Category Archives: Finance

What happens when the government refuses to deliver bad news?

In the late’70’s Jimmy Carter made speeches where he tried to be honest with the people. He said “It’s clear that the true problems of our Nation are much deeper — deeper than gasoline lines or energy shortages, deeper even than inflation or recession.” It continued a tradition of honesty that all Presidents provided in troubled times. Carter had to know it was not a way to boost his approval ratings. What he didn’t see coming was a new approach to campaigning and governing: The always be positive approach of Pollyanna Ronald Reagan’s (It’s morning in America!”). The people loved his optimism and Reagan backed it up with debt fueled growth that lasted until 2007.

Every President read the history and learned the (Carter) lesson – never be a downer. Borrow (from the future) to prolong growth.

Along came 2008 when the (economy’s) wheels finally came off. How was a President going to claim that things were not that bad or at least – improving. The best thing to would have been to use the disaster to make radical changes to the system but then the President would have to admit we were in deep trouble. Bush Jr. and his successor wanted to only deliver optimism since a liquidity crisis is exacerbated by fear, so someone in the Bureau of Labor Statistics (BLS) decided to fudge.

The most visible statistic the government produces that tells us where we stand is the unemployment rate. If its high and rising then even sunny old Ronnie couldn’t convince us that everything was OK. When firings exploded in 2008 a funny thing happened to the UR calculation. The number of people looking for work suddenly plummeted. (?) The unemployment rate never rose as high as it would have and then miraculously fell in leaps and bounds (starting in 2009), not because of positive job creation but entirely due to all these people who conveniently decided to NEVER look for work again.

Its true that the number of people who become discouraged during recessions tends to rise and then when things get better it goes back up again. We saw this in the 1990 recession but strangely the ranks of the discouraged rose after the 2001 and the 2008 recession and then never recovered. Even stranger, the participation declined the most in the 16-24 age group rather than among the aging baby boomers .

Lowest since our 1980 mess

The simple math is that the decline in the participation rate has reduced the unemployment rate by 10%. Yes 10%. (more than 800,000 people dropped out of the labor force last month alone) The current unemployment rate would actually be 16.3% if we used the same basis as 2006. It would be higher if we quite logically assumed that more people entered the job market due to bad times. This spectacular misrepresentation creates 2 problems:

  1. Policy makers feel no urgency to fix the unemployment problem – what problem? 
  2. The Federal Reserve feels obligated to sound inflation alarms because labor markets appear artificially tight – we’re not far from a 5% handle! … or they have to perpetually explain why they are not worried about the low rate creating wage rises. At some point private sector economists will force them to tighten based on these crazy numbers.
Eventually the world adjusts to the fake numbers and they begin to believe that we really have a 6.3% rate which sounds utterly benign. Who’s worried about outsourcing or poor  income distribution when everyone has a job? Government budget deficits are benign if everyone’s working and paying taxes – right? Our do-nothing congress is perfectly rational when it chooses to do nothing. We could easily wake up, in say 2 years, with an unemployment rate of 1% or less while wages are stagnant and no one can get a “middle class” job. I presume that at some point the BLS will begin to raise the participation rate to avoid this embarrassing contradiction – but when? In the meantime policy makers are doing nothing and underemployment cripples young people’s long term prospects, to say nothing of the worsening actuarial nightmare of Medicare and Medicaid. FDR’s fear of fear has lead us, 70 years later, to complacency based on … lies – what else can we call them?
Policy makers need a healthy dose of fear.

Good-bye Moral Hazard?

The ECB finally drew a line in the sand. It told Cypress to let a bank go and only save the guaranteed deposits. No more European $ are forthcoming. Cypress agreed and blew away the unsecured bank creditors (of Cyprus Popular) instead of bankrupting its citizens. (like Ireland and Spain).

Have the rules suddenly changed?

Imagine a world where you chose your bank based on its record of fiscal prudence rather than whether it had an ATM close to your house. What if the deposit rates at Chase were far lower than at Citibank – would you still keep your money there? What rate would be high enough to entice you to cross the street and take the extra risk at a scary regional bank?

We’re supposed to be making such decisions. Banks should compete for our money with higher yields or greater safety. Institutional bond buyers should be hiring real credit analysts and or even S&P or Moody’s for what they’re supposed to do. It seems like forever since the government didn’t stand behind every bank and every deposit. Are we up to the work involved? Will everyone just panic and take their money out of every bank?

That’s what’s happening in Cyprus (banks are closed ’til Thursday). The ECB must convince the world that bad wood is being chopped down and write-offs are healthy. If they succeed then they’ll emerge with a stronger competitive banking sector – something they desperately need. If they lose their nerve then they’ll end up like us – with  a giant corrupt uncompetitive system .. that has led to this:

The Fed must buy US bank assets to save them.

 

 

 

 

 

 

 

 

 

 

 

Does the stock market like sequesters?

Progressive talk radio is in agony. The Sequester is going to force layoffs of teachers, firemen and aid to the poor like Block Grants to the states. The federal government spends money mainly on the poor with a few exceptions like the defense department and Medicare for rich people. When spending goes down the poor get hit. That’s why if you listen to hate radio, Rush and Sean are OK with the Sequester.

Financial gurus are aflutter over the contractionary impact of the cuts. How much is it as a percent of GDP? “Businesses are very nervous about the impact and so can’t plan or carry on with normal decision making.” Really? Do these experts ever actually look at the S&P 500? Last I checked it was within 1% of a 13 year high!

The stock market is showing its true colors. It doesn’t care about the poor. It doesn’t care about income distribution, a failing education system or even GDP growth (which has been dismal lately). The poor don’t buy iPads or new cars. They never did. Bigger classrooms in poor urban neighborhoods don’t have any impact on earnings. Higher crime in Chicago – no biggie. Violent shootings, high gas prices, civil wars in the Middle East, political gridlock in Washington – forget about all of it. Liberals will be angry at the insensitivity of the market. Conservatives are driven crazy by the higher highs while the White House is occupied by a socialist.

Rant on and spread fear but please don’t assert that this will all lead to a collapse in the stock market. Such fear mongering may add weight to your complaints but over and over again the market will prove you wrong and your ignorance of what drives stock prices will damage your brand – or at least it should.

Of course there is the possibility that the stock market is really dumb and hasn’t actually figured out that all of this going on.

 

Are rating agencies at fault?

The human race as an impressive ability to delude itself. There are some stunning examples such as how Hitler came to believe to the very end the fiction (that he and Goebels had written) that a magic weapon would save the day. Various political “experts” were brought on Fox news to proclaim the inevitable victory of Mitt Romney. There seemed to be so many of them and the strength of their conviction was so intense, that eventually these experts came to believe their own lies. The network itself apparently forgot that the lies were being spread to increase ratings and comfort the Republican audience.

The financial crisis of 2008 exposed a similar situation. The banks were packaging  junky mortgages that they knew would never be repaid. For this they had been widely criticized and various journalists like Matt Taibbi saw this as a grand conspiracy.

The problem with this conspiracy story is that the banks themselves came to believe their own lies, so much so that they purchased the very same securities they knew to be toxic. When they came apart the creators of the junk drowned in their own muck. For 25 years investment banks have paid rating agencies to get good reviews on questionable securities and derivatives. Institutional buyers of these assets absolutely understood the system, yet they used the ratings to justify purchases. It saved them the time and effort required to do the credit analyses themselves. When the music stopped their bosses would get fired and the portfolio managers could pretend that the ratings meant something.

Washington has indicted Standard & Poor’s for producing propaganda. The company must be a little miffed because it knows that all of its customers understood exactly how the scam worked. This corrupt system was not regulated by the SEC before the crash (or after) so how can the government win the case?

Wouldn’t it be more logical to simply regulate rating agencies.? Let’s start by requiring regulatory bodies like the Bank for International Settlements to use only approved agencies that are not paid by the banks themselves.  The BIS sets capital requirements for the global banking system. It is bizarre to think that it currently allows banks to pay rating agencies so that capital requirements do not become too onerous. The fox is still living in the chicken coop.

Instead of taking it to court – let’s chop its legs off. 

Gold Bug Inflation Paranoia

I assume that everybody knows at least one gold loving, conspiracy believing, proselytizer. They are just dying to share with you all the reasons why you should be collecting canned food and buying gold bars. They hate the Fed and believe that inflation is perpetually under-reported, and that the Federal Reserve is a den of thieves conspiring daily to destroy the USA. The problem is that US inflation has no pulse in spite of Fed efforts to revive the economy and that even during the 2008 meltdown gold went down with everything else – wasn’t it supposed to go up?

Informed gold bugs will tell you that the real buyers of gold are not in the United States, they’re in China and India. The key then is to understand when those buyers will become more aggressive. It seems that India is where they should really focus.

  • India manipulates its currency so much that it is widely believed that the Rupee is the most undervalued currency in the world.
  • By keeping its currency very cheap, imports are artificially expensive and exports [like online computer programmers] are extremely cheap.
  • This of course is a perfect cocktail for ever rising inflation – currently calculated to be around 13%!
  • Short term interest rates however are set around 9% for a juicy negative “real yield” of 4%. That’s what you lose each year by keeping your money in the bank.

What to do – Buy Gold.

That is exactly what they’re doing – so much so that it is wrecking their trade account and driving up the price:

 Their trade account is a mess so the government had to raise the duty on gold imports from 4% to 6% to try to quell gold demand.

This tells the story:

So the next time you start to get lectured about the Fed and the imminent rise in US  inflation that will make gold skyrocket, you can quietly explain that it may indeed go up but it has absolutely nothing to do with US policy.

It’s all about India.

They’re Profitable, Just Don’t Ask How They Make Their Money

After the financial meltdown of 2008 everyone understood [again] why banks are special-they’ve got our money. If they go broke, we all end up living in cardboard boxes. The government showed us by their actions that the fate of one (major) bank is highly correlated with all its competitors. If one goes, they all go. This industry, more than any other, directly determines the economic future of the country.

The problem that has become more than evident is that the money center banks do not have a business model that produces stable earnings. Their brokerage subsidiaries make less and less due to the transparency of every market and low commission rates. Their real estate lending is utterly dependent on cyclical and demographic conditions that have become unstable or unreliable. Their advisory services [Investment management and M&A] cannot make up for the volatility in these other areas. What to do?

Steel, cheat, lie, and rip-off as many people as you can:

  • Rig the LIBOR rate to benefit your positions- even if it is at the expense of your customers 
  • Launder drug money so as to get it in -house, then charge an exorbitant  fee to manage it.
  • Specialize in exotic derivatives where customers have no idea what the bid offer spread really is.
  • Foreclose on mortgages that are being paid on time = a new way to acquire cheap real estate  
  • Get free government guaranteed funding (TGLP) in perpetuity.
  • Make it clear to Washington that indictments are unaffordable so wrist slapping is the most that can happen. (Never admit guilt)

 Result: Financial-fraud prosecutions by the Department of Justice are at 20-year lows. Obama may rant as though he is all for justice and consumer protection but this is (apparently) an act for the benefit of the people or critics who see a need for better regulation to avoid future meltdowns.

Maybe the hammer is set to fall when the banks are sturdy enough to handle real punishment. The problem is that even four years after the meltdown, with the stock market at record highs, no one seems to believe that the banks are stable and profitable enough, to be investigated, regulated, and controlled. The window to change the behavior and structure of our banking system is closing.   

Expect more scandals.

 

 

Hank Greenberg wants his (AIG’s) profits back??

Hank wants a do-over. He wants to imagine a world where the federal government saves the day in 2008 but without taking over the company which was the price for guaranteeing all its obligations.

In 2008 the government supplied AIG with $182 billion to cover its problems. The U.S. government had to stand behind the swaps in order to guarantee the solvency of the global financial system.

In exchange for taking over their positions the government took over 92% of the company when the stock price was around $1.50. It then sold off chunks of the company and as the economy improved AIG moved back into the black. If in the end the government is able to come out ahead then that is only because its power to create liquidity and honor contracts saved the system from a domino style liquidity collapse. AIG would not exist were it not for the Feds and for that matter neither would any bank or even Goldman Sachs.

The man we needed in 2008

Historically the US government has been very shy about getting paid for its function as a company/industry savior. It rarely sets a fair price up front and seems scared off by zealots crying socialism!  The Fed is still guaranteeing the principal of the commercial paper issued by banks (TGLP) and getting nothing in return – no stock, no share of profits, nothing.

The problem is that it has to set the price of the VIG (it’s cut) up front. Marcus Crassus (in ancient Rome) used to bargain with homeowners (to buy their houses) as the dwellings burned to the ground, before ordering in his firemen to put out the blaze. That’s a good way to get a deal. It made Crassus (arguably) the wealthiest man in the history of the Earth!

We needed him as the government’s chief negotiator during the conflagration of 2008 (or at least a decent historian).

The RI Annual Scrooge Award goes to …

Corporate America!

For their deft ability and success at tax avoidance while the country goes broke we can only applaud their competency. Let us never again speak about how high corporate tax rates are strangling the private sector. With this many loopholes the rates mean absolutely nothing.

Why should corporations pay taxes at all you ask?  Like people they use up national resources that must be replenished and maintained like roads, power utilities, water supplies, and regulatory agency oversight. Local real estate taxes cover some of this but never the long term investment costs. They expect their buildings to be protected by firemen and policeman and their energy supplies to be safely delivered with the help of the defense department. When their uncovered employees need medical services they will be using up public hospital resources.

If we set the rate to zero then some of the money flows down via dividends to the wealthy shareholders thus exacerbating our income distribution mess but frequently the money just gets stored up in Fort Knox size bank accounts- waiting for redeployment. Apple and Google seem very good at this.

The rate of payment has been declining for decades but in the last few years it has totally stalled:

 

Corporate profits however are on fire. You can see here how they have bounced back beautifully

from the recession collapse. Some of the reason for the mismatch is that those losses from 2008 could be carried forward but after 4 years it’s time to conclude that tax avoidance is the new big thing.

 

That leaves us with a missing hole estimated to be approximately $250bn/yr. at a time when our budget deficit is the highest since WW2! So here’s to you corporate bums, traitors and deadbeats, you have outfoxed the IRS and directly contributed to bankrupting the country you live in.