are "completely inadequate and completely arbitrary." The Commissioner's office countered that insurers need to file an administrative appeal first before seeking relief in court. That is a delay that the Commissioner can more easily abide because, after all, it is not his bottom line that is hemorrhaging red ink. Judge Neel will decide by Monday whether the insurers must retreat to Square One.

By attempting to cap rate increases, the governor is skirting, not solving, the problem of runaway healthcare costs. As Scot Lehigh remarks in this morning's Boston Globe, "Patrick’s approach is a bit like banging on the TV screen because you don’t like the DVD that’s playing." The problem is embedded in the medical delivery system itself, according to a recent report by Massachusetts AG Martha Coakley. (Remember her? The roadkill plastered to Scott Brown's tire treads?) The insurers are merely messengers.

The crux of the dispute is this: can a government regulator compel private carriers to subsidize services at below-market rates? For that matter, can the government compel consumers to buy the services? And can the government dictate what providers charge for their services? These are all things that ObamaCare proposes to do.

Democrats who are celebrating the new health reform act as "historic" in the same way as Franklin Roosevelt's New Deal legislation in the 1930s should re-read their history. FDR's reform agenda came to a screeching halt when he tried to pack the U.S. Supreme Court. Some things, as today's dealers may soon find out for themselves, just ain't legal.

A cautionary graphic appeared in yesterday's Financial Times:

The graph plots the difference between the interest rate demanded for Greek government bonds compared to that for German bonds. The bigger the difference (or "spread"), the greater the perceived risk of default for Greek debt relative to Germany's (Germany being the safe-haven benchmark within the Euro-zone).

What do I care? asks Joe Six-Pack, I only drink Bud anyways.

See, Joe, here's the deal. A higher debt premium makes it more expensive for Greece to service the debt, thereby impairing its credit standing (Fitch just downgraded Greek debt to BBB-, one notch above junk status), thereby driving rates even higher. It is a vicious feedback cycle over which Greece has absolutely no control. None. At some point the bond vigilantes take over and cause the default that lenders and borrowers both are trying so desperately to avoid. (Think back to Lehman Brothers in September 2008.) Minyanville's James Kostohryz reports today that bank runs have started in Greece, presaging that the end is near. In his words, "If Greece goes down, this is a big deal."

The bigger problem is that there are a raft of countries ready to "go Greek," including (I hafta tell ya, Joe) the U-S-of-A. Through its Zero Interest Rate Policy, the Administration here at home has been able to roll over government debt at historically low rates. But ZIRP can get zapped at any moment, if the bond vigilantes so decide. Earlier this week the rate on 10-year notes flirted with 4%. If we get a breakout on yields, the federal budget deficit (now running at about $1.5 trillion annually) will explode higher.

That makes America's economic recovery a lot like Cinderella's coach at 11:59 p.m. It looks good--until it doesn't.

Monday Muse

Sharon Corr

Goodbye

Quote for the Week, April 4-10, 2010

A man's silence is wonderful to listen to.
--Thomas Hardy

Weekly Wrap

Cool! Tax error in my favor. Collect $800. Do not pass Go. Proceed straight to my bank and deposit. Now. Before the ink disappears or the check self-destructs. Maybe it's a hologram of a check, because I can't believe this thing is for real. What did I do to deserve this?

Turns out that my wife and I each qualified for something called a Make Work Pay tax credit of $400 each. When I filled out our joint income-tax return two months ago, I did not claim the credit. I did not realize it was for us. When I saw "credit," I figured it was for illegals or NINJAs or fat-cat investors, not for plain ol' middle-class folks. I thought "Make Work Pay" was just a variation of the usual "Make Workers Pay." No way was I going to trigger something like that. I decided to leave that part blank and hope that the IRS computers would not flag me.

Apparently the computers have been re-programmed. It used to be that they would scan your return in search of additional ways to gouge you, even for ridiculously small amounts (I was once billed, incorrectly, for five bucks). Under Obamacare, they look for ways to pay you back. And the Make Work Pay program is a big-time payback. Anyone with annual earned income under $95,000 is eligible. That adds up to over $10 billion a year. The IRS power-vacuum that used to suck greenbacks out of your wallet has turned into a leaf-blower. Now there is Change that y'all can believe in!

If the money really belongs to us, then why did the government take it in the first place? Think of the time and expense involved in bureaucrats' collecting, fondling, then returning what's yours (the money, I mean). When lawmakers sell their votes for bribes, it's called corruption. But when they dispense "credits" to buy votes, it's called stimulus. Eventually the credits will have to be taken back anyway to repay the creditors (the buyers of U.S. Treasuries) who financed the give-away in the first place. Watching the money go back and forth is enough to give you whiplash.

The monthly employment report from the Bureau of Labor Statistics reminded us this morning that there are still 15 million out-of-work Americans who would love a paycheck, not to mention the Make Work Pay credit that goes with it. Headlines trumpeted that 162,000 jobs were added in March, the biggest gain in three years. But 48,000 of those were temporary census hires who will be back on the street by mid-summer. So think instead of 114,000 net new jobs, not enough to offset the increase of 398,000 in the labor force. The unemployment rate remained at 9.7%.

The jobs-gained number would have been higher except for one thing: the Census Bureau is having a hard time finding enough temps to finish the headcount. Here in Oxford County positions, particularly for counters in sparsely settled areas, go unfilled. Short-term, part-time jobs apparently hold little attraction for displaced workers looking for real, lasting jobs. Those folks are still waiting, no matter what the government cheerleaders are saying. And three months from now they will be joined by tens of thousands of teachers to be laid off before the start of the next school year.

Fannie Mae Update

Home loans are becoming delinquent faster than they can be written off!

Why the Debt Super-Cycle Must End

[click on chart to enlarge]
courtesy economicedge.blogspot.com

This is a very simple chart [says blogger Nathan A. Martin].

It takes the change in GDP and divides it by the change in Debt. What it shows is how much productivity is gained by infusing $1 of debt into our debt-backed money system.

Back in the early 1960s a dollar of new debt added almost a dollar to the nation’s output of goods and services. As more debt enters the system, the productivity gained by new debt diminishes. This produced a path that was following a diminishing line targeting ZERO in the year 2015. This meant that we could expect that each new dollar of debt added in the year 2015 would add NOTHING to our productivity.

Then a funny thing happened along the way. Macroeconomic DEBT SATURATION occurred causing a phase transition with our debt relationship. This is because total income can no longer support total debt. In the third quarter of 2009 each dollar of debt added produced NEGATIVE 15 cents of productivity, and at the end of 2009, each dollar of new debt now SUBTRACTS 45 cents from GDP!

This is mathematical PROOF that debt saturation has occurred. Continuing to add debt into a saturated system, where all money is debt, leads only to future defaults and to higher unemployment...

Thus money creation at the saturation point stops adding to productive efforts and becomes a roll-over affair with only the financial services industry profiting via interest and fees. In other words, money goes out and circles right back around to the banks instead of rippling through a healthy non-saturated economy...

[The full article with additional charts can be found at Nathan's website.]

Monday Muse

Rosanne Cash

Blue Moon With Heartache

Weekly Wrap

The President's signature earlier this week on the healthcare reform bill passed (finally) by Congress showed that he is a leftie in more ways than one. The bill will have far-reaching consequences, becoming evident only with time. I have said all along that the Democratic initiative, without a public option, is the status quo on steroids. It guarantees more business for private insurers. It mandates more spending for health coverage and maybe for health care, which are two different things. It will almost certainly raise the portion of GDP devoted to health services.

But private insurers, at first enamored of the prospect of a captive clientele compelled to buy their product, have thought twice about it. They have decided that they don't want the extra business after all. Their margins, which currently run in the 15-to-20-percent range, will get crushed as they take on sicker clients. It is bad enough already that they have to petition state regulators every year for hefty premium increases to keep up with soaring costs. Do you think they enjoy asking for 20-, 30-, even 40-percent hikes? It makes them look bad. Greedy. Cold-hearted. Unlike Wall Street banksters, they actually care about public perception.

Unfortunately for them, Barack Obama needed someone to campaign against in order to save his floundering reform effort. His problem was solved when he picked up a copy of the L.A. Times in early February and read that WellPoint's Anthem Blue Cross subsidiary had filed for a 39% increase in premiums paid on individual policies in California. (That even trumped the 23% hike sought by Anthem for its 11,000 HealthChoice policyholders here in Maine.) Obama immediately went after the nefarious insurers. "If we don't act, this is just a preview of coming attractions," he warned. "Premiums will continue to rise for folks with insurance."

He failed to add that even if we do act, premiums will rise. "Health insurance companies don't determine the cost of health care," pointed out WellPoint spokesman Jerry Slowey, "they reflect it." But Obama has a solution for that. It's called price-fixing. Government panels will be set up to review best practices, ration benefits, and regulate payments to providers. Markets will not be allowed to work because it is assumed that they cannot work.

The new mix of incentives and penalties will insure that there is greater demand for health services. The question is, who will pay? The newly insured, to the extent that they are able (income thresholds to be set by the government), will be forced to pay some. To the extent that they are unable, taxpayers will be forced to pay some. Existing policyholders and their sponsors will pay some (higher premiums). Insurers, becoming little more than regulated utilities, will give up some (lower margins). Providers will be asked to give up some (lower reimbursements). The end result? I predict a crowding out of private carriers, fewer providers per capita, and setbacks in health outcomes, with higher costs besides.

But it will happen so slowly that we will hardly notice. Makes me think of the frog in a kettle of gradually heated water. Unable to detect the change in temperature, it will succumb before jumping out.


update, 04-23-10--same message, this time from David Stockman, OMB Director in the Reagan Administration:

ObamaCare...will give the public sector huge new leverage to control the flow of dollars within the nation’s $2.3 trillion health spending system. The rather predictable outcome is a significant de-monetization of the system in the form of reduced provider incomes, longer cues (i.e. pushing spending into the future), reduced levels of care (i.e. less in-patient care, fewer tests) , and lower quality and availability of care ( i.e. fewer elective hip replacements). All of these forces of rationing and de-monetization will reduce hiring budgets and staff-patient ratios within the system.

Monday Muse

Stevie Nicks

Fleetwood Mac

Landslide

Weekly Wrap

[click to enlarge]

Take a quick look at these two graphs from CalculatedRiskBlog. Above, we see that the Mortgage Bankers Association's Purchase Index, updated every Wednesday, shows that mortgage applications for new homes have slipped to a twelve-year low, despite the soon-to-expire First Time Homebuyer's Tax Credit. Below, notice that initial unemployment claims, updated every Thursday, are stubbornly sticky at 450+ K. Look back to the double-dip recession of 1980-82 and ask yourself whether we should be girding ourselves for a similar chart pattern this time around:

Testifying on Capitol Hill Wednesday, the dean of two-handed economists used both hands to fend off congressional critics. Fed Chair Ben Bernanke delicately dodged questions about shady accounting at Lehman Brothers in the months leading up to the financial-sector meltdown in September 2008. The questions were sparked by last week's revelation that Lehman, prior to its bankruptcy, had used an accounting gimmick known as Repo 105 to overstate the health of its balance sheet. Recall that Lehman was raising capital like crazy during the winter and spring of 2008. Falling for the Repo 105 lipstick, investors in those secondaries eventually got gaffed.

Where were the regulators? Treasury Secretary Timothy Geithner, then heading up the New York Federal Reserve Bank, has used the DNR Defense--"do not recall." Likewise, Bernanke insisted on Wednesday that the accounting tricks were "hidden," even as two Fed officials were on the premises at the time, protecting the Fed's interests in discount-window loans to Lehman. They were there to Follow the Money, but did not follow far enough.

Now today comes the news that Merrill Lynch ratted to both the SEC and the Fed two years ago about Lehman's "aggressive" accounting. Caught, like Lehman, in the vise of the growing credit crunch, Merrill found itself at a competitive disadvantage to a firm cooking its books. Advised then of the tilted playing field, the Fed now claims no knowledge. Huh? As Tyler Durden at ZeroHedge tartly observes, the Fed is simply a tool of the industry and should not be part of any regulatory solution to the current financial crisis:

And this is the Fed that lame duck and financially supremely challenged Chris Dodd wants to put in charge of regulating everything in this country? If that really ends up happening, we are so #&$*ed... but not before Goldman funnels all of Americas' money into its Middle-Class Irredeemable Negative Interest Rate All-market Fund SIV.

How much confidence should we have in Big Ben?

THIS much.

.

Out of Balance, Out of Control

The Economist, in a chilling article on gender imbalances in some countries, observes:

Throughout human history, young men have been responsible for the vast preponderance of crime and violence—especially single men in countries where status and social acceptance depend on being married and having children, as it does in China and India. A rising population of frustrated single men spells trouble.

Not a problem in the U.S., but according to The Atlantic, this is:

[T]his era of high joblessness will likely change the life course and character of a generation of young adults—and quite possibly those of the children behind them as well. It will leave an indelible imprint on many blue-collar white men—and on white culture. It could change the nature of modern marriage, and also cripple marriage as an institution in many communities. It may already be plunging many inner cities into a kind of despair and dysfunction not seen for decades. Ultimately, it is likely to warp our politics, our culture, and the character of our society for years.

Either way, you have unchecked male hormones ready to wreak havoc. Alienation...

at home, on the streets...

...even in academia.

.

Monday Muse

Carrie Underwood

Quitter

Weekly Wrap

Personal consumption: up 3% since Christmas 2008

The American consumer is back, or so the data would suggest. As the graph above shows, personal consumption expenditures fell back in the fall of 2008 and winter of 2009, but have recovered since then. Rallying for the past year, the stock market believes the recovery is real. But is it sustainable?

Intuitively, it would seem that consumption should be held hostage by persistently high unemployment. So where is the money coming from?

Not here:

Disposable Income: flat for the past year

No new income? No problem. The banks will lend it to us, right?

Nope:

Consumer credit: down sharply in the past year

How about under the mattress?

Bingo:

Personal savings: dwindling again

The takeaways from this little slide show:

(1) as layoffs mounted in 2008, consumers rationally cut spending

(2) and started saving;

(3) with jobs still scarce, consumers must now draw on savings.

Today's headline: retail sales in February rose 0.3% from the month before, according to the Commerce Department. January's figures, however, were revised downward, so we are doing little better than running in place. Less than half of the retail-sales volume lost since the cycle peak has been recovered. Further progress will require a significant infusion of new jobs, and soon.

The Golden Bird Flies Over Rumford

Latin rhythms at the Muskie Auditorium

March 10, 2010

Music player here

Monday Muse

"Mama" Cass Elliot

Dream a Little Dream of Me

Weekly Wrap

It was a race against time, as Christopher Columbus knew all too well. After more than a month at sea, his crew was getting cantankerous, and he was not sure how much longer they would follow him through uncharted waters. He knew the earth was round. What he didn't know was how big around. What if he had miscalculated? Perhaps this voyage to the Orient would take longer, a lot longer, than what he had figured.

A possible mutiny was not his only worry. Embedded in the wooden hulls of his three vessels were shipworms, steadily munching away on the cellulose keeping the crew afloat. Known as "termites of the sea," shipworms are not actually worms, but bivalve mollusks. In their larval stage, they invade submerged wood and, fitted with shell "bits" at their front ends, start drilling. After a while they grow to 2-3 feet long, and the infested wood takes on the appearance of Swiss cheese (above). Not a comfortable thought when you're a thousand miles or more from your home port.

Columbus's fleet was now due for some scheduled maintenance. As often as you might change the oil in your car's engine, sailors back then had to haul their vessel out of the water and refresh the pitch applied to the hull to deter the teredos. Any damage would have to be caulked before setting sail once more. Columbus was in dire need of a pit stop, but there was no beach around. That's when he was approached by a government economist.

"What are you doing here?" Columbus demanded.

"I was appointed by His and Her Majesties to count the gold that you said you would find, remember? Besides, I have some good news. The teredos have stopped eating our ships. What do you say we break out a cask of vino?"

Known for his ill temper, Columbus exploded.

"Have you got rocks in your cabeza? So what if the worms have stopped! We're still taking on water through the holes they already made!"

Columbus needed dry land, not a dimwitted sycophant. He was of half a mind to heave the economist overboard to feed the sharks, but sent him off to clean the heads instead.

Over 500 years later, optimistic economists still find favor in royal courts. They make six figures and primp for CNBC. They stand behind presidents and prime ministers at important press conferences and fly to places like Davos, Switzerland, to hang with their buds. They find jobs for their girlfriends at the World Bank. They rock and they roll.

Here in the U.S. they blithely announce that the recession is over. Any month now, they say, we will stop losing jobs. That's when things will be all better. But stopping the infestation is not the same as fixing the problem. Holding at zero net new jobs means that we are still taking on water. We need to repair the damage by adding 12 million jobs.

Today's news from the Bureau of Labor Statistics: the teredos are still chewing. According to the Establishment Survey, 36,000 jobs were lost in February. And what do all those unemployed whose benefits are running out think? That maybe it's time to turn the ship around.

Pushing on a String

Trough? Or cliff-drop?

Still believe this is a typical recession? John Mauldin, in his weekly newsletter Thoughts from the Frontline, would like to draw your attention to the graph above. He has this to say:

The money multiplier, as measured by the ratio of M0 to M1 growth, is at its lowest level ever...the normal, accustomed relationships about money supply and inflation are proving to be wrong. We live in extraordinary times. We are coming to the End Game of the debt supercycle that has lasted for 70 years. Everything is changing in front of our eyes.

Here is what he is talking about. M0 (M-zero) is a measure of the monetary base, consisting of all currency plus central-bank credit. This is the supply controlled by the Federal Reserve Bank. M1 refers to the money available to all us poor folks for our day-to-day transactions. It is the sum of currency outside the vaults of depository institutions plus demand and other checkable deposits issued by such financial institutions as your friendly neighborhood bank (or your predatory Wall Street bankster).

In our system of fractional-reserve banking, M1 is some multiple of M0, as commercial banks extending lines of credit to their customers are required to retain in reserve only a fraction of the total dollar amount of their loans. In this way, money created by the Fed gets multiplied by the institutions doing business with the public. If the Fed wants to rev up business activity, it expands M0, intending thereby to lever up M1.

This is what the Fed is (frantically) trying to do now. Problem is, a dollar of M0 does not go as far as it used to. Twenty-five years ago it grew three dollars of M1; now it buys a measly 81 cents. This begs the Morning After question, what happened? Simply put, banks are reluctant to lend, and consumers and businesses are reluctant to borrow. As Mauldin explains:

Bank lending has fallen percentage-wise the most in 67 years. The actual amount of bank loans is falling each and every quarter, with no signs of a bottom. Consumers are reducing their debt and leverage. Bank loans are being written off at staggering rates. Over 700 banks are officially on watch by the FDIC, with more banks being closed each week.

There is at least $300-400 billion in losses on commercial real estate waiting to be written down. Housing foreclosures are rising and hundreds of billions have yet to be written off. As more families fall into unemployment or underemployment, there will be more writedowns. Is it any wonder that banks are having to shore up their balance sheets and make fewer loans?

Essentially the multiplier graphed above measures confidence. The low level of confidence permeating our economy makes the Fed helpless. Getting out of this mess is up to you and me.