By Jim Willie CB, Golden Jackass
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The background noise has been considerable. The USCongress, the august body that often passes legislation without reading it, evaluates a new initiative to reinstitute the Glass Steagall Act. Pass it, don’t read it! Great idea! In the wisdom from post-Depression seven decades ago, the same Congress imposed firewall separation among the commercial banks, the brokerage houses, and the insurance firms in order to prevent systemic financial sector failure. That is precisely what happened in the last two years, without proper recognition or diagnosis, except by this and some analysts. Insolvent systems do not spring back to life with grandiose infusions of phony money and complete covers for fraud. They remain insolvent. The bank woes will suffer massive relapse this year, from fresh commercial mortgage losses, from prime Option ARMortgage foreclosures, and from continuing overload of toxic losses from gargantuan residential property held on their books that they stubbornly refuse to put up for sale. If the US housing market shows any remote signs of price stability, it is due to a few hundred thousand foreclosed homes held by banks, floating on their ruined balance sheets, held back from dispatch to real estate brokers in auction. Keep price stable by erecting a banker dam on properties. It must release, but it might head straight into the Fannie Mae toxic pit.
Another popular bizarre balance sheet item is the bank reserves held for interest yield within the safe confines of the US Federal Reserve. The USFed itself might desperately need such funds to ward off its own deep insolvency in the hundreds of billion$. They did after all, ramp up toward 50% their ratio of USAgency Mortgage Bonds, most of which are worth far less than the stated value on their cratered books. The ugly truth on this matter is that US big banks face additional huge losses, so the reserves held at the USFed should be regarded as Loan Loss Reserves, hardly robust assets. They are still insolvent. These big banks are so dead, that the only partners they attract are other vampires. Non-performing loans have soared to a record 5%, shown below. Now factor in that US banks carry over $7000 billion in commercial loans. The resultant $350 billion of non-performing loans on the books of banks is disclosed, but what is not disclosed is their additional toxic assets off balance sheet and other various credit derivatives like Interest Rate Swaps. These huge supposed bank reserves are not going anywhere, surely not the USEconomy. The big banks are still wrecked.
Quietly the USCongress has been working on new legislation to reform the financial system regulatory structure. It reads like a TARP to the sixth power. The House of Representatives has passed its version, the House Resolution 4173. The US Senate must next tackle the issue.The House version calls for up to $4 trillion in big bank aid if and when another banking system breakdown occurs. Despite all calls to reverse rescue for financial firms too big to fail, this bill does exactly the opposite. My pattern of analysis, successful for five years, has been to hear the words, to expect precisely the opposite in the action taken, and to regard the words as pure deception to calm the opposition and lull it into a moribund state. The people are easily fooled, and rarely comprehend new legislation once forged into law. Hear the words, anticipate the opposite. That tactical approach was honed in my work by observing Greenspan. Without any hint of doubt, the USCongress is a trained lackey for Wall Street and the bankers. The nation has lost control to bankers long ago. The end game is a shattering reality.
BLANK CHECK TO FANNIE & FREDDIE
Turn to the Eye-Popper this past week, an event that should have caused incredibly deep alarm, disgust, dismay, disconcertment, and consternation. Instead, the US financial markets have been so anaesthetized by nationalizations, big bank welfare, major fraud cases, outsized executive bonuses for failed bankers, prattle about recovery by political and bank leaders, and mindless federal programs that cost multiples more than benefits. So the news of an unlimited line of funds, not at all a credit line, comes to the viewing audience. This is a BLACK HOLE of unlimited diameter. One should be immediately suspicious, before reading any details. Fannie Mae & Freddie Mac (F&F) have been the source of at least $2000 billion (yes, $2 trillion) in missing funds from the Papa Bush and Clinton Administrations. Politicians love the Fat Fannie Freddie Duo, since it has served as a slush fund source for two decades. These missing, stolen, counterfeited, absconded funds are documented by the auditors to the USDept Housing & Urban Development. The follow-up stopped in its tracks, as officials in the USDept Treasury halted investigations, informing auditors that the funds are designed to fund black bag projects, including the Working Group for Financial Markets. This is all well documented, and not in dispute any longer. My theory from September 2008 onward has been that Fannie & Freddie were put under conservatorship within the USGovt in order to prevent investigations of fraud, to prevent discovery of Wall Street bond counterfeit, to prevent lawsuits on improper securitization of mortgage income streams (usage of single income with multiple bonds), and to prevent mortgage rates from rising as foreign creditors dumped mortgage bonds. The joke on Wall Street these days has been that Fannie Mae is a great firm to leave, since despite allegations of criminal activity, nothing happens on the legal side, and besides, the exit bonuses are in the multi-million$. Ex-CEO Franklin Raines, friend to all politicians, earned $62 million upon exit amidst controversy and shades of fraud.
So next, the blank check is written for Fannie & Freddie, and one should suspect that the funds will flow freely. Any expectation of major home loan balance reduction for the benefit of the people might be misplaced. We shall see! Maybe it will come! The USDept Treasury announced last Thursday the removal of the $400 billion financial cap on the money line provided to keep the companies afloat. To date, US taxpayers have parted with $110 billion to the fat duo. All estimates submitted by the USGovt about loss magnitude have been laughable. My forecast over a year ago was for at least $2 trillion and possibly $3 trillion in losses ultimately, over 10 times what officials stated. My figure is looking better every passing week. Denials persist that the original $400 billion limit was nowhere approached. So why extend the line of funding to unlimited? The reasons are two-fold in my view. First, grandiose grotesque gargantuan losses are coming, since liquidation of bad home loans has been halted. A huge dam of toxic loans is on the Fannie & Freddie books. As Rich Santelli of CNBC said on Tuesday, “This move permits Fannie Mae to load on all kinds of additional pigslop onto their balance sheet, and to do so without end.” He followed with some denigrating remarks about the wisdom of fiscal leadership. Second, the blank check will permit continued coverup of the mortgage bond fraud, along with rafts of broken credit derivative contracts. The coverup requires much additional papering over. The size of the Interest Rate Swap book on the F&F books must be greater than the global economy, maybe by a multiple.
Next is large scale mortgage portfolio liquidations, mortgage portfolio writedowns, and possibly some actual loan balance reductions finally. Massive losses will be revealed by Fannie & Freddie, but the public and financial sector will applaud the cleansing process. An astonishing volume of backlog home loan constipation might be relieved by means of this official enema in the planning stage. Housing prices are certain to drop if F&F refuse to permit their managed home portfolio to grow without limit. If F&F dump homes on the housing market, the prices will drop another 15% to 20% easily. The alternative is more what my forecast has in store, a truly staggering shocking alarming home rental business by the USGovt as landlord. The Fat F&F Duo can mitigate the negative political reaction by reducing home loans in a substantial way and to a meaningful degree, which would help to stop the foreclosure parade and the reversal of the Ownership Society nightmare.
MOTIVE FOR THE USGOVT HOME OWNERSHIP
Fannie Mae and Freddie Mac provide vital liquidity to the mortgage industry by purchasing home loans from lenders and selling them to investors. Most investors lose heavily, but the bond brokers make out very well indeed. Together, F&F own or guarantee almost 31 million home loans worth about $5.5 trillion, almost half of all mortgages. Without USGovt aid, the firms would have gone bust long ago, leaving millions of people unable to obtain a mortgage. The biggest headwind facing the housing recovery has been the rise in foreclosures as unemployment remains high and the hidden bank inventory of foreclosed properties swells each month. The Obama Admin dare not disclose its long-term plans for the two agencies under conservatorship.
Pardon me during outbursts of laughter at the mere word ‘conservatorship’ since nationalization was under that thin veil all along, as in all along. The formal steps were missing, but no longer. The Toxic F&F Duo will never return to their former power and influence, not to mention integrity, if they have had any for 20 years. The Obama Admin might do best to conceal its plans of federal residential property ownership, since it might read like a Communist Manifesto. In summer 2005, my forecast for Fannie Home Rentals has come true, with nary a peep of objection. Rentals are seen as a great solution. The F&F shareholders should face total ruin with share price at zero. Instead, Fannie Home Rentals should provide a massive revenue stream useful in justifying a stock share price. At the same time, the financial sector will likely applaud all initiatives that result in removing home supply from selling inventories. The federal landlord plan actually will permit some home price stability. Let’s not even touch on executive bonuses and compensation packages for the current managers of these financial sewage treatment plants.
My personal conjecture is that Fannie Mae is burning through money 5 times faster than the topline figures show. The USGovt will next be funding the Great Black Hole in a more visible fashion, if that is a positive development. One might even conclude that the blank check is not price inflationary, since it goes right into the toilet. This is Weimar Defecation. It will affect the USDollar and USTreasury global integrity. Worse, we are at the forefront of a blossoming of the USGovt emerging as a significant national landlord. What we have is the onset of precisely the opposite of the Ownership Society put forth by ex-President Bush II. What irony! Or was it the plan? Just like the Greenspan Project to undermine the US financial grid? One should harbor great suspicion that the USGovt has been collecting mortgages on a grand basis, as has been the USFed. My full expectation is that the USFed will dump their entire mortgage bond assets on the USGovt at the appropriate timely moment, despite any lack of value, and receive nearly full book value. The taxpayers inherit the sewage. Furthermore, gigantic tranches of home loans from the residential sector are likely to come from the commercial banks, heading directly to the Fannie & Freddie balance sheets. This flood will accelerate the disenfranchisement of the proletariat, as home foreclosures continue unabated, and the USGovt entrenches its property ownership. Those who fail to see the trend toward a communist state with military dictatorial powers are at best sleep and at worst blind.
Numerous theories have been floating in the media and in internet journals, where the most responsible journalism exists, by far, bar none. Former HUD auditor Catherine A Fitts shared her opinion that the banks are going to take huge writedowns on the commercial side. To make room on their balance sheets to handle the commercial mess, the residential portfolios are going to be shifted to Fannie & Freddie in a manner that will protect the major banks. The F&F balance sheets are where residential mortgages will go to die, she expects. The market cannot handle the home sale flow from liquidations. And besides, the Federal Housing Admin and Ginnie Mae are too small and too logistically strained to move such volume so quickly. The sewage treatment plant is well equipped. All roads lead to F&F Processing Plant. The USGovt auditors will proclaim profits from Fannie Home Rentals, but hide the enormous losses.
Dan Amoss of the Strategic Short Report shares his opinion on a trend. He said, “The market will eventually adopt the view that Fannie Mae and Freddie Mac have been nationalized. Last week’s elimination of limits on Treasury’s capital infusion into Fannie and Freddie is a defacto nationalization. In other words, there is no longer much chance of a re-privatization, but instead we will see a gradual transformation of these Frankensteins into new branches of government. They will implement the official government agenda for housing, without much regard for prudent lending. This will have huge consequences for the Treasury market. While the federal government will stick to its Enron-style accounting, and not officially consolidate Fannie/Freddie assets and liabilities onto the government balance sheet, the smarter foreign creditors will. These creditors will start viewing Fannie/Freddie liabilities as equal to Treasuries in terms of default risk.But this does not mean that spreads on Fannie/Freddie liabilities will tighten down to Treasuries. Rather, it will substantially increase the long-term default risk of Treasuries, and Treasury buyers will demand higher rates to compensate for this risk.” Amoss anticipates the principal mortgage provider in the future is indirectly going to be the USGovt. Amoss also states that the USTreasury debt is to be mixed with the USAgency Mortgage debt in perception, no longer distinguishable since the former funds the latter. THE RISK OF USTREASURY DEFAULT HAS LEAPED HIGHER!! Since Fannie & Freddie are deeply insolvent, the new USGovt debt ratio also leaped higher.
On the entire motive theme, ponder the following. The USTreasury Bonds are at risk of higher bond yields. They will likely not shoot up rapidly, since the JPMorgan machinery is still in operation, namely the Interest Rate Swaps. Check the Office of Comptroller to the Currency for basic evidence. A reversion to the mean, a reversal of the lopsided positions, a return to normalcy would clearly involve over a $1 trillion loss to the JPMorgan monster. The IRSwap contracts are firmly in place, ramped up, heavily fortified by Printing Pre$$ activity without scrutiny or bounds, never properly audited since done by venerable JPMorgan. While we all decry the rise of credit derivatives, few complain about low interest rates in today’s age of speculation. Artificially low cost of money has fueled two decades of asset bubbles and the ruin of the US industrial base. My view is that the USFed is desperate to end their 0% rate, since they realize it caused the housing & mortgage bubbles in 2003-2007. But the USFed has returned to the scene of the crime with entrenched 0% rates, stuck for over a year. The USFed definitely does NOT want long rates to rise. They are scared witless of rising mortgage rates, since they would kill the housing market altogether, or at least put it under a massive wet blanket for an indefinite time. The IRSwap detonation could happen at either end, on the short rate or long rate, much like a stick of dynamite with a fuse at each end. Risk is acute if the USFed were to hike the FedFunds rate, since they would directly set off IRSwap explosions. The USGovt borrowing costs would triple also.
RISK RISK RISK, MONETIZATION & INTEGRITY
Harken back just a few weeks, when the USDept Treasury and USFed announced on a repeated basis the end of Quantitative Easing. Their words were laughable, intended to deceive, and were whole portions of propaganda. INSTEAD, THEY DID THE EXACT OPPOSITE, AND MADE THE FORMAL ANNOUNCEMENT BETWEEN THE CHRISTMAS AND NEW YEAR HOLDIDAYS. The move to permit unlimited Fannie & Freddie funding is an end-around maneuver to prevent long-term interest rates from rising, or at least to insulate the mortgage finance arena from higher long-term interest rates. IT COMES AT A COST, OF SYSTEMIC RISK, OF PERCEIVED DEFAULT RISK, OF USGOVT DEBT FOUNDATION RISK. The year 2010 might be characterized by a rise in the entire USTreasury bond yield spectrum, from short-term to mid-term to long-term. It is not just a bad thing, a risk filled development. It is a risk of game over! The monetization threat and deep monetary inflation to fund USTreasurys (indirectly Fannie & Freddie debt) are important parts of the vicious cycle displayed in the December 16th article entitled “Full Circle of Govt Debt Default” (CLICK HERE). The full circle (see the chart) starts and ends with the USDollar and the USTreasurys, from debts, monetization, and monetary inflation gone haywire. The toxic chickens come home to roost!!
The credit markets must prepare for one of two undesirable outcomes. Either interest rates rise markedly in order to fund the USGovt federal deficits or else Printing Pre$$ output of phony money must escalate without bounds. Next comes debt explosion or Weimarinflation. The federal deficits must be securitized, in other words, converted into bonds and funded. The process so far has involved an incredible amount of hidden monetization. It is slowly being discovered, but not reported by the sleepy lapdog intrepid press & media. My articles have detailed some of the primary bond dealer monetization in Permanent Open Market actions, and some of the foreign central bank monetization of mortgage bonds to fund USTreasury bids. The year 2010 will feature monetization of USGovt debt and of mortgage losses out in the open to a much greater degree. The effect will be to place the USGovt debt viability at grave risk. It will be interesting to watch the debt ratings agencies (Standard & Poors, Moodys, Fitch) squirm. They are under tremendous pressure not to repeat their lackadaisical behavior in the past. They are downgrading European nation sovereign debt. They are denying openly the justification to downgrade both United Kingdom Govt and United States Govt debt. Their denials are damning in themselves, since why mention the lack of justification for such downgrade unless they should be downgraded by any reasonable measure. The USGovt short-term funding requirements are almost as great as their active monetization, the clear expedient. The USEconomy tolerates huge Ponzi Schemes from the inside, like Madoff, like Fannie & Freddie, like AIG, like Wall Street itself. Rather the USEconomy has become one huge Ponzi. Its expansion on the margin is uncontrollable, just like its appetite for new funds is uncontrollable. The blank check to Fannie & Freddie is testimony to the need to fund the Ponzi Scheme, but it is phony money entering a vast and widening Black Hole.
Last autumn 2008, one year ago, the USDollar embarked on what my analysis called a Dollar Death Dance. The bounce from the November depths last month at 74.5 to the hardly rarified air near 79 has been sudden. The rise in rebound has been built upon several factors. The Dubaidebt mess has exposed European and London banks for further losses, leading to an exit from both the Euro and British Pound currencies. The US banks are more adept at hiding their losses, extended their toxic loans, pretending they will find eventual value. The Dubai shock has made vividly clear the heightened risk of a European Union fracture, a threat to the Euro currency, and a need for Germany to cut off the Southern Europe impaired limbs, debt and all. One must wonder with sinister thoughts if the Dubai debt was permitted to default, or orchestrated to default, precisely at the most promising season for gold, into the year end strength. It short-circuited the strong gold season. But one thing is for sure about seasonality issues. They have been widely destroyed in recent years in numerous asset classes. The late winter and spring for gold should be strong again, as the USDollar will expose its toxic fundamentals. The only thing making the ugly pig with lipstick look good is the unfavorable comparison to broken European national debt structures, which do not have the benefit of the Printing Pre$$ Privilege or the vast criminal sydicates supported by it.
The Competing Currency Wars have heated up again from comparisons rather than open hostility to protect exports. Money departs the Euro harbors and enters the toxic USDollar pits, where the stench of Printing Pre$$ overdrive operation fills the air, where the shame of unlimited Fannie & Freddie black hole directed funds tarnishes the USDollar image, and where the unprosecuted Wall Street bond fraud festers like an open sore. This sudden US$ rebound has left the G-20 Meeting declarations a recent bad memory. The emerging nations had shown steady disrespect for the so-called developed nations, the deep debtors who long ago lost their industrial base. They transformed industry to debt, a miracle of modern central banking!! There is nothing like some debt liquidation to show how the USDollar still has remnants of a safe haven. Its security has only remnants, torn shreds adorned by stars and stripes once given respect. Let’s not even touch the endless wars, the clandestine military business in narcotics, the private contractor fraud in the war effort, the missing $50 billion in Iraqi Reconstruction Funds that nobody is looking for. These activities smear and harm the US image in powerful ways, often without US awareness from inside the US Dome of Perception.
Just what is the force to sustain the USDollar rebound? More European member nation debt woes. More credit derivative liquidation and payouts. The US$ rebound runs on noxious fumes. This is the Dollar Death Dance, part II. The long-term trend will remain down. The immediate activity could feature more of the same. The short covering of the Dollar Carry Trade has been clear. It will have to muster enough funds, courage, and wisdom to put that carry trade into second gear. It is inevitable. It is justified. It will be profitable. It certainly will be dangerous, since the USDollar is still the global reserve currency. That status is threatened though. Clearly, the USDollar rebound, a move of a mere 6% in the last few weeks, is the only factor pushing down the gold price. One can see that the gold price decline has run its course. The overbought condition has worked itself off. The risk of a move to 1060-1080 is apparent. However, the moving averages are rising. The stochastix are ready to cross over in a positive way. Last but not least, the fundamentals for the USGovt finances and the USDollar in particular could not be more acutely horrible, miserable, outrageously negative, and represent a palpable threat of a sovereign debt default down the road. At least we will see a monetary crisis centered upon the USDollar. That would pressure the eventual default.
The USDollar rebound and the reflexive gold correction have been rapid and thus are unstable. They are both nurtured by European and London weakness, rather than US strength. The long-term trend is solid and up for gold. With all the hubbub and gnashing of teeth, the gold price is still above its October highest level. My favorite question of US$ Bulls is “What has been fixed?”The answer is nothing. Much money has been spent, and huge deficits have been racked up, but to what end? No remedy, no reform, no structural imbalances corrected, no deficit reduction, no military expense curtailment, no end to banker welfare, no successful modification to home loans, no end to home foreclosures, no end to job cuts, no end to supply chain disruption, no end to the USGovt and USFed acting as primary lenders, not just lenders of last resort. The USDollar is running on fumes, and the end to its bounce is near. The gold bull will run again. Three to four steps up, one step back.
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Jim Willie CB is a statistical analyst in marketing research and retail forecasting. He holds a PhD in Statistics. His career has stretched over 25 years. He aspires to thrive in the financial editor world, unencumbered by the limitations of economic credentials. Visit his free website to find articles from topflight authors at www.GoldenJackass.com . For personal questions about subscriptions, contact him at JimWillieCB@aol.com
Freddie 30 Year Fixed At 5.14%, 4 Month High, As 30 Year-1 Year ARM Spread Hits Another Absolute Record
A week ago Zero Hedge discussed the spread between the Freddie 1 Year ARM and the 30 Year fixed, concluding that the recent record spread is indicative that the Fed will do all it can to become the new subprime lender of any resort, even if it means creating exponentially more roll risk, as it seeks to lend money regardless of the probability of ultimate payback. Today Bloomberg points out that the Freddie 30 Year has just hit a 4 month high of 5.14%, a level last seen at the end of August. What is notable is that in less than two weeks the 30 Year Freddie Fixed has jumped by 20 bps. At this rate we will overtake the 2009 high of 5.59% within a month. However, our original observation is that even as the 30 Year Fixed has finally started to move in line with the 10 Year Treasury, which just can’t find a floor in the past week, the 30 Year Fixed – 1 Year ARM spread has simply exploded: when we looked at its last it was 60 bps, a week later, it is now at 81 bps. The Fed is now literally throwing money away in the form of Adjustable Rate Mortgages.
Luckily the SEC has finally started investigating the New Centuries of the last housing crash (we sure aren’t holding our breath for any convictions in the next million years – after all Mary Schapiro is in charge of it all). Yet it gives us hope that at some point, regardless of how long after the next housing bubble has finally burst, the biggest criminals of the current cycle, those residing in Marriner Eccles building, will also be finally put to justice.
Submitted by TrimTabs’ Charles Biderman
Are Federal Reserve and U.S. Government Rigging Stock Market? We Have No Evidence They Are, but They Could Be. We Do Not Know Source of Money That Pushed Market Cap Up $6+ Trillion since Mid-March.
The most positive economic development in 2009 was the stock market rally. Since the middle of March, the market cap of all U.S. stocks has soared more than $6 trillion. The “wealth effect” of rising stock prices has soothed the nerves and boosted the net worth of the half of Americans who own stock.
We cannot identify the source of the new money that pushed stock prices up so far so fast. For the most part, the money did not from the traditional players that provided money in the past:
- Companies. Corporate America has been a huge net seller. The float of shares has ballooned $133 billion since the start of April.
- Retail investor funds. Retail investors have hardly bought any U.S. equities. Bond funds, yes. U.S equity funds, no. U.S. equity funds and ETFs have received just $17 billion since the start of April. Over that same time frame bond mutual funds and ETFs received $351 billion.
- Retail investor direct. We doubt retail investors were big direct purchases of equities. Market volatility in this decade has been the highest since the 1930s, and we no evidence retail investors were piling into individual stocks. Also, retail investor sentiment has been mostly neutral since the rally began.
- Foreign investors. Foreign investors have provided some buying power, purchasing $109 billion in U.S. stocks from April through October. But we suspect foreign purchases slowed in November and December because the U.S. dollar was weakening.
- Hedge funds. We have no way to track in real time what hedge funds do, and they may well have shifted some assets into U.S. equities. But we doubt their buying power was enormous because they posted an outflow of $12 billion from April through November.
- Pension funds. All the anecdotal evidence we have indicates that pension funds have not been making a huge asset allocation shift and have not moved more than about $100 billion from bonds and cash into U.S. equities since the rally began.
If the money to boost stock prices did not come from the traditional players, it had to have come from somewhere else.
We do not know where all the money has come from. What we do know is that the U.S. government has spent hundreds of billions of dollars to support the auto industry, the housing market, and the banks and brokers. Why not support the stock market as well?
As far as we know, it is not illegal for the Federal Reserve or the U.S. Treasury to buy S&P 500 futures. Moreover, several officials have suggested the government should support stock prices. For example, former Fed board member Robert Heller opined in the Wall Street Journal in 1989, “Instead of flooding the entire economy with liquidity, and thereby increasing the danger of inflation, the Fed could support the stock market directly by buying market averages in the futures market, thereby stabilizing the market as a whole.” In a Financial Times article in 2002, an unidentified Fed official was quoted as acknowledging that policymakers had considered buying U.S. equities directly, not just futures. The official mentioned that the Fed could “theoretically buy anything to pump money into the system.” In an article in the Daily Telegraph in 2006, former Clinton administration official George Stephanopoulos mentioned the existence of “an informal agreement among the major banks to come in and start to buy stock if there appears to be a problem.”
Think back to mid-March 2009. Nothing positive was happening, and investor sentiment was horrible. The Fed, the Treasury, and Wall Street were all trying to figure out how to prevent the financial system from collapsing. The Fed was willing to print whatever amount of money it took to bail out the system.
What if Ben Bernanke, Timothy Geithner, and the head of one or more Wall Street firms decided that creating a stock market rally was the only way to rescue the economy? After all, after-tax income was down more than 10% y-o-y during Q1 2009, and the trillions the government committed or spent to prop up all sorts of entities was not working.
One way to manipulate the stock market would be for the Fed or the Treasury to buy $20 billion, plus or minus, of S&P 500 stock futures each month for a year. Depending on margin levels, $20 billion per month would translate into at least $100 billion in notional buying power. Given the hugely oversold market early in March, not only would a new $100 billion per month of buying power have stopped stock prices from plunging, but it would have encouraged huge amounts of sideline cash to flow into equities to absorb the $300 billion in newly printed shares that have been sold since the start of April.
This type of intervention could explain some of the unusual market action in recent months, with stock prices grinding higher on low volume even as companies sold huge amounts of new shares and retail investors stayed on the sidelines. For example, Tyler Durden of ZeroHedge has pointed out that virtually all of the market’s upside since mid-September has come from after-hours S&P 500 futures activity.
If we were involved in a scheme to manipulate the stock market, we would want to keep it in place until after the “wealth effect” put a floor under the economy of, say, three quarters of positive GDP growth. Assuming the economy were performing better, then ending the support for stock prices would be justified because a stock market decline would not be so painful.
We want to emphasize that we have no evidence that the Fed or the Treasury are throwing money into the stock market, either directly or indirectly. But if they are not pumping up stock prices, then who else is?
Equity Mutual Fund Cash Equal to 3.8% of Assets in November, Just above Record Low of 3.5% in Mid-2007. U.S. Equity Funds Get Estimated $5.1 Billion in December, First Inflow in Five Months.
The Investment Company Institute reported Wednesday that equity mutual funds held just 3.8% of their assets in cash and equivalents in November. To put this percentage into perspective, the record low was 3.5% in June 2007 and July 2007. While the amount of cash increased $8.1 billion in November, assets shot up $229.1 billion, leaving the ratio of cash to assets unchanged.
Source: Investment Company Institute.
U.S. equity fund flows reversed sharply in December. After posting fairly large outflows from September through November, U.S. equity funds received an estimated $5.1 billion (0.1% of assets) this month.
Apart from the shift in U.S. equity fund flows, mutual fund flows did not change much in December. Global equity funds continued to post moderate inflows, taking in an estimated $7.1 billion (0.7% of assets). This month’s inflow is in line with the inflows of $7.8 billion in October and $6.0 billion in November.
Finally, bond funds continued to rake in huge amounts of cash. They received an estimated $25.8 billion (1.2% of assets), putting them on track to post an unprecedented ninth consecutive monthly inflow exceeding $25 billion.
Mutual fund investors tend to be poor market timers. Based strictly on mutual fund flows, the clear contrarian play would be to short bonds right now. This year’s record inflow of $375 billion into bond funds is 44% higher than the record inflow of $260 billion into U.S. equity funds at the stock market top in 2000.
Note: Flows for December 2009 are estimates based on our daily survey and data from the Investment Company Institute.
We Plan to Stay Neutral (0% Long) on U.S. Equities This Weekend. Investment Demand Remains Favorable: TrimTabs Demand Index Bullish at 58.9 on December 29.
We plan to stay neutral (0% long) on U.S. equities in our model portfolio. As we discussed Tuesday, real-time income tax data shows no sign of a recovery in the U.S. economy.
But we do not want to be short mostly because investment demand is favorable. The TrimTabs Demand Index (TTDI), which uses 21 flow and sentiment variables to assess overall investment demand was 58.9 on Tuesday, December 29. While this reading is well below the interim high of 77.1 on Friday, December 18, it is still above the neutrality line of 50. The index is so bullish mostly because indicators that tend to be leading—notably excess margin debt and the cash balance of equity mutual funds—are indicative of greed.
Corporate Liquidity Likely to Be Neutral to Bullish Next Week. New Offering Calendar Will Be Virtually Shut Down, While Corporate Buying Likely to Remain Light.
Another reason we plan to stay on the sidelines is that corporate liquidity is likely to be neutral to bullish next week.
On the sell side, new offerings are likely to be light because underwriters will just be returning from extended vacations. New offerings amounted to just $350 million in the week ended Wednesday, December 23, and they are almost certain to be lower this week (Dealogic reports that less than $50 million is scheduled for later this week in addition to the $4 million that priced Thursday through Tuesday).
On the buy side, the economy’s weakness suggests corporate buying is unlikely to surge into the New Year. Nevertheless, new cash takeovers and new stock buybacks combined are likely to rival or exceed new offerings next week.
Taking a look back, corporate liquidity was extremely bearish in December. The $75.5 billion in corporate selling (new offerings + net insider selling) was 4.2 times the $18.0 billion in announced corporate buying (new cash takeovers + new stock buybacks). Yet corporate selling was highly concentrated, with large follow-on deals for three big TARP banks accounting for 79% of the corporate selling. We expect corporate liquidity to turn bearish again starting in the third week of January as companies take advantage of bubbly stock prices to unload more new shares.
Same Unemployment Insurance Misreporting, Different Day: Initial Claims Down 22,000 As EUCs Surge Almost Two Hundred Thousand
The fabulous news of the day undoubtedly will be the latest release from the Dept of Labor: Initial Claims for the week ended December 26 came in at 432,000, a 22,000 decline from the prior week, and below consensus. The number was sufficient to prompt Bloomberg’s Courtney Schlisserman to come up with the following observation, “Fewer Americans than anticipated
filed claims for unemployment benefits last week, pointing to an
improvement in the labor market that will help sustain economic
growth next year.” Perhaps Courtney and Steve Liesman should sit down in a corner and finally figure out what this whole EUC (Emergency Unemployment Compensation) business is – trust us, it is not that difficult. And for the week ended Dec. 12 it surged by 191,669 to almost 4.5 million, another all time record. Three weeks ago we were shocked when this number hit the all time high of 4.2 million: in a mere 21 days it has added a whopping 7% to the total. Unfortunately, at this point we have gotten a little desensitized to new EUC records. We ask Ms. Schlisserman what happens to the “sustainable economic growth” when there are 0 Initial Claims (hurray!!) and a million EUC claims weekly (d’oh)? Again, a simple question. Luckily for Bloomberg, the DOL and the BLS there is no consensus number for EUC, as the downside surprises there would have been staggering, if anyone actually cared to report those on the front pages of the even impartial mainstream media.
To be honest, Courtney does point out that Conference Board numbers we discussed yesterday, which demonstrated that Americans have now written off any possibilities for a raise until the 30th century.
Americans are concerned about their financial
future. Fewer consumers in December believed their incomes will
increase over the next three to six months, the Conference
Board’s confidence report this week showed.
And with wage deflation still pervasive, John Williams’ hyperinflation thesis may just have to be put on the backburner for a few [months/years/decades].
For all of those who feel China is going to take over the free
world, just remember that when you blow a bubble (particularly a
balance sheet bubble) it is bound to pop. The damage from the pop
invariably does more harm than the boost from the bubble. It has always
been the case, particularly when leverage is involved – which makes the
impact that much more devastating. If anybody can attest to this, it
should be us Americans (British, Spanish, Irish, those from Dubai,
Methinks that before China gets a chance to
become a preeminent world power, their profusely blown asset bubble (by
way of a most accomadating fiscal policy) will blow up in their face
and they will go through what the US, Japan and UK just (is still) went
through, exacerbated by the fact that they are still a net export
reliant economy when the bubble blowing is removed. With the developed
world in sluggish mode, they will have very little to fall back on as
their asset prices collapse to equilibrium and debt from their
steriodal lending system is left under or uncollateralized and unable
to be serviced.
Why does everybody confuse bubbles with economic progress?
Dec. 31 (Bloomberg) — Li Nan has real estate fever. A 27- year-old
steel trader at China Minmetals, a state-owned commodities company, Li
lives with his parents in a cramped 700- square-foot apartment in west Beijing.
Li originally planned to buy his own place when he got married, but after watching Beijing real estate prices soar,
he has been spending all his free time searching for an apartment. If
he finds the right place — preferably a two-bedroom in the historic
Dongcheng quarter, near the city center — he hopes to buy immediately.
Act now, he figures, or live with Mom and Dad forever. In the last 12
months such apartments have doubled or tripled in price, to about $400
per square foot.
“This year they’ll be even higher,” says Li in the Jan. 11 issue of Bloomberg BusinessWeek.Does this scenario sound even remotely familiar???
of Chinese are pursuing property with a zeal once typical of
house-happy Americans. Some Chinese are plunking down wads of cash for
homes. Others are taking out mortgages at record levels. Developers are
snapping up land for luxury high- rises and villas, and the banks are
eagerly funding them. Some local officials are even building towns from
scratch in the desert, certain that demand won’t flag. Straight out of the Dubai make money now and pay for it later handbook of bubblistic speculation! And if families can swing it, they buy two apartments: one to live in, one to flip when prices jump further. Imported speculators from Miami, LA and downtown Brooklyn!
And jump they have. In Shanghai, prices
for high-end real estate were up 54 percent through September, to $500
per square foot. In November alone, housing prices in 70 major cities
rose 5.7 percent, while housing starts nationwide rose a staggering 194
percent. The real estate rush is fueling fears of a bubble that could
burst later in 2010, devastating homeowners, banks, developers, stock markets, and local governments.
Let’s get this straight. “Fears of a bubble”!!! A 54% gain in 9 months
does not confirm a bubble???!! What is the long term historical average
in China. Probably 2% to 4% annually, or on pace with inflation, give
or take. So, if pundits are not sure a 25x increase is a bubble, what
would it take to convince them?
“Once the bubble pops, our economic growth will stop,” warns Yi Xianrong, a researcher at the Chinese Academy of Social Sciences’ Finance Research Center. On Dec. 27, China Premier Wen Jiabao told news agency Xinhua that “property prices have risen too quickly.” He pledged a crackdown on speculators.
Actually, once the bubble pops, their economic growth will collapse,
and trend in reverse. That’s what happens when bubbles pop. If the
growth just stopped, then it would make sense to encourage bubbles,
wouldn’t it? You can just reignite another bubble when the previous one
pops and start the cycle over again. It appears as if this is the
playbook some of our central bankers are following. Unfortunately, they
are called boom/bust cycles, not boom/stop cycles. Bubbles are not
indicative or true organic growth, they are a sign of growth borrowed
from future time periods that MUST be paid back with hard money
interest. The bigger the bubble, the bigger the “vig”.
parallels with other bubble markets, the China bubble is not quite so
easy to understand. In some places, demand for upper middle class
housing is so hot it can’t be satisfied. In others, speculators keep
driving up prices for land, luxury apartments, and villas even though
local rents are actually dropping because tenants are scarce. What’s
clear is that the bubble is inflating at the rich end, while little
low- cost housing gets built for middle and low-income Chinese.This is not hard to parallel. This is exactly what happened in NYC, particularly Manhattan and Downtown Brooklyn. See “Who are ya gonna believe, the pundits or your lying eyes?”#000000;”> (for pictures) and “Who are you going to believe, the pundits or your lying eyes, part 2” (for numbers and a very shaky video),
I illustrated a trip from Chelsea Piers in Manhattan to Prospect Park
in Brooklyn, capturing the rampant supply of residential, office and
commercial space that is STILL being put up despite the extreme glut
currently in this rapidly declining market. As you look through all of
this visual material, remember banks have supplied the capital for
building all of these empty edifices, at no less than 10x leverage.
None of this inventory was targeted at the middle and lower classes. As
ironic as it may sound, this activity ultimately ends up causing
downward social mobility as asset values collapse under mounting debt.
See Super Brokers form to push Super Broken products to make those with High Net Worth Super Broke for my take on social mobility, downwards style).
Beijing’s Chaoyang district, which represents a third of all
residential property deals in the capital, homes now sell for an
average of almost $300 per square foot. That means a typical 1,000-square-foot apartment costs about 80 times the average annual income of the city’s residents. I’ll give this until the end of 2010 to blow up!
an analyst at U.S. investment manager Pimco, estimates that only 10
percent of residential sales in China are for the mass market.
Developers find the margins in high-end housing much fatter than
returns from building ordinary homes.
How did this
bubble get going? Low interest rates, official encouragement of bank
lending, and then Beijing’s half-trillion- dollar stimulus plan all
made funds readily available. City and provincial governments have been
gladly cooperating with developers: Economists estimate that half of
all local government revenue comes from selling state-owned land. “Nuff said!
Chinese consumers, fearing inflation
will return and outstrip the tiny interest they earn on their savings,
have pursued property ever more aggressively. Companies in the
chemical, steel, textile, and shoe industries have started up property
divisions too: The chance of a quick return is much higher than in
their primary business. Oh my!
Built on Sand
“When you sit down with a table of businessmen, the story is usually how they got lucky from a piece of land,” says Andy Xie,
an independent economist who once worked in Hong Kong as Morgan
Stanley’s top Asia analyst. “No one talks about their factories making
money these days.”
I am leaving out significant
parts of the article, so as not to excerpt too much. I suggest you
follow the link to read it in its entirety. The following portions do
support my suspicions of where all of the alleged consumer activity in
China is coming from, though:
Key to Growth
The government is reluctant to crack down too hard because
construction, steel, cement, furniture, and other sectors are directly
tied to growth in real estate. In November, for example, retail sales
of furniture and construction materials jumped more than 40 percent. At
the December Central Economic Work Conference, an annual policy-setting
confab, officials said real estate would continue to be a key driver of
The worst scenario is that the central
authorities let the party go on too long, then suddenly ramp up
interest rates to stop the inflationary spiral. Without cheap credit,
developers won’t be able to refinance their loans, consumers will no
longer take out mortgages, local banks’ property portfolios will sour,
and industrial companies that relied on real estate for a chunk of
profits will suffer. Nahhh! Really!
One difficulty in handicapping the likelihood of a nasty pullback is
the opacity of the data. As long as property prices stay high, the
balance sheets of the developers look strong. And no one knows for sure
how much of the more than $1.3 trillion in last year’s bank loans
funded real estate ventures.
a substantial portion of that sum went into property, much of it
indirectly. Banks often lend to state-owned companies for industrial
purposes. But the state companies can then divert the funds to their
own real estate businesses or relend the money to an outside developer. Enter the domino/daisy chain effect in case of collapse…
the big banks may be cutting back on their real estate risk by selling
loans to smaller local banks and credit co-ops…
I explored these possibilities about a year and a half ago. See China Macro Update, (also of interest is the HSBC opinion and 2H08 update).Then My view of the China hype bears additional fruit and All of my warnings about China are starting to look rather prescient.
By Charles Hugh Smith, OFTWOMINDS On this last day of 2009, I want to address what I call the transition to risk. One analogy is the way that the risks of suffering a fatal heart attack rise in a completely hidden way. The body doesn’t signal the slow accumulation of fatty deposits in arteries; the process is silent. Nor is there any conscious awareness that arteries are hardening. The accretion of risk is slow, steady, invisible–until it’s too late. Some transitions to risk are highly visible. If you’re driving on winding mountain roads and suddenly enter a thick fog bank which cuts your visibility to a few feet, the risks posed by continuing at high speed skyrocket. The prudent person slows down or even pulls well off the road; the imprudent person ends up a statistic. Then there are situations in which risk is building but someone with anasymmetric stake in the game convinces everyone the risk remains low to serve their own needs. The boat is leaking, the winds are rising, but the skipper’s profits require completion of the passage. So he reassures the nervous passengers that everything is fine, the weather is actually improving, and the ship’s pumps can easily handle the leaks. In an economy with a mainstream media controlled by a handful of corporations and a government financial policy in the hands of a few secretive manipulators, this “reassurance” comes in the form of blatant propaganda. Here is an example from today’s “news”: (a.k.a. disinformation) The number of jobless workers continuing to claim benefits, meanwhile, dropped by 57,000 to 4.9 million, also better than the increase that analysts expected. This supports the “headline” propaganda: “Jobless claims fall unexpectedly as layoffs ease.”
But the propaganda/disinformation masks the reality that it’s actually 10 million people who are receiving benefits, and that number increased by 200,000: But the so-called continuing claims do not include millions of people that have used up the regular 26 weeks of benefits typically provided by states, and are receiving extended benefits for up to 73 additional weeks, paid for by the federal government. About 4.8 million people were receiving extended benefits in the week ended Dec. 12, the latest data available, an increase of 200,000 from the previous week. The rise is partly a result of another extension of benefits by Congress in November. President Obama earlier this month signed legislation that continues the extended federal benefits for the first two months of next year. That will prevent about 2 million jobless workers from running out of benefits in January and February, according to an estimate by the National Employment Law Project, a nonprofit group. Tennessee saw the largest decrease in initial claims, 2,972. So in a state with over 6 million residents, the “good news” which “proves” the economy is “rebounding” is that the “headline initial claims” number decreased by 3,000 people? This number is so small that it is in essence statistical noise. And since we weren’t told how many citizens of Tennessee transitioned to extended benefits, for all we know the truth is that the number of unemployed people in TN actually rose substantially. How many people are unemployed but not receiving benefits? How many are seriously underemployed, barely scraping by on reduced hours or gutted customer contracts? By the Bureau of Labor Statistics’ own estimates, this number is over 9 million. Why the real unemployment rate is far higher than the official one. (This is one of my stories over at AOL’s Daily Finance site.) Toss in absurd “adjustments” such as the assumption that small businesses hired 1.2 million people that aren’t counted in other surveys, and you get a real unemployment/underemployment number which is roughly double the “official” 10%. “Ladies and gentlemen, this is Captain Smith speaking. The Titanic is officially unsinkable, so while the crew clears the ice from the fore deck, go back to sleep or resume your entertainments.” Here’s my disassembly of the bogus GDP “headline” number which (surprise) “proves” the economy is “recovering”: How Misleading Economic Data Increase Investor Risks. If the economy is “growing again,” then why are sales and income taxes still falling?State, Local Tax Revenues Decline 7% By borrowing trillions of dollars and using those taxpayer funds to prop up a failed banking/speculative finance sector, the Treasury and the Fed have greatly increased the risk of systemic failure. Every day that the Federal government sells tens of billions of dollars in new debt– and rolls over all the trillions of short-term bonds which are maturing–the risks of rapidly rising increases rates increases. Rising rates would destroy the housing market by raising the costs of mortgages. They would undermine the entire shaky regime of “cheap easy credit” which props up not just the housing market but the entire economy. Every day that the Federal, State and local government apparatchiks dissemble, obfuscate, and kick the can forward, their legitimacy declines and the concurrent risk of systemic failure increases. Every day the mainstream media prints/speaks/distributes propaganda under the guise of “official statistics” and “news,” it loses legitimacy and adds to the risk of public outrage when the constant reassurances are all revealed as false. While the official line of propaganda is that the “recession ended in August or September,” the reality is the systemic risk rubber band has simply been stretched to an unprecedented point of stress. In their supreme arrogance and hubris, Geithner, Bernanke and Co. are confident (or at least publicly so) that they can manipulate the smoke machines and the mirrors indefinitely. 2010 will be the year the rubber band snaps and their arrogant confidence will be revealed as the empty tricks of conjurers. Beneath the superficial reassurances and the ginned up statistics, risk has been building, slowly but relentlessly. The transition from low to high risk has been visible to those who refuse to be lulled to sleep by the official assurances. While no one knows when the rubber band will snap, those who have watched the systemic risk rise are confident it will break. Will the smoke-and-mirrors work for another year? Perhaps. But the rubber band is already refusing to stretch any more, despite the stupendous pressure being applied by the Fed and Treasury. Betting the rubber band will stretch another year is a very high-risk bet. Permanent link: The Transition to Risk NOTE ON THE SURVIVAL+ BOOK: I am reformatting the interior for improved readability, so the book will not be available for the next few days. Your patience will be rewarded with a new cover and more readable text. NOTE: the Kindle reader for PCs is now available for free which means you canread the Kindle version of Survival+ on your PC. Of Two Minds is now available via Kindle: Of Two Minds blog-Kindle Thank you, Maria K. ($25), for your exceedingly generous contribution to this site. I am greatly honored by your support and readership.
The hidden transition to ever-higher systemic risk was the major story of 2009: nothing’s been fixed, and the risks of systemic failure are rising every day.
On this last day of 2009, I want to address what I call the transition to risk.
One analogy is the way that the risks of suffering a fatal heart attack rise in a completely hidden way. The body doesn’t signal the slow accumulation of fatty deposits in arteries; the process is silent. Nor is there any conscious awareness that arteries are hardening. The accretion of risk is slow, steady, invisible–until it’s too late.
Some transitions to risk are highly visible. If you’re driving on winding mountain roads and suddenly enter a thick fog bank which cuts your visibility to a few feet, the risks posed by continuing at high speed skyrocket.
The prudent person slows down or even pulls well off the road; the imprudent person ends up a statistic.
Then there are situations in which risk is building but someone with anasymmetric stake in the game convinces everyone the risk remains low to serve their own needs.
The boat is leaking, the winds are rising, but the skipper’s profits require completion of the passage. So he reassures the nervous passengers that everything is fine, the weather is actually improving, and the ship’s pumps can easily handle the leaks.
In an economy with a mainstream media controlled by a handful of corporations and a government financial policy in the hands of a few secretive manipulators, this “reassurance” comes in the form of blatant propaganda.
Here is an example from today’s “news”: (a.k.a. disinformation)
The number of jobless workers continuing to claim benefits, meanwhile, dropped by 57,000 to 4.9 million, also better than the increase that analysts expected. This supports the “headline” propaganda: “Jobless claims fall unexpectedly as layoffs ease.”
But the propaganda/disinformation masks the reality that it’s actually 10 million people who are receiving benefits, and that number increased by 200,000:
But the so-called continuing claims do not include millions of people that have used up the regular 26 weeks of benefits typically provided by states, and are receiving extended benefits for up to 73 additional weeks, paid for by the federal government.
About 4.8 million people were receiving extended benefits in the week ended Dec. 12, the latest data available, an increase of 200,000 from the previous week. The rise is partly a result of another extension of benefits by Congress in November.
President Obama earlier this month signed legislation that continues the extended federal benefits for the first two months of next year. That will prevent about 2 million jobless workers from running out of benefits in January and February, according to an estimate by the National Employment Law Project, a nonprofit group.
Tennessee saw the largest decrease in initial claims, 2,972.
So in a state with over 6 million residents, the “good news” which “proves” the economy is “rebounding” is that the “headline initial claims” number decreased by 3,000 people? This number is so small that it is in essence statistical noise. And since we weren’t told how many citizens of Tennessee transitioned to extended benefits, for all we know the truth is that the number of unemployed people in TN actually rose substantially.
How many people are unemployed but not receiving benefits? How many are seriously underemployed, barely scraping by on reduced hours or gutted customer contracts? By the Bureau of Labor Statistics’ own estimates, this number is over 9 million. Why the real unemployment rate is far higher than the official one. (This is one of my stories over at AOL’s Daily Finance site.)
Toss in absurd “adjustments” such as the assumption that small businesses hired 1.2 million people that aren’t counted in other surveys, and you get a real unemployment/underemployment number which is roughly double the “official” 10%.
“Ladies and gentlemen, this is Captain Smith speaking. The Titanic is officially unsinkable, so while the crew clears the ice from the fore deck, go back to sleep or resume your entertainments.”
Here’s my disassembly of the bogus GDP “headline” number which (surprise) “proves” the economy is “recovering”: How Misleading Economic Data Increase Investor Risks.
If the economy is “growing again,” then why are sales and income taxes still falling?State, Local Tax Revenues Decline 7%
By borrowing trillions of dollars and using those taxpayer funds to prop up a failed banking/speculative finance sector, the Treasury and the Fed have greatly increased the risk of systemic failure.
Every day that the Federal government sells tens of billions of dollars in new debt– and rolls over all the trillions of short-term bonds which are maturing–the risks of rapidly rising increases rates increases.
Rising rates would destroy the housing market by raising the costs of mortgages. They would undermine the entire shaky regime of “cheap easy credit” which props up not just the housing market but the entire economy.
Every day that the Federal, State and local government apparatchiks dissemble, obfuscate, and kick the can forward, their legitimacy declines and the concurrent risk of systemic failure increases.
Every day the mainstream media prints/speaks/distributes propaganda under the guise of “official statistics” and “news,” it loses legitimacy and adds to the risk of public outrage when the constant reassurances are all revealed as false.
While the official line of propaganda is that the “recession ended in August or September,” the reality is the systemic risk rubber band has simply been stretched to an unprecedented point of stress. In their supreme arrogance and hubris, Geithner, Bernanke and Co. are confident (or at least publicly so) that they can manipulate the smoke machines and the mirrors indefinitely.
2010 will be the year the rubber band snaps and their arrogant confidence will be revealed as the empty tricks of conjurers.
Beneath the superficial reassurances and the ginned up statistics, risk has been building, slowly but relentlessly. The transition from low to high risk has been visible to those who refuse to be lulled to sleep by the official assurances. While no one knows when the rubber band will snap, those who have watched the systemic risk rise are confident it will break. Will the smoke-and-mirrors work for another year? Perhaps. But the rubber band is already refusing to stretch any more, despite the stupendous pressure being applied by the Fed and Treasury.
Betting the rubber band will stretch another year is a very high-risk bet.
Permanent link: The Transition to Risk
NOTE ON THE SURVIVAL+ BOOK: I am reformatting the interior for improved readability, so the book will not be available for the next few days. Your patience will be rewarded with a new cover and more readable text.
NOTE: the Kindle reader for PCs is now available for free which means you canread the Kindle version of Survival+ on your PC.
Of Two Minds is now available via Kindle: Of Two Minds blog-Kindle
Thank you, Maria K. ($25), for your exceedingly generous contribution to this site. I am greatly honored by your support and readership.
for the full posts and archives.
Ambassador Richard Jones, the Deputy Executive Director of the International Energy Agency, has some eye popping things to say about the energy space. The Paris based IEA was first set up as a counterweight to OPEC during the oil crisis in 1974, and has since evolved into a top drawer energy research organization with one of the best 30,000 foot views of the energy universe.
World GDP will grow an average 3.1%/year through 2030, driving oil demand from the current 84 million barrels/day to 103 million b/d. That means we will have to find the equivalent of six Saudi Arabia’s to fill the gap or prices are going up a lot. His ultra conservative target has crude at $190/barrel in twenty years, and his high priced scenario would send you rushing for a change of fresh underwear.
Some 39% of that increase in demand will come from China and 15% from India. A collapse in investment caused by the financial crisis last year means that supply can’t recover in time to avoid another price spike. More than 1.5 billion people today don’t have electricity at all, but would love to have it. The best the Copenhagen climate negotiations can hope for is for CO2 to rise until 2020, and then plateau after that, because once this greenhouse gas enters the atmosphere it is very hard to get out. It would take 100 years of natural decay to get CO2 levels back to where they were just 20 years ago.
This will require a massive decarbonization effort reliant on nuclear, hydro, alternatives, and carbon capture and storage. Up to half of the needed carbon reduction can be achieved through simple efficiency measures, like ditching the incandescent light bulb, driving more hybrids, and closing dirty, old coal fired power plants. Natural gas will be a vital bridge, as it is cheap, in abundant supply, and emits only half the carbon of traditional fossil fuels.
The total 20 year bill for the rebuilding of our new energy infrastructure will exceed $10 trillion. Each year we kick the can down the road, this price tag rises by $500 billion. Now you know why I spend so much time on energy research.
Richard, who comes from a diplomatic career in Kuwait, Kazakhstan, and Israel, certainly didn’t pull any punches during my extended interview with him. I have been a huge fan of the IEA’s data base and forecasts since their inception. Better use the current weakness in oil prices to accumulate long term positions in crude through the futures (LOH10), the ETF (USO), the offshore drilling companies like Transocean (RIG), and leveraged oil and gas plays like Chesapeake Energy (CHK) and Devon Energy (DVN). When oil comes back, it will do so with a vengeance.
For more iconoclastic and out of consensus analysis, please visit me at www.madhedgefundtrader.com .
- China Central Bank Zhou says 2010 is crucial for ‘defeating’ crisis (Bloomberg) in the meantime his subordinated are learning the intricacies of Treasury collateralized $19.95/pop reverse repos, in advance of withdrawing trillions in excess liquidity
- Lawmakers want probe into aid for Fannie and Freddie – we’ll spare you the Dan Brown suspense – the answer is the Federal Reserve in the 85 Broad lobby with a money printer
- FDIC moves to seize slice of bank stock rallies (WSJ) – paging the worthless Mary Schapiro – when will the insider trading in New York Community Bancorp finally be investigated?
- Speaking of worthless, regulatory-captured windbags, Wall Street waits as SEC fails to bring Madoff-inspired reforms (Bloomberg)
- The end of Uncle Ben’s unlimited piggybank means no more gains for those who benefited from taxpayer generosity to deadbeat homeowners (Bloomberg)
- Do we need a new reserve currency? (Emirates Business)
- So much for Wall Street sobering up (Fortune)
- With Greece teetering the worst may not be over for Europe (NYT)
- McKinsey’s Anil Kumar preparing to plead guilty in Galleon case, bolster case against Raj Raj (WSJ)
- Aiful debt swap sellers to pay $975 million to settle contracts (Bloomberg)
- Kass: Squawking about the headwinds (Street)
- Rusal, the biggest Hong Kong IPO in two years is just so indicative of the times: “If the company doesn’t come to the market to raise funds,
it will go under a mountain of debt.” (Bloomberg)
By Karl Denninger, The Market Ticker
Let’s score the 2009 edition first:
- The economy will NOT recover in 2009: I’ll take this one, although some would argue I only deserve half (I said 8% unemployment U3, we actually got 10%.)
- Deflation, not inflation, will become evident well beyond housing. Miss. Valid if you look at energy, but the "well beyond" includes a meaningful subset of the various things people buy. Nope.
- Housing prices will continue to decline: Direct hit.
- The Fed’s attempt to "pump liquidity" will be shown to be an abject failure: 1/2 a point. Certainly if you look at stock prices, it’s a miss. If you look at whether credit creation was stabilized and increased, its a horrifying score. We did get the instability in the dollar, but no bond market crash. I didn’t specify how, so I can’t take credit for that which I didn’t predict.
- GDP will post a 12-month negative number, Depression print. Clean miss.
- The stock market has not bottomed. 1/2 credit. It had not bottomed but my SPX 500 @ 500 call was not achieved. The 50% swing, however, got damn close. Lots of money to be made if you’re quick and good, but an absolute minefield if you’re a long-term investor – spot on.
- Precious metals will not be a safe haven: Clean miss. Gold and silver have both performed well.
- The Dollar will not collapse. Correct. It hasn’t. It ended the year of 2008 at 82, it now trades at 78, down 5% or so.
- The pound or Euro – and perhaps both – will be where the FX dislocation initiates if it occurs. Early, which means wrong. Clean miss although the last month sure looks bad for the Euro.
- The US Consumer goes from negative savings to positive: Direct hit.
- Commercial Real Estate will effectively collapse: Direct hit although the effect has been well-hidden. Several Tickers have been written on this, including major banks walking off 50% underwater properties. I can’t take full credit as the REIT explosion I expected didn’t happen, so I only get half a point.
- Along with the above, expect 10% of retail stores to close. I don’t have accurate numbers on this but it sure looks that way.
- Several states will get in serious financial trouble and the default of one or more may occur. Point. While the default didn’t happen that wasn’t a condition of the test, and the list of states in trouble is long and getting longer.
- Mortgages are not done: No kidding. Default/delinquency/foreclosure rates continue to skyrocket. Point.
- If you want to refinance you may get one brief shot with long rates around 4%. You got two, but I don’t lose for multiple points of impact. Both of those were good opportunities IF your property isn’t severely underwater (in which case there is no such thing as a good deal.)
- Those who have said that the corporate bond market is being "unreasonable" will start to look like the jackasses that they are. Maybe. Actual defaults did in fact skyrocket but new issues are coming to market and subscribing – even for crap-grade paper. I can’t take a point on this one as my expectation when I wrote it was that issue would go in the toilet. Miss.
- The calls for "more lending" will go exactly nowhere. Bingo.
- GM and Chrysler will go bankrupt. Bingo.
- Protectionism and currency manipulation: Miss, at least in the way I described it.
- Commodities will appear to be headed for a new bull market (falsely): Hit. Soy, Wheat, etc – all looked to be going parabolic in June. Now, not so much. "Beans in the teens" eh? NOT!
- Sovereign debt defaults will number at least three: Clean miss. Greece and a couple of others are on track but didn’t happen this year. No points for "on track."
- China will have its first large-scale rumbling of civil unrest: Clean miss. I have to admire how they prevented it – more capacity building into an overcapacity world. That won’t end well but for now they’ve stove it off.
- Foreign uptake of Treasuries will be choked off – by necessity: Hit. Almost missed that one, but China has stopped buying as the trade imbalance disappeared. They have, as expected, turned resources inward.
- The City will get it worse than we are: Since the test was relative I get credit for it; they’re doing things like imposing 90% taxes on banker bonuses.
- Things will get "revolting" in nations: Nope. Riots and such in Greece don’t count – "revolting" meant what it said.
I count 14 "hits" (including half-points) out of 25, for a score of 56%. That’s not so good, especially compared to last year.
Ok, so where did I go wrong?
That’s pretty simple: I dramatically underestimated the willingness and ability of "the criminal class" (that would be those in DC and on Wall Street) to lie, cheat, steal, paper over insolvency and get away with it – at least for a while.
Will this ultimately lead to an actual recovery? No. It mathematically can’t. A short-term bounce in various metrics, yes, just like an insolvent person can spend on his credit cards until they get cut off and look like they’re improving.
The S&P 500 currently stands at roughly 1120. Most "market callers" are expecting another 20% increase next year, which would put it at 1350, just 15% off the all-time high of 1576 and fairly close to where it finished 2007 – that is, as if 2008 and 2009 never happened. Lunacy, says I, unless leverage can return to where it was in 2007.
Let’s remember what happened in 2005 and 2006 that made those things possible. Investment and commercial banks were stuffing various sorts of securitized paper with garbage loans they knew could not be paid, then selling them off to "investors" (who would later be shown to be bagholders.) This allowed for an unprecedented expansion in consumer and financial system credit – and that, in turn, allowed the buying of "stuff", whether it was companies playing LBO or you buying a house to flip with an OptionARM.
That was the legacy of the "expansion" in 2005 through 2007, and it is not coming back.
In short this time it really is different, and the proof is right here:
This is the first time since records began at The Fed that credit outstanding has decreased. I have taken the liberty of breaking down the periods into 10 year chunks, which makes it easier to see:
Pay attention to this last graph, as it is the important one in terms of the 2003-2007 "recovery" – note that we went from ~32 trillion in outstanding debt to $53 trillion at the peak, an expansion of 66%.
That’s how we "recovered" from the tech bust, and to believe that we will "recover" from this one you must either find a way to expand debt by a similar amount – that is, to nearly $90 trillion all-in – or figure out how you will get $35 trillion in spending in the US economy above and beyond what we’re doing now over the next three to four years. In short, we cheated, and to believe we can do it again you must explain how we can cheat once more – and to that degree.
And by the way, for those keeping score – since our monetary system is debt-based declining credit outstanding is the definition of deflation in the monetary sense!
This is exactly what Bernanke said he could avoid. He was wrong and there is no further room for argument on that point.
Further, I do not believe for a second that the Bernanke’s "pulling back" from the monetary playing field has a thing to do with the "stability" of the markets, especially housing. Specifically, there is no evidence to be found that housing has stabilized or is improving – quite to the contrary. Treasury’s "modification" programs have been a joke, with banks either not following through with their supposed responsibilities and borrowers unable to provide documentation of income and assets (because they didn’t have the documentation required at the time of the original loan, and still don’t!) In short all these "programs" are simply an attempt to paper over the Ponzi in residential housing – with little actual success, but lots of smoke, mirrors and lies.
Madoff got away with the same game for years – produce some false statements and keep soliciting for that new business. All is well until the cash flow forces disclosure of the fact that you’re broke – then the ugly truth, that there is no money as it’s all gone – comes out.
Such is happening now. Servicers have been passing through the interest payments on MBS but principal isn’t there to be repaid. The journal entries are being ignored – for now – because none of this trash is actually trading. It’s all being held at or near "par" (100 cents on the dollar) when in fact many of these securities will be lucky to recover anything at all. Even the "credit supported" tranches are in trouble – nobody ever believed, especially in the "prime" space, that defaults could reach beyond 2 or 3% and recoveries be under 80 or so. But they are. Worse, the HELOCs and "silent seconds" are in fact worth zero where the house is worth less than the first note due to priority of claims – yet most of those are being carried at or near full value.
A big part of the reason for this deterioration is due to "misclassification" of loans. That is, loans were claimed to be "prime" when they were not – they were either "ALT-A" or worse, Subprime in fact, but stuffed into MBS as "prime paper" and then resold onward. Fannie and Freddie have been recently fingered as a major part of this, but unlike the author of the recent WSJ Opinion piece I believe this scam went much further than the two GSEs – and there has yet to be any honest examination (say much less prosecution) for this conduct.
There’s a rather complex "prisoner’s dilemma" going on at the present time, with none of the banks wanting to liquidate either securities or inventory lest they trigger an avalanche. Yet each is eying the door, fully-aware that the first one through will be the only one who gets through should anyone bolt. One of the more-interesting identities for the man yelling "FIRE!" could be a lawsuit – or state prosecution – over the myriad misrepresentation in this space during the bubble years.
Last year (2009) there was almost no net debt issuance between corporates and Treasuries, adjusted for Quantitative Easing. Indeed, it was only about $200 billion. That this sort of extreme measure was required to prevent a bond market implosion is rather telling. But what’s worse is what’s on the calendar for 2010 – nearly $2 trillion of net issue, duration-adjusted. A huge part of this is Treasury debt, and there the news is even worse, as there’s a serious duration problem in this regard – nearly half (about 40%) has a maturity of one year or less. This means that Treasury must roll over that debt - about $3 trillion worth - "or else."
Ask the asset-backed commercial paper market and auction-rate securities folks what happened to them when their short-duration paper couldn’t be rolled on commercially-reasonable terms. Then extrapolate that to what happens to Treasury if (or possibly when) they’re unable to roll $3 trillion plus issue another $2 trillion on top of it to fund the deficit. Do you really think that $5 trillion and change of Treasury paper is going to be "all ok" sans "monetization" – or will "they" foment an intentionally-engineered stock market crash to scare people into Treasury debt? I wish Timmy the best of luck with this – he’s going to need it.
Remember, the belief that foreigners will not be there to rescue us this time around is not speculation – it in fact is born out by the latest TIC data, which showed that China had bought a net zero in Treasury issue in October. Nor did anyone else step to the plate. In short foreign nations are chock full of their own issues and are either issuing debt themselves or need their capital internally.
The equity market loves "liquidity" no matter how it comes, whether the truth is embedded in reports or not. Nasdaq 1999 anyone? Those firms were not making money and never would but that didn’t stop their stocks from doubling, tripling, and in some cases skyrocketing to 10x their IPO prices.
The key point is that most of them eventually collapsed and were worth zero, but if you were quick (or lucky) you made a lot of money. Of course the other side of that ditty is that if you weren’t you lost everything.
There are many who claim that valuations are not "extended" or "bubble-like" and point to the disasters of Q3 and Q4 of 2008 as "drags" on the P/E ratio, claiming that one should ignore negative earnings. This is kinda of like going to the casino and only counting the winning wagers when determining how well you’ve done. It may look impressive when you brag to your friends but it won’t change the fact that you go home broke, and ignoring negative earnings is part and parcel of the same sort of disease.
The fact of the matter is that if you look to corporate and personal income taxes they have all but collapsed. These are of course regressive and governments have been handing out various tax breaks to corporations so this may not be a fair indication of business and consumer activity.
However, sales taxes are, if anything, going up in percentage charged - not down – and yet they are also deep in the red in terms of collections by the states. Since some "necessities" (specifically food in many states) are not taxed this is particular troublesome since this trend points directly toward a collapse in discretionary spending – exactly what we need to power the economy forward. Then there’s China, which reported on the 27th that toy shipments to the US were down 15% year/over/year from 2008 – but we’re told that Christmas sales were down "only" 1%. Riiiiight.
So much for "economic recovery."
Productivity has been on a tear – and no wonder. Watching everyone around you get laid off has a way of providing a hell of an incentive to work harder, lest you follow your friends to the unemployment line.
These trends – letting employees go and demanding that your remaining workers do more for the same pay, does provide a lift to profits. For a while. But it also destroys the base of consumers you need to buy those products over time, and thus the lift that you enjoy from such downsizing and squeezes is short-lived. The hangover from that speedball should be hitting in Q1 or Q2 of the coming year, and I expect it to be quite the doozy.
China, on the other hand, has outdone us. Burdened with far too much capacity they are, of course, building even more! That would be great except that there’s no chance they can absorb the output internally. Not that they care in the short term, as their definition of "GDP" is different than ours – they count a product when it is produced, not sold. Gee, why are there all these products lined up unused, from cars to washing machines to – gasp – literal empty CITIES of townhouses and apartments? How far does that bubble inflate before it blows up? Hell if I know – the Chinese are not exactly models of transparency so the degree of game-playing they can get away with before someone yells "FIRE!" and runs for the door is more difficult to discern than it is over here.
In the last few days the Chinese Premier has said that he won’t "bow to pressure" to allow the yuan to appreciate. This of course is code for a weak currency which China desperately wants for its export trade. Then again, so does Japan, and so does anyone else who exports. Competitive devaluation sounds quaint, but you’re seeing it, and it is likely to continue as an attempt to play "beggar thy neighbor" in the coming year – and beyond. Playing with explosives these nations are (including our country!)
In the credit arena few lessons seem to have been learned. CDOs, CDO^2s and other similar loose-pin grenades aren’t back – yet – but an awful lot of questionable deals are, including, believe it or not, a couple of PIK/Toggle issues. Those, for the uninformed, are bonds that allow payment not in money but in more debt! This sort of "debt pyramiding" is the epitome of stupidity when done by a person and a fairly reliable sign of impending default. In the corporate world we call it "reaching for yield." Uh huh.
Many market commentators believe that last year and through March 09 was a "financial panic" similar to 1987, from which the market recovered quickly. Really? Go look up the page a bit at the credit chart for the 1980s. Do you see any contraction in 1987 and 1988 – anywhere? Nope. None. In fact, credit growth continued unabated even though the stock market crashed. The same occurred in the 2000-2003 time frame (again, look above) during the Tech Implosion. That’s the differentiating factor: This was not a market panic, it was and is a credit lock-up caused by outstanding debt exceeding servicing capacity for several years, where the premise became not paying debt through current income but rather a Ponzi-style pyramid that permitted refinancing and the appearance of solvency only so long as asset prices rose!
This is an event that last occurred in America in the 1920s and it occurred this time for the same reason it did the last time: lax or utterly absent regulation allowed people to foist off trash on people while claiming that it was "money good", just as happened with Florida Swampland in the 1920s. The entire premise of the so-called "financial innovation" then, as now, was fraud.
The simple fact of the matter is that greed often comes with stupidity and nearly always is shortly followed by disaster. "Rescued" by governments the "princes of finance" learned nothing, were forced to disgorge nothing, and still walk free among us instead of being either jailed or worse, strung up from a lamp post.
Whether the people of the various nations will put up with another trip down the bailout, Quantitative Easing or "stimulus" road is another matter entirely. Tim Geithner and others have gone too far in their grandstanding, cheerleading and claims of "Armageddon Avoided" – or if you prefer, "Mission Accomplished." Such claims make for great sound bites but have a habit of slamming the door on future intervention, especially if the need for it appears shortly after the claimed "success." Remember well that 2010 contains a midterm election in November, and as things stand our new President has seen his approval rating drop faster than a condemned man does through the floor when the handle is pulled.
Then there’s the "HAMP", or "mortgage modification" programs generically (there have been several.) It was claimed that HAMP in particular would prevent 4 million foreclosures by the end of 2009. It has actually resulted in about a half-million trial modifications, but fewer than 100,000 permanent changes. This should not surprise – the reason people got in trouble in the first place as that they bought more house than they could reasonably afford on any rational mortgage plan, using schemes such as 1.5 or 2% negative amortization "OptionARMs." These were not actual mortgages in intent – they were predicated on ever-rising home "values" so that they could be rolled over in a couple of years and amounted to a perpetual below-market rent payment to a bank, collateralized via the speculative bet that prices would continue to rise. When home prices stopped going up there was literally no way around the inevitable – foreclosure.
Government refuses to recognize this as all the trash paper is literally everywhere around the globe! What’s worse is that the very same banks that were making these bets along with homeowners then extended HELOC and other second-priority lines behind the first, extending the trash brigade even further.
Never mind Geithner’s insanity, as displayed here:
GEITHNER: We were very careful from the beginning—but the qualifications get lost—to say that we are going to focus the bulk of the financial force on bringing interest rates and mortgage rates down to cushion the fall in housing prices and help stabilize home values, which will feed into people’s basic sense of financial stability.
The reason we got a bubble in the first place was due to excessively-low rates – that is, a cost of borrowing money that did not reflect the fundamental economic realities of repayment and duration risk.
Insanity defined: Doing the same thing over and over but expecting a different result.
There is much hot air blown about how businesses and consumers have "de-levered." Hogwash. Again, back to the top graph – we’ve taken a whole $21 billion off the net credit exposure. Oh sure, if you remove FedGov from the picture (and you arguably should) it’s more like $850 billion – but let’s be real here – we’re talking about a fifty-three trillion dollar debt.
Even a trillion is less than a 2% reduction in net leverage!
That’s "de-leveraging"? Like hell.
There is much, much more to go. To get back to the leverage levels seen in 2000 – which themselves were overheated – we’d have to drop back some twenty five percent, or roughly $13 trillion dollars.
We’re less than 10% of the way there, and we were overheated in 2000.
What’s a more reasonable leverage level? How about the "more reasonable" time period between 1951 and say, 1983? 175% of GDP? That would require we cut the outstanding debt by close to half!
Will we see policies that accomplish that? Not voluntarily!
On a more-macro (beyond one year) level, let’s look at this last-decade debt chart again:
In the beginning of 2000 the total systemic debt outstanding was approximately $25 trillion. It is now about $53 trillion, or more than double where it was in 2000. Let’s look at where we were in various metrics at that time:
GDP was at $9.7 trillion. It is now 40% higher, roughly. (Gee, did we really produce all that with our hands, or did we borrow the money, spend it, and then count that as "GDP growth?")
Aggregate GDP over the 2000-2009 years was about $124 trillion; of that, about 20% (25 trillion) was increase in debt over the same period of time. Our so-called "growth" over these years was in fact a chimera in that more than half of it was not real – and that’s assuming ZERO interest expense now and forevermore. Of course interest expense isn’t, in fact, zero……
The S&P began the year 2000 at 1469. It now stands at 1126, and that’s before inflation adjustment. The DOW was at 11,500, again, before inflation adjustment, and the Nasdaq 100 was at 3708 (it currently trades 1870.) Again, all before inflation. Take 30% off all of today’s numbers to adjust for devaluation of the currency’s purchasing power (that is, inflation) over the last decade and you’re roughly in the ballpark. The bottom line: you have lost big – more than half if you were in the S&P 500, about 40% in the Dow and a crushing 70% if you were in the Nasdaq 100 over the last ten years.
There was no shelter to be found in Real Estate either. Home prices are back to 2000 levels in many parts of the nation, but a huge number of homes are "underwater" on the profligacy of debt taken on by Americans: about 25% of all loans are underwater nationally and nearly half in Florida. In 2000 that number was basically zero.
There was no net job creation but we went from 282 million to 307 million people in America. That means 25 million people are unemployed simply due to population growth. Ain’t that grand?
Median household (and per-capita) income has actually declined since 2000 adjusted for inflation. Of course gasoline is more than twice as expensive ($1.26/gal in January of 2000), eggs are more expensive (double, roughly) and such. Never mind medical insurance and health care – double-digit escalations every year have been the rule rather than the exception with medical insurance costs being up a literal 200% or more over the last ten years.
This little game of Ponzi (faking "GDP" by taking on more and more debt), by the way, is not new. I present for your edification the following table:
This is the aggregate GDP (that is, all GDP produced) during each decade from 1960 onward, the "DTi" (or debt increment) during that decade – that is, the additional debt outstanding in all sectors during that decade, and the percentage of "GDP" that in fact was NOT from production, but rather was "created" due to raw borrowing.
What we are facing down today is a fifty year Ponzi scheme. Drill that into your head folks – for fifty years we have created false output gains, with the last 40 of those years having between 15-20% of each year’s supposed "GDP" not created by the work of people, but by BORROWING MORE MONEY which will have to be repaid with interest.
This is why we hit the wall in 2007.
To run an increase in GDP of about 5%, as so many "pundits" are claiming we will going forward, we would have to increase the total debt in the system to roughly $90 trillion dollars from the present $53 trillion over the next ten years.
That debt would, of course, need to be serviced. And nobody in their right mind can possibly believe that government could take on another $37 trillion – when the current oustanding public debt is just seven trillion (that is, government would have to increase its debt by 500%!)
If you take nothing else away from this Year in Review Ticker, it should be that singular chart above and a decent understanding of what it means:
To come back into equilibrium, assuming we do not decrease debt in the system at all, we would have to shrink GDP by about 20%. But shrinking GDP means that money available to pay down debt would also decrease which would generate even more defaults.
This is how deflationary depressions happen – years, even decades of playing Ponzi by layering debt upon debt. Bernanke and Geithner, along with President Obama, are well-aware of these facts which is why they are all pounding the table demanding that banks "loan more."
The problem with such a prescription is that the wise person won’t borrow, for he knows what’s coming. The unwise has no collateral to pledge, and thus can’t borrow.
If the government forces (either by persuasion or legislation) lending to those who can’t pay they only extend the Ponzi and in doing so make the inevitable collapse WORSE.
We have made no progress economically in terms of the common weal of the average American but have added debt in dramatic amounts to paper over the deficiency. That’s the bottom line on the 2000s, and despite all the crooning that "the economy is on the mend" one has to look at the reality of the common man on the street to see what’s coming around the bend for our economy and ask the following question:
How do we get positive economic growth when by every metric available the disposable personal income available to Americans has gone down, personal wealth has in fact decreased when one subtracts out debt (and you must; nobody in their right mind argues that if you go to the bank and take a cash advance for $20,000 on your credit card that you are "more wealthy" as a consequence of having done so!) and while employment at first blush looks "equal" to 2000 in fact there are 25 million more unemployed due to population growth – people who create drag on the economy due to entitlement spending rather than contributing to productive output?
So with all this said, here’s what I believe we’re looking at for 2010… ready or not, here it comes!
No, this is not a new Bull Market; the market will be lower on December 31st than it is on January 4th, quite possibly by a a hell of a lot. We may not break the March 2009 lows – but I also don’t believe for a second we’re going back to 1576 on the SPX. Not without the leverage – and we can’t get the leverage. I believe we will end the year down from where we begin on January 1st. McHugh calls it "Wave 3 Down"; I call it "aw crap." Either way "irrational exuberance" is back for now but cash flow always wins in the end. I’ll be a "generational buyer" of stocks when dividend yields are over 5% and P/Es are in single digits. We didn’t get there last year and yet those are the historical metrics that mark true Bear Market bottoms. With that said, I would not be surprised if we hit 1220 on the SPX some time earlier in the year – but it is by no means a lock, contrary to what virtually everyone in the "pundit community" expects (most of which are looking for 1350 or more!)
The Long end of the Bond Curve is going to move higher on yields. We have completed a long-term (multi-year) inverted Head and Shoulders pattern. The probability of the targets set by that pattern being achieved is extremely high. The target? 6.9% on the 30 year "long bond" – a rate that puts 30 year mortgage money at least to 7%. This prediction assumes that we do not get a panic-style sell-off in the Stock Market – if we do get one (and I think it’s 50/50 on that) then I withdraw this prediction.
House prices will fall another ~20% – whether as a consequence of the rate back-up or utter destruction in the markets generally. Sorry folks, the housing mess is not over. The math on this is simple; a $200,000 principal loan at 4.75% for 30 years produces a P&I of $1039.18. That same payment with a rate of 7% produces a principal financed of $157,107.95. If, for whatever reason (engineered or not) the stock market collapses then you get your housing price crash anyway.
Banks will "give up" on holding their real estate as rates start to backup and will dump their foreclosure inventories. Why? Because the regulators may let them to play games with alleged "values" when people can get mortgages at 4%, but at 7% there’s just no way the numbers work and the fraud becomes too difficult to countenance. There are rumors of major banks dumping hundreds of thousands of homes on the market next year – this is likely the backstory on "why."
Credit will not ease for "ordinary people." All the exhortations about "lending more" have been going on now for more than two years yet have gone nowhere. The jawboning will continue but the results will not come, simply because there is no more good collateral left against which to lend. This will in turn lead to.
A massive second wave of small business bankruptcies will sweep the nation. We’ve seen the first part of it. The second will be worse – far worse. With long rates backing up and the 30% credit card sweeping the land those who have relied on credit to operate in the small and mid-sized business world will get relentlessly squeezed. Many will fall.
Unemployment will appear to be stabilizing – for a while – but that will prove illusory. We finish 2010 over 10% - no material improvement. If things get real bad we might see 12-14%. Yes, U-3. I won’t stick my neck out that far as a prediction but I believe ending the year at or above 10% is a lock.
The "revolting" call for last year was early – but not wrong. There will be at least one major coup or other violent overthrow of a government in 2010 tied to economic instability – either directly or via a war it spawns.
The states will go to the government well for handouts, they will probably get them, but it won’t matter. They’ll get some assistance at least, but in the grand scheme of things it doesn’t make any difference in a world where long rates are rising precipitously. California and Arizona are in the biggest trouble, with Michigan, New Jersey and New York right behind. The public employee unions will have a kitten but again, it won’t matter – that which isn’t there isn’t there, whether you want it to be or not.
A "double dip" will be recognized by the end of the year. Between taxes and rising rates – or an intentionally-detonated stock market to stop the long end of the bond curve going bananas – you can bet on it.
China will lose control of their property and plant bubble – with horrible consequences. They’re good at the game, but that which can’t go on forever won’t. I bet it blows up before the end of the year. If so, Australia’s property market better watch out – they’re levitating on the strength of China’s commodity demand and pricing there is California-style.
The Canadian Real Estate Market will show signs of cracking – especially in places like Vancouver. They may have another year before it all goes to hell, but the time approaches. Beware.
The Fed’s games will "leak" and credibility will be shaken severely. There’s too much pressure. Something will give, somewhere. Washington DC is too hostile a place for the "hold hands and head for the cliff together" game to work with an election coming up……
The Democrats lose big in the House. Time is probably too short for a viable third party to emerge for the midterm elections, and I don’t expect the Democrats to lose House control. However, I do expect them to lose their filibuster-proof majority in the Senate, and to lose enough seats in The House to trash their "steamroller" approach to legislation. This might be bullish for the markets late in the year and into 2011 – maybe (divided government is generally good for the markets.)
Congress continues to try to spend its way out of the recession – and runs head on into rising rates. Watch the TBAC reports. Those will be your "tell" along with the TIC data.
One or more of the PIIGS (Portugal, Ireland, Italy, Greece, Spain) either defaults technically or is forced into austerity by the ECB. Further, Eastern Europe becomes dangerous destabilized. There is a real possibility of outright hostilities in that part of the world next year. Let’s hope not. The ECB has a nasty problem on their hands; I have said for quite some time that the Euro is likely to trade at PAR down the road. This year is probably not the year for it, but the cracks in the dam that ultimately could destroy the European Union should become very apparent in 2010.
Contrary to virtually EVERY "investment pundit" on the street today return OF capital will once again assert itself as the primary consideration. Sentiment indicators as of 12/31, along with 52-week highs, all are at levels that have been associated with tops on a historical basis. Treasury has to issue $2.5 trillion this year, while we all cheered when they issued $1.5 trillion last year – and got away with it. China has housing trading at 80x average incomes, Australia and parts of Canada have housing markets at 10x or more average incomes and the banksters and "investors" alike appear to have learned nothing, with "reaching for yield" coming back in force. Ponzi ponzi ponzi! Add to this geopolitical event risk and things get interesting. That which can’t continue forever won’t – we merely argue over timing, not outcome. I’ll lay the marker on one or more of these timers reaching zero in 2010.
Note: Subject to minor edits/revisions and perhaps an addition or two until the end of January 1st, as usual.
Edit: 1960s DTi had a misplaced divisor – corrected and paragraph referencing "nutty Ponzi" in that decade removed.
By Karl Denninger, The Market Ticker
Someone smelled a bit of smoke yesterday, but the real fire sale was this morning…..
To put this in perspective that issue traded nearly 8 million shares today, against a normal volume of 1/10th that.
PHK is a closed-end PIMCO fund. What’s in there? As of September 30th, Pimco disclosed the holdings – have a look….
There’s a pretty good mix of "stuff", including a fair bit of mortgage-related exposure.
What would prompt "someone" to unload nearly $80 million bucks worth of this issue more-or-less "all at once" earlier today – and with what looks like a market order – a "get me out right now irrespective of price" sort of circumstance?
I have no clue, but this sort of closed-end fund doesn’t normally see this kind of volatility, and a quick perusal of the credits in their latest disclosure leads one to wonder: does someone smell smoke – serious smoke – in enough of this fund’s exposure to be willing to accept a price SOME TWENTY PERCENT OFF ITS CURRENT TRADING LEVEL to get out RIGHT NOW?
Sure looks that way to me……
(At a dividend yield of 11.8% it’s pretty tough to argue that you’re not taking significant risk in this thing. Bill Gross and PIMCO always seem to have the inside edge for some odd reason…. until they don’t. Is this one of those times?)
Hattip Zerohedge for the original look….