FedUpUSA

Archive for January, 2010

“Sell and Fold” the New “Buy and Hold”

By Bill Bonner

01/28/10 Paris, France – Where we are now is a matter of great debate: Are we in recovery? Or is the depression deepening?

No one knows for sure. Investors stumble around in the dark, bumping into data and knocking over lamps. It would be nice if someone would turn on the lights. But that’s not how it works.

The best we can do is to try make out the shapes of the biggest pieces of furniture in the room. What else is out there? We don’t know.

Broadly speaking, the period we are in is deflationary. It is a period of credit contraction (at least in the private sector), de-leveraging and depression. How can we be sure? Well, let’s turn on the lights…

Take a look at this chart, for example. What it shows is not a ‘jobless recovery.’ It shows no recovery at all.

This slump is worse than any since World War II because it is correcting an expansion that dates all the way back to 1945! Credit began increasing right after the war. It kept increasing until 2007. Then, in the private sector, it began going the other way.

That trend continues.

It makes sense from a theoretical point of view, too. Every big credit expansion is followed by a big credit contraction. As credit expands, more and more mistakes are made. You can see how this works by looking at the mortgage industry. The first borrowers were solid. Subsequent borrowers were not-so-solid, but they were still generally reliable. The last borrowers – at the height of the frenzy in 2006 – often had no jobs, no income, and no plausible way of repaying their mortgages. Those mistakes are now being corrected.

Overall, credit is still expanding – thanks to the US federal government. But credit is contracting sharply in the private sector…where it counts most. Business lending is falling at a 16.6% rate… the steepest plunge since 1948 (when businesses stopped borrowing for war production). But government borrowing is more than making up for the shortfall in private borrowing. Overall, credit-market debt is up 5.5% in the seven quarters since the business cycle peak in December 2007.

Private sector credit down. Public sector credit up. What to make of it?

We can presume that eventually the government will run into the same wall the private sector hit in 2007-09. Looking through the history of economic crises, so well documented for us by Carmen Reinhart and Ken Rogoff, we see that crises in the private sector typically lead to crises in the public sector. As the private sector sobers up… the public sector goes on a spree. It won’t be long before it, too, crashes and burns.

We can anticipate how this crash in public debt will come about. This passage, from a brief account of French financial history called The Undying Debt by Francois Velde, is a story of the past. It may also be a story from the future:

With the opening of hostilities [in WWI], the Bank of France suspended the link between francs and gold, and part of the war was financed with large issues of paper currency. When France’s prime minister Poincare re-established the link in 1928, he could only do so at 20% of its pre-war parity.

In other words, the French got into a fix. They got out by defaulting on 80% of their obligations. The history of French financial management is not so different from that of any other nation. Time after time, France found itself a little short. And time after time, it defaulted…devalued…and reneged on its promises. Over nearly three centuries, a government debt equal to ten ounces of gold – with a present value of about €7,850 – was reduced, says Velde, to €1.20. That’s about “enough to buy a café crème at the bistro on the way out from the Treasury.”

(I don’t know what bistro Velde is talking about. A café crème usually cost me twice as much!)

Returning to the image we led off with, investing is not just like trying to find your way through a room in the dark. It’s like trying to find your way through a room in the dark…when the furniture is all moving! Trouble is, in the here and now there is so much furniture moving around, it is hard to make a move without tripping over something.

Under these conditions, I’m not sure we can come to any useful conclusions about how one price will move relative to the others. Which will go down most, the dollar or the euro? Will copper rise in dollars? Or fall against cotton? Will bond prices go up before they go down? We can’t say.

But we can say that governments are very good at borrowing…and not so good at re-paying. So even if credit-contraction and deflation is the trend of the moment in US financial markets, government credit-creation is rapidly expanding…and that’s inflationary.

That’s why we are wary of government debt. We own no US Treasuries…or any other form of government obligation. Shorting US and European government bonds is probably a good speculative play.

Just a day after the hearings investigating the taxpayer bailout and subsequent cover-up of the beneficiaries of taxpayer largesse up on Capitol Hill, AIG apparently needs more money.  It appears they are burning through taxpayer money at the rat e of $1 Billion a week!

AIG Draws $2.4 Billion From Fed Credit Line, Most Since October

Jan. 28 (Bloomberg) — American International Group Inc., the bailed-out insurer whose borrowing through a U.S. commercial paper program was set to expire this month, increased its draw on a Federal Reserve credit line by the most since October.

AIG owes $25.8 billion on the line, about $2.4 billion more than last week, according to Fed data released today. The draw has increased for six straight weeks. The company said in November that it may borrow additional funds from its five-year Fed credit line to make payments on maturing commercial paper.

“This helps to highlight the risks we’re exposed to as citizens standing behind AIG,” said Bill Bergman, an analyst at Morningstar Inc. in Chicago. “While there’s much more liquidity in markets as a whole, lenders are still being selective.”

AIG, which got a $182.3 billion government bailout, had relied on the U.S. commercial paper program as firms including MetLife Inc. and General Electric Co. reduced their use of government-backed funds. New York-based AIG said it lost access to its traditional sources of liquidity after its 2008 rescue.

Commercial paper is used by companies to finance daily expenses such as payroll and rent. The Fed, which started a program in October 2008 to bolster the market after the Lehman Brothers Holdings Inc. bankruptcy, said it may wind down the facility in February. Lending through the program peaked a year ago at $350 billion.

Mark Herr, a spokesman for the insurer said the increase was fueled by the need for funds to repay expiring commercial paper. He declined to comment further.

Life Insurance

AIG paid down its Fed line by about $25 billion in December by handing over stakes in two non-U.S. life insurance units. The company has said it plans to sell American International Assurance Co. and American Life Insurance Co. to rivals or private-equity buyers or in initial public offerings “depending on market conditions.”

AIG said in November that it will need to repay $23.2 billion in maturing debt, excluding commercial paper, in the four quarters ending September 2010. The insurer said it will make the payments with revenue from its businesses, proceeds of asset sales, dividends from subsidiaries and the Fed credit line.

MetLife, the largest U.S. life insurer, had no borrowing through the commercial paper program at the end of the third quarter, compared with $1.65 billion on Dec. 31, 2008. GE, which competes against AIG in the plane-leasing business, used the program in the fourth quarter of 2008, and didn’t expect to tap it again, the Fairfield, Connecticut based company said in a filing.

Plane Leasing

AIG has tapped a separate Treasury Department facility for $4.2 billion to help restructure its money-losing mortgage guarantor and the plane unit it was trying to sell, the insurer said in November. AIG got the $29.8 billion facility in April as part of its fourth bailout.

The insurer’s rescue includes a $60 billion Fed credit line, a Treasury investment of as much as $69.8 billion, and up to $52.5 billion to buy mortgage-linked assets owned or backed by the company.

AIG said in a November filing that it may “borrow additional funds” from the Fed credit line to make payments on the $5.8 billion in commercial paper that matures in January.

The draw has climbed by $5.9 billion in the past six weeks. The latest increase marked the biggest weekly gain since the end of October, when it surged by about $3.6 billion.

To contact the reporter on this story: Hugh Son in New York at hson1@bloomberg.net;

Will We See Bankster Baseball?

Posted by Karl Denninger

There are times that I wonder if the looting will keep on until the people express their anger with necktie parties – or worse.

The arrogance of Wall Street knows no boundaries.  The latest is on display in these two stories, first from Bloomberg:

Now the firms and their chiefs, confronting a wave of public anger against their bonuses awarded in the wake of the financial industry bailout, are trying to devise a strategy to fight both the proposed new limits on banks’ size and activities as well as the bank tax. While they are still plotting tactics, one thing has become clear: The banks don’t want to go to war with the commander-in-chief.

“We don’t want to fight the administration,” said Rob Nichols, whose trade group, the Financial Services Forum, represents the chief executive officers of the largest financial companies. “We just want to sit at the table and have a productive conversation about the kinds of reforms needed to address the real causes of the recent crisis.”

I’ll tell you exactly what sort of reforms are necessary:

• No more obfuscation, lies about credit quality, and intentionally peddling things you think are worthless.  And don’t start that crap about shorting things “as a hedge” when you constructed them – if you’re the company that put them together if you’re not damn sure they’re marketable, you don’t sell them.  Ever see the sign in a restaurant: “If you’re not proud of it, don’t serve it”?  WELL?

• Those who have committed this sin must atone.  This means admitting what you did, it means giving back as much money as is left, and it means if you broke the law on top of it pleading guilty and accepting your punishment. 

• Since “animal spirits” seem to be impossible to tame, it also means breaking up lending and depository functions into what amounts to a regulated public utility.  Gamble with your own money – but never with ours, and never, ever with a sovereign backstop.  Ever.  This means depository and lending institutions may not participate in any way, shape or form in the securities markets – including the purchase, sale, holding or trading of derivatives.  Period.

• No more “mark to myth” and no off-balance-sheet anything.  Every investor must be able to read a balance sheet and have a full and fair view of your firm’s assets and liabilities.  Period.

• Oh, and stop trying to influence Bernanke’s appointment – that’s reported in this story as well.  Attempting to influence the selection of your regulator should be treated as a felony – just like bribing someone – because it effectively is.

This isn’t confined to the US either:

Bankers stood shoulder-to-shoulder at the Swiss ski resort of Davos to try to prevent a scatter-gun approach to new financial regulation by different countries.

They united against Barack Obama’s threat to break up banks and Gordon Brown’s growing enthusiasm for a Tobin tax on all financial market transactions.

Again: Quit stealing.

Or just listen to your buddy from Davos:

The founder of the World Economic Forum has said there is a lack of public trust in political and world leaders.

Klaus Schwab told the BBC that business leaders must show that they serve society to heal this rift.

It’s hard to show that when you’re robbing everyone you see blind.

Money Market Funds: No Longer Safe

Posted by Karl Denninger

Here’s something you won’t see talked about much – unless you dig for it.

Zerohedge covered it – the fact that money markets are no longer guaranteed liquid.  But look at what The Wall Street Journal had to say:

Money-market funds could be forced to pay out less interest under new federal rules designed to make them sturdier.

With memories still raw from the 2008 meltdown of Reserve Primary Fund, the Securities and Exchange Commission released rules on Wednesday that require funds to hold more liquid and higher-quality assets and disclose the value of their assets per share more frequently.

This makes it sound as though the funds will be safer – and more liquid – right?  That is, there will be less risk of what happened when Reserve broke the buck and then threw up gates.

Bloomberg said:

Funds must be able to sell 10 percent of their assets in one day and 30 percent within a week under rules approved today by the Securities and Exchange Commission. The SEC’s 4-1 vote also imposed new restrictions on buying lower-rated securities and required more disclosure on declines in funds’ share prices.

“These rules will take important initial steps toward making money-market funds less vulnerable to runs,” SEC Chairman Mary Schapiro said at a meeting in Washington. “The new rules will have substantial benefits for investors.”

Less vulnerable to runs, eh?  That’s a rather nuanced statement that at first sounds like “less likely for you to get stuck without access to your money”, right?

Well, don’t be so sure.  Buried in there is this:

Suspension of Redemptions: The new rules permit a money market fund’s board of directors to suspend redemptions if the fund is about to break the buck and decides to liquidate the fund (currently the board must request an order from the SEC to suspend redemptions). In the event of a threatened run on the fund, this allows for an orderly liquidation of the portfolio. The fund is now required to notify the Commission prior to relying on this rule.

Formerly the fund had to seek permission to suspend redemptions.

Not any more.  Now the fund’s board is empowered to do so unilaterally and advise the SEC, as opposed to asking the SEC for permission to toss up the gates.

This is not a small difference folks.  Indeed, it is a major problem.  You could easily find your so-called “safe” money market fund gated and you unable to get to your money until the fund liquidates – without warning.

So yeah, the funds are now “less vulnerable to runs” as if there’s a problem they can immediately bar the door and keep you from leaving with your cash!

That’s not quite what you thought that paragraph said, is it?

Many people treat these funds as if they were equivalent to a checking account.  Some of the funds will even send you a book of checks!

Investors no longer can reasonably rely on daily liquidity for these funds as a consequence of this change.  While under normal conditions daily liquidity remains available it is precisely under abnormal conditions that an investor is likely to most need access to this money instantly, for example to meet a margin call or for other emergency funding requirements.

The inversion of the former rules in this regard means you can no longer treat these as cash equivalents with a higher yield.  Indeed, there is damn little reason for anyone to buy these at all now – you’re really not any better (or worse) off if you simply deposit the money in Treasury Direct and then buy a ladder of short-term bills – say, 4 or 13-week instruments. 

Yes, you’ll earn jack doing this.  But you’re going to earn jack anyway in a money market fund, you won’t pay a management fee with a Treasury Direct account, and at least thus far there is no material threat of the US Federal Government throwing up gates.

Inexorably the noose tightens around your neck.  Beware.

An Elegant Solution

Financial Jenga

The heads of the global banking cartel are currently gathered for their annual meeting in Davos, Switzerland. They have received enormous subsidies and bailouts at the expense of taxpayers in many nations all around the world. Those nations that possess representative governments are now beginning to respond to the outrage of their citizens at this gross injustice. In Britain, this has taken the form of a proposal to tax financial transactions. In the US, President Obama recently proposed regulations to limit the risk-taking activities of banks and to force the “too big to fail” institutions to shrink. The bankers’ response is a proposal to take regulatory power away from national governments according to a British Press outlet.

This of course would be precisely the WRONG action. National governments in representative systems are forced to respond to the concerns of their citizens. The bankers’ proposal would push the power even further away from the people and vest it in unaccountable supra-national bureaucracies. Our response should be precisely the opposite – devolve regulatory power over the banks back from the Federal government back to the state level. This should be particularly true for commercial banking. First, power should be as close to the citizens as reasonably practical so that the exercise of government power will be as responsive as possible to the average citizen. Second, power should be decentralized so as to reduce the incentive to abuse it and to minimize the damage when such abuse does occur.

One very positive effect would be to create a framework that automatically penalizes large organizations. Giant banks constantly lobbied to reduce the role of the states in banking regulation in the name of “efficiency” starting in the 1970s. One of the chief claims advanced during that period was that US banks would be unable to compete with foreign (especially Japanese) banks without consolidation. That turned out to be correct as the US banks produced a bubble very comparable to the one that has led to a 20 year depression in Japan.

The collapse of the states’ role led directly to the creation of corrupt TBTF mega-banks by reducing the cost of geographic consolidation, just as the weakening and then repeal of Glass-Steagall enabled the growth of financial conglomerates via acquisition across business lines. President Obama has called for limiting the ability of banks to take risk and also breaking up the TBTF banks. We agree and call upon the president to immediately re-implement Glass-Steagall in order to confirm the seriousness of his words via corresponding action. In addition, we call upon him to remove all federal roadblocks to state banking regulation.

The mega-banks object to state regulations because it would increase their cost of compliance. We agree that it would increase such costs and further state that such an outcome would be a GOOD thing. It would create an automatic systemic incentive not to expand. It would be far better for the banks to decide to break themselves up rather than to mandate such an outcome. The legal and regulatory environment can provide the proper incentives and then leave the implementation to the individual players when they find such actions to be in their self-interest. The explicit repudiation of the “too big to fail” doctrine should be sufficient as the only reason to create such behemoths was to become large enough to hold the US economy and financial system hostage. But it never hurts to create the right incentives – all that Washington DC needs to do is stop interfering with the states’ ability to regulate.

This seems to be an elegant solution.

AIG, Paulson and Geithner

Posted by Karl Denninger

These hearings are simply amazing.

First, Tim Geithner.  Timmy made a lot of noise about “total meltdown” risk (and indeed even referenced the possible loss of civil order!) but the question that was not asked is this: Who stoked that fear in Congress?  That would be Bernanke and Paulson, right?  They in fact told Congress “either hand over $700 billion for buying troubled assets or tanks will be in the streets.”

But then – on top of that – they didn’t do what they said they needed the money for and there were no tanks!

So we’re stuck with a handful of facts, none of which are in dispute:

1. Congress was told that either $700 billion be handed out immediately or civil order would be lost.  They were told this by Bernanke and Paulson and believed it.
2. Congress took the action Paulson and Bernanke demanded but then did not spend the money as they said they would, and yet the “or else” did not happen.
3. Yet neither Paulson or Geithner will take responsibility for the precise actions taken during what they, along with Bernanke, claimed was literally an “end of the world” event!

Paulson gets the cake though - he admitted (under oath!) that The Fed just blatantly printed the money to rescue AIG and the banks (!!!)

So let’s see - it wasn’t his decision, it wasn’t Timmy’s decision, and yet at the very same time the entire world was about to come to an end unless the Congress immediately handed over $700 billion of taxpayer money?

Oh, and let’s keep going.  Paulson got skewered with what I pointed out in August of last year – that is, that he knew full well he wasn’t going to buy any “toxic assets” prior to the final vote being taken in The House but notified nobody in Congress of this fact.

Then Mr. Baxter’s turn comes and he says that Geithner signed off on paying AIG counterparties at par.

Didn’t Timmy claim he had no part in the negotiations with AIG and the determination of what to pay?  I thought he did….. maybe I misheard, but I seem to remember that he has continually maintained that he had no part in the decision process and in fact recused himself……

Oh wait – here it is!

I had no role in making decisions regarding what to disclose about the specific financial terms of Maiden Lane II and Maiden Lane III, and payments to AIGs counterparties.

Uhhhhhhh Turbotax Timmy?  How do you explain that?