FedUpUSA

Archive for the ‘risk’ Category

Submitted by James Bianco of Bianco Research

•    The Wall Street Journal – Fed Proposes Tool to Drain Extra Cash
The Federal Reserve on Monday proposed selling interest-bearing term deposits to banks, a move the U.S. central bank would make when it decides to drain some of the liquidity it pumped into the economy during the financial crisis. The new facility is intended to help ensure that the Fed can implement an exit strategy before a banking system awash with Fed money triggers inflation. Fed Chairman Ben Bernanke has described term deposits as “roughly analogous to the certificates of deposit that banks offer to their customers.” Under the plan, the Fed would issue the term deposits to banks, potentially at several maturities up to one year. That would encourage banks to park reserves at the Fed rather than lending them out, taking money out of the lending stream.The central bank said the proposal “has no implications for monetary policy decisions in the near term.” “The Federal Reserve has addressed the financial market turmoil of the past two years in part by greatly expanding its balance sheet and by supplying an unprecedented volume of reserves to the banking system,” it said. “Term deposits could be part of the Federal Reserve’s tool kit to drain reserves, if necessary, and thus support the implementation of monetary policy.” Michael Feroli, an economist at J.P. Morgan Chase, said “it’s another step forward in the exit-strategy infrastructure, but it’s been well flagged in advance, so it’s not a surprise.” When Fed officials decide to tighten credit, they would likely use the term-deposits program ahead of — or in conjunction with — adjusting their traditional policy lever, the target for the federal funds interest rate at which banks lend to each other overnight. The Fed also said Monday that its balance sheet rose slightly to $2.2 trillion in the week ending Dec. 23. The Fed’s total portfolio of loans and securities has more than doubled since the beginning of the financial crisis. As part of its efforts to fight the downturn, the central bank is buying $1.25 trillion in mortgage-backed securities, a program it says will end in March. The Fed now holds $910.43 billion in mortgage-backed securities, it said Monday.

•    Bloomberg.com – Fed Proposes Term-Deposit Program to Drain Reserves
The Federal Reserve today proposed a program to sell term deposits to banks to help mop up some of the $1 trillion in excess reserves in the U.S. banking system.  The plan, subject to a 30-day comment period, “has no implications for monetary policy decisions in the near term,” the central bank said in a statement released in Washington. Fed Chairman Ben S. Bernanke is preparing tools and strategies to shrink or neutralize the inflationary impact from the biggest monetary expansion in U.S. history. Central bankers are also conducting tests of reverse repurchase agreements and discussing the possibility of asset sales. Term deposits may help the central bank “assert operational control over the federal funds rate” once officials decide to lift the overnight bank lending rate from the current range of zero to 0.25 percent, said Lou Crandall, chief economist at Wrightson ICAP LLC in Jersey City, New Jersey. Excess cash “would be locked up” rather than put downward pressure on the federal funds rate, he said.The Fed won’t begin raising interest rates until the third quarter of 2010, according to the median estimate of 62 economists surveyed by Bloomberg News in the first week of December.

•    The Financial Times – Fed to offer term deposits to banks
The US Federal Reserve plans to offer term deposits to banks as part of its “exit strategy” from the exceptionally loose monetary policy used to fight the recession. In a consultation paper released on Monday the Fed said it planned to change its rules so that it could pay interest on money locked up at the central bank for a defined period. The Fed added that the well-flagged rule change – designed to allow it more influence over the $1,100bn in excess reserves held by banks – was part of “prudent planning. . . and has no implications for monetary policy decisions in the near term”. It is one of a number of measures that has been outlined over the past few months by Ben Bernanke, chairman of the Fed, as an option to drain liquidity from the financial system in a manner that protects the economic recovery while heading off the threat of inflation.

•    The Federal Reserve – Notice of proposed rulemaking; request for public comment.
The Board is requesting public comment on proposed amendments to Regulation D, Reserve Requirements of Depository Institutions, to authorize the establishment of term deposits. Term deposits are intended to facilitate the conduct of monetary policy by providing a tool for managing the aggregate quantity of reserve balances. Institutions eligible to receive earnings on their balances in accounts at Federal Reserve Banks (”eligible institutions”) could hold term deposits and receive earnings at a rate that would not exceed the general level of short-term interest rates. Term deposits would be separate and distinct from those maintained in an institution’s master account at a Reserve Bank (”master account”) as well as from those maintained in an excess balance account. Term deposits would not satisfy required reserve balances or contractual clearing balances and would not be available to clear payments or to cover daylight or overnight overdrafts. The proposal also would make minor amendments to the posting rules for intraday debits and credits to master accounts as set forth in the Board’s Policy on Payment System Risk to address transactions associated with term deposits.

Comment

We believe the proposal of this new tool signals the Federal Reserve is still flailing around trying to look busy so everyone is assured they have a plan.  The fact is they have no plan and are still throwing everything on the wall to see what sticks. From the November 4 FOMC minutes:

Participants expressed a range of views about how the Committee might use its various tools in combination to foster most effectively its dual objectives of maximum employment and price stability. As part of the Committee’s strategy for eventual exit from the period of extraordinary policy accommodation, several participants thought that asset sales could be a useful tool to reduce the size of the Federal Reserve’s balance sheet and lower the level of reserve balances, either prior to or concurrently with increasing the policy rate. In their view, such sales would help reinforce the effectiveness of paying interest on excess reserves as an instrument for firming policy at the appropriate time and would help quicken the restoration of a balance sheet composition in which Treasury securities were the predominant asset. Other participants had reservations about asset sales–especially in advance of a decision to raise policy interest rates–and noted that such sales might elicit sharp increases in longer-term interest rates that could undermine attainment of the Committee’s goals. Furthermore, they believed that other reserve management tools such as reverse RPs and term deposits would likely be sufficient to implement an appropriate exit strategy and that assets could be allowed to run off over time, reflecting prepayments and the maturation of issues. Participants agreed to continue to evaluate various potential policy-implementation tools and the possible combinations and sequences in which they might be used. They also agreed that it would be important to develop communication approaches for clearly explaining to the public the use of these tools and the Committee’s exit strategy more broadly.

The Federal Reserve first hinted at term deposits almost two months ago, although exactly what they were talking about was left vague until now.

Remember that the Federal Reserve has to withdraw over a trillion dollars of excess liquidity.  The easiest way to do this is to sell hundreds of billions of MBS, Treasuries and agencies.   As the bold highlighted passage above implies, they are scared to death of doing this, so they propose complicated schemes to withdraw liquidity like reverse repos and now term deposits.

We have argued that these schemes will not work.  They cannot be done in the sizes necessary or enough to even matter.  The Federal Reserve could possibly drain tens of billions of dollars via these schemes, but collectively that will amount to a rounding error when the goal is to withdraw over a trillion in excess reserves.

The Federal Reserve does not want to admit defeat, so they continue pursuing these strategies that will not make a difference.  We believe they also do it to “look busy” as they are taking measurements and notes as to how to withdraw all the liquidity they have pumped in.  They think this will give the market comfort that someone is on the case and that inflation expectations will not get out of control.  The market is not buying this.  Inflation expectations, s measured by TIPS inflation breakeven rates, are going vertical.

Reinvestment Risk

As to term deposits, the Federal Reserve is proposing an illiquid short term instrument for banks to invest in.  Banks would buy these instruments and “lock up” the excess reserves they now have.  This would have the same effect as draining excess reverses.  The maturities of these instruments would be as long as one year.

It is unclear if there will be a secondary market for these instruments, and if so, how liquid it will be.
Without a secondary market, buyers of these instruments face huge reinvestment risk.  The future course of short term interest rates is arguably to the most uncertain it has been in decades.  Will the Federal Reserve stay near zero until 2012 or will they be forced to raise rates in the first half of 2010?  Given all this uncertainty, who wants to lock up money in something that cannot be sold before maturity?  This is especially true given the Federal Reserve’s statement that the “maximum-allowable rate for each auction of term deposits would be no higher than the general level of short- term interest rates.”

The general level of short-term interest rates is set on known instruments that have generations of history and active secondary markets.  If the Federal Reserve wants to introduce a new, and wholly unknown instrument with an uncertain secondary market and offer no interest rate premium, then we cannot see how this will work beyond a token amount after some arm twisting to get them sold.  The Federal Reserve will have to offer a premium for uncertainty and illiquidy to make this fly in any major way, something they said they will not do.

Complicated Is Simple

The Federal Reserve owns 80% of AIG.  With each passing day it looks like the Federal Reserve is adopting AIG Financial Product’s business practices.  That is, when faced with a financial problem, they create complicated tools (like CDS).  When critics says these new products will not work, tell them they do not know what they are talking about and create even more complicated tools to dazzle everyone.  Once the tools are so complicated that no one understands them, you will be hailed as an expert with no peer.  You might even be named TIME’s Person of the Year.

As everyone is engrossed by assorted groundless Christmas (and other ongoing bear market) rallies, and oblivious to the debt monsters hiding in both the closet and under the bed, Zero Hedge has decided it is about time to present the ugliest truth faced by our ‘intellectual superiors’ and their Wall Street henchman who succeeded in pulling off Goal #1 for 2009 – the biggest ever bonus season (forget record bonuses in 2010… in fact, scratch any bonuses next year if what is likely to transpire in the upcoming 12 months does in fact occur).

If someone asks you what happened in 2009, the answer is simple – two things. There was a huge credit and liquidity crunch, and then there was Quantitative Easing. The last is the Fed’s equivalent of band-aiding a zombied and ponzied corpse, better known as the US economy. It worked for a while, but now the zombie is about to go back into critical, followed by comatose, and lastly, undead (and 401(k)-depleting) condition.

In 2009, total supply of all USD denominated fixed income, net of maturities, declined by $300 billion from $2.05 trillion to $1.75 trillion. This makes sense: the abovementioned crunches stopped the flow of credit from January until well into April, and generally firms were unwilling to demonstrate to the market how clothless they are by hitting the capital markets until well into Q2 if not Q3. What happened was a move so drastic by the Fed, that into November, the worst of the worst High Yield names were freely upsizing dividend recap deals (see CCU) – the very same greed and stupidity that brought us here. Luckily, so far securitization and CDOs have not made a dramatic entrance. They likely will, at which point it will be time to buy a one-way ticket for either our southern or northern neighbor, both of which, in the supremest of ironies, transact in a currency that will survive long after the dollar is dead and buried.

Back to the math… And here is the kicker. Accounting for securities purchased by the Fed, which effectively made the market in the Treasury, the agency and MBS arenas, but also served to “drain duration” from the broader US$ fixed income market, the stunning result is that net issuance in 2009 was only $200 billion. Take a second to digest that.

And while you are lamenting the death of private debt markets, here is precisely what the Fed, the Treasury, and all bank CEOs are doing all their best to keep hidden until they are safely on their private jets heading toward warmer climes: in 2010, the total estimated net issuance across all US$ denominated fixed income classes is expected to increase by 27%, from $1.75 trillion to $2.22 trillion. The culprit: Treasury issuance to keep funding an impossible budget. And, yes, we use the term impossible in its most technical sense. As everyone who has taken First Grade math knows, there is no way that the ludicrous deficit spending the US has embarked on makes any sense at all… none. But the administration can sure pretend it does, until everything falls apart and blaming everyone else for its fiscal imprudence is no longer an option.

Out of the $2.22 trillion in expected 2010 issuance, $200 billion will be absorbed by the Fed while QE continues through March. Then the US is on its own: $2.06 trillion will have to find non-Fed originating  demand. To sum up: $200 billion in 2009; $2.1 trillion in 2010. Good luck.

As we pointed, the number one reason why 2010 is set to be a truly “interesting” year is a result of the upcoming explosion in US Treasury issuance. Fiscal 2010 gross coupon issuance is expected to hit $2.55 trillion, a $700 billion increase from 2009, which in turn was  $1.1 trillion increase from 2008. For those of you needing a primer on the exponential function, click here. But wait, there is a light in the tunnel: in 2011, gross issuance is expected to decline… to $1.9 trillion.

And while things are hair-raising in “gross” country (not Bill…at least not yet), they are not much better in netville either. Net of maturities, 2010 coupon issuance will be about $1.8 trillion, a 45% increase from the $1.3 trillion in FY 2009 (and the paltry $255 billion in 2008).

Now everyone knows that the average maturity of the UST curve has become a big problem for Tim Geithner: nearly 40% of all marketable debt matures within a year (a percentage that has kept on growing). In fact, the Treasury provided guidance in its November 2009 refunding, in which it stated that it intends “to focus on increasing the average maturity” of its debt after relying heavily on Bill issuance in H2. Once again, we wish Tim the best of luck.

Why our generous best intentions to the US Treasury? Because unless the US consumer decides to forgo the purchase of the 4th sequential Kindle and buy some Treasuries (and not just any: 30 Year Bonds or bust), the presumption that the Bond printer will have the option of finding vast foreign appetite for its spewage is a very myopic one. We already know that China is a major question mark, and will aggressively be looking at pumping capital into its own economy instead of that of Uncle Sam’s – at some point the return on investment in its own middle class will surpass that of funding the rapidly disappearing US middle class. That tipping point could be as soon as 2010.

As for Japan – the country has plunged into its n^th consecutive deflationary period. Whether or not the finance minister announces yet another affair with the Quantitative Easing whore on any given day, depends merely on what side of the bed he wakes up on. The country will have its hands full monetizing its own sovereign issuance, let alone ours.

Lastly, the UK – well, with the country set to have zero bankers left in a few months, we don’t think the traditionally third largest purchaser of US debt will be doing much purchasing any time soon.

None of this is merely speculation: October TIC data confirmed these preliminary observations. It will only become more pronounced in upcoming months.

How about that great globalization dynamo: emerging markets? Alas, they have their hands full with issuing their own record amounts of both sovereign and corporate debt as well: in 2009 gross EM debt issuance reached an astounding $217 billion, $29 billion higher than the previous record in 2007. Gross EM issuance was particularly high in the last quarter at $73 billion, with October breaking the record for the largest ever monthly gross issuance of emerging market global bonds at $38 billion (January is traditionally the busiest month of the year.) With $81 billion, 2009 was notably a record year for sovereign bonds, while gross issuance of corporate bonds amounted to $136 billion, the second highest level after that of 2007 with $155 billion.

Bottom line: everyone has major problems at home, and is more focused on the supply than the demand side of the equation.

What options does this leave for the administration? Very few, and all of them are ugly. As we stated earlier on, the options for the Fed are threefold:

1. Announce a new iteration of Quantitative Easing. This will be met with major disapproval across all voting classes (at least those whose residential zip codes do not start with 10xxx or 068xx), creating major headaches for Obama and the democrats which are already struggling with collapsing polls.
2. Prepare for a major increase in interest rates. While on the surface this would be very welcome for a Fed that keeps hinting that deflation is the biggest concern for the economy, Bernanke’s complete lack of preparation from a monetary standpoint (we are surprised the Fed’s $200 million reverse repos have not made the late night comedy circuit yet) to a forced interest rate increase, would likely result in runaway inflation almost overnight. The result would be a huge blow to a still deteriorating economy.
3. Engineer a stock market collapse. Recently investors have, rightfully, realized there is no more risk in equities, not because the assets backing the stockholder equity are actually creating greater cash flow (as we demonstrated recently, that is not the case), but simply because taxpayers have involuntarily become safekeepers for the entire stock market, due to Bernanke’s forced intervention in bond and equity markets. Yet the President’s Working Group is fully aware that when the time comes to hitting the “reverse” button, it will do so. Will the resultant rush into safe assets be sufficient to generate the needed endogenous demand for Treasuries is unknown. It will likely be correlated to the size of the equity market drop.

If the Fed decides on option three, we fully believe a 30% drop (or greater) in equities is very probable as the new supply/demand regime in fixed income becomes apparent. We hope mainstream media takes the ideas presented here and processes them for broader consumption as indeed the Fed is caught in a very fragile dilemma, and the sooner its hand is pushed, the less disastrous the final outcome for investors. Then again, as Eric Sprott has been pointing out for quite some time, it could very well be that the US economy has become merely one huge Ponzi, and as such, its expansion or reduction on the margin is uncontrollable. We very well may have passed into the stage where blind growth is the only alternative to a complete collapse. We hope that is not the case.

Merry Christmas and Happy Holidays to all readers.

From Bloomberg, Citigroup Stock Sale Discount Prompts Treasury to Delay Disposal of Stake :

Dec. 17 (Bloomberg) — Citigroup Inc.,
the last of the four largest U.S. banks to seek funds to exit a
taxpayer bailout, raised $17 billion by selling stock for a price so
low that the U.S. delayed plans to shrink its one-third stake in the
lender.

Citigroup sold 5.4 billion shares at
$3.15 apiece, less than the $3.25 the government paid when it acquired
its stake in September. The New York-based bank said the Treasury won’t
sell any of its shares for at least 90 days.

Investors demanded a bigger discount from Citigroup than Bank of America Corp. or Wells Fargo & Co.,
which together raised more than $31 billion this month to exit the
Troubled Asset Relief Program. Wells Fargo, which trumped Citigroup’s
bid to buy Wachovia Corp. last year, leapfrogged its rival by
completing a $12.25 billion share sale Dec. 15. JPMorgan Chase &
Co. repaid $25 billion in June.

“The market cast its vote and they’re low down on the ballot,” said Douglas Ciocca,
a managing director at Renaissance Financial Corp. in Leawood, Kansas.
“Citigroup needs to show steps to reinstall the quality of the brand.”

With
the sale, Citigroup’s common shares outstanding increased to 28.3
billion. That’s up from 22.9 billion as of Sept. 30 and 5 billion at
the end of 2007.

“More shares outstanding means less value per share,” said Edward Najarian,
an analyst at International Strategy and Investment Group in New York,
who has a “hold” rating on the shares. “The whole structure of their
deal to pay back TARP wasn’t very good for common shareholders and that
is being reflected in the pricing.”

I think
one of the most important points are being missed. Most of these banks
swore that they didn’t need TARP. Despite this, in order to return it,
they must go back out to the capital markets. Why do you have to hit
the market to return a loan that you said you didn’t need, unless you
needed it? This obvious lie has went unchallenged.

It gets
worse. Citi is diluting the hell out of it shareholders, as well as all
of the other TARP banks that are selling shares. Some may even be
taking on debt. They are doing this primarily to gain the freedom to
declare bonuses at higher rates despite uncertain credit condition
surrounding the toxic assets that caused the problem in the first
place. Why in the world would any lender or shareholder agree to
dilution and/or higher debt service “primarily” to pay higher bonuses
to employees in the highest compensated (as a percent of net revenue)
industry in the world???

Imagine if you ran this business, you
have rocky times during a recession with revenues in nearly all aspects
of your business down save the blatant risk taking of trading, and you
go to your bank and say I need a big loan so I can pay myself a $20
million bonus increase.
Do you think Citibank would give you this
loan? They expect it from their shareholders. The same goes for
Goldman, JPM, BAC, etc.

Also from Bloomberg: Weak Banks Should Face Curbs on Bonuses, Dividends, Basel Regulator Says

Dec. 17 (Bloomberg) — Global regulators urged national
authorities to limit bonus and dividend payments by banks with
weakened capital safety nets as part of proposals to reduce
risks to the financial system.

Banks should increase the quality of the capital they hold
to cope with losses, the Basel Committee on Banking Supervision
said in a report on bank capital and liquidity published today.
Banks with depleted capital buffers shouldn’t use predictions of
recovery to justify generous dividends to investors and
employees, the committee said.

Global regulators have been wrestling with plans to
increase supervision of banks following the worst economic
crisis since World War II. The Group of 20 Nations agreed in
April that banks should be required to hold more and better
quality capital to reduce risks to the financial system.

“It’s not acceptable for banks which have depleted their
capital buffers to try and use the distribution of capital as a
way to signal their financial strength,” the committee’s
statement said. “The proposed framework will reduce the
discretion of banks which have depleted their capital buffers to
further reduce them through generous distributions of
earnings.”

It’s amazing that this even needs to be said.

Submitted by Greg Simmons and Brett Buchanan of Scope Labs

Are financial markets a direct reflection of the overall health of a nation? I wish they were not, but I fear they are.

I wonder at times if our nation has entered a state of purgatory –
all of us mulling around in the waiting room to Hell, anxiously
counting the minutes until the grim reaper saunters through the door
sickle in hand his mission to send us off to eternal damnation.
Unfortunately, there is little time to close this door so that we may
stave off this potential fate that looms so near. What we need to alter
this course is a procession of men who possess moral fortitude and
common sense, men of rationality and reason. Men of action who will set
in motion the dismantling of institutions that bleed this nation dry.

Hope is not a strategy. This present state of manufactured optimism
emanating from the White House and our news outlets is contemptible. We
are in dire need of new reformist leadership and of new voices that
will speak the truth. A national purification is long overdue. Time is
not on our side. Look at the track record this nation has racked up
over the last few decades and this economic and moral purgatory in
which we find ourselves might very well mark the beginning of our walk
of death down the long road to Hell.

I make this analogy of a national state of purgatory not in jest,
but rather in practical terms. This nation has gone the way of an
absolute meltdown of morality and ethics. We’ve reverted to a sort of
Wild West where anything goes. From the halls of congress to our
corporate boardrooms our collective morality bar has sunk so low we
cannot go any lower without disconnecting from the great past this
nation is starved to regain. We stand dangerously close to the point
where immorality begets our undoing.

Personally, I am father to a daughter of fourteen years. Brett, my
co-author, is father to a twenty-month old daughter and an
eighteen-year old son. We desperately want to create for our children a
better world. But we are fallible men, and certainly not saints. The
paragraphs you are about to read are not written from some moral high
ground, or a Holier-than-thou pulpit, but rather from saddened hearts
when we see that by walking our own moral tightrope, if we were to
allow ourselves to slip below the bar, however slightly, we would be
just as guilty as the worst perpetrators of our nation’s moral
destruction. Also, when witness to greater moral transgressions, by our
own inaction, we become part of the problem. And we are just two men.
Amplify this by fifty million, one hundred million, or three hundred
million fold and it is no wonder immorality permeates our society.

This article is our personal effort to call people’s attention to
the truth. The brevity of our circumstance is immeasurable by past
reference. Economically, we have never been so challenged. Over the
past few decades a gullible US population cheered the halls of congress
and the Oval Office alike as the incestuous bedfellows of money and
politics ushered in a financial Coup d’état – co-opting our public
trusts with the greed and excess of Wall Street. Profits are now had at
any cost – damn the long-term consequences. Instead of being exposed as
the obvious fraud he was, Bernie Maddoff was coddled by the SEC – an
institution whose role as regulator is a complete failure. As Wall
Street and Washington raped an entire nation, employees of the SEC were
too busy surfing porn on the Internet and running private businesses
instead of doing the jobs taxpayers pay them to do. All the while,
young girls were selling their virginity to the highest bidder in
public cyber-forums where grown men (not hormonally charged teenage
boys) seek out their sexual fantasies in the netherworld of Internet
pornography. What of the wives, children, and even parents of these
men? Do they approve of such questionable actions?

Think of our children turning on the television to see people eating
bile, cow blood, and live bugs for money on game shows like Fear
Factor, or Flavor Flav and his hit reality show where he maintains a
stable of women all of whom physically fight each other to have sex
with him because he’s a celebrity – and a damn ugly one at that. And
finally, there’s always Survivor, the ultimate demonstration of all
things wrong with modern human interaction. A reality show that pits
person against person in a deceitful game of moral destruction where
lack of ethics are rewarded, instead of punished. Survivor, this is
what our nation’s leadership has become. Win at any cost. Damn the
future of anyone but myself.

Morality is in great part the measure of a nation. Have we unlearned
morality? Is this why we find ourselves staring down the abyss?

We are allowing ourselves to become more corrupt by the minute. We
stare into the face of our future being raped, but we do nothing. We
are as corrupt as the corrupters. We accept the unacceptable. We fail
to understand that absolute power, corrupts absolutely. In what will go
down as the greatest financial heist in history our leaders have chosen
to reward corrupt individuals and their hollow corporations for what
are arguably criminal levels of risk behavior by the moneyed elite of
this country. What message does that send to our children, or to anyone
for that matter? Be as corrupt as possible in the US and you will be
rewarded? Be the biggest failure jeopardizing the fate of others then
stand in the corporate welfare line with all the other wealthiest
institutions of the world, your greedy hand extended for a government
bailout check while you simultaneously foreclose on an entire nation?
Talk about the rich corralling the masses. It’s no wonder someone
coined the term “The Sheeple.”

The path we traveled to this purgatorial limbo is both easily
understood and misunderstood. The answers to understanding are
sometimes right in front of us. What are seemingly benign things or
actions, those everyday judgments or decisions we make to do one thing
or another, are not always benign. Tell a little white lie to make that
one sale that will put us into our bonus. Rig the game in our favor so
that we might enjoy a little more opulence for the few decades we have
remaining on this planet. Look the other way while the Federal Reserve
and Wall Street blow economic bubble after economic bubble and in the
process create a six-hundred trillion dollar shadow banking system that
plays by no one’s rules but its own. In the case of Goldman Sachs, and
Wall Street in general, lie, cheat, and steal their way to
profitability at the expense of three hundred million taxpayers. The
fact is that we have become an uncooperative nation willing to take
advantage of anyone for the sake of profit. The idea of building a
cooperative future where everyone wins has been sacrificed at the altar
of short-mindedness.

It might be this purgatorial limbo I speak of is simpler than it
appears. It could be that we are collectively suffering the
consequences of the “Peter Principle”, or getting to the job of
failure. This principle supposes that an individual rises in a
corporate hierarchy to their first level of incompetence. An assembly
worker gets promoted to supervisor then to assistant manager, then
manager, until he next gets promoted to an upper management job for
which he is ill equipped and subsequently gets promoted no further as
he can no longer demonstrate the competence required for the task at
hand. He rather relies on subordinates who are then stuck with an upper
manager who cannot carry out his own duties. Could this be the state of
our nation? Have we been promoted as far as our competence allows? Are
we in fact incompetent to handle our future? Have we now elected a man
just incompetent enough for the Presidency who is being manipulated by
Goldman Sachs, the Federal Reserve, and a circle of (previous) Wall
Street insiders now on the government payroll as cabinet members and
high-ranking advisors? The saddest thing is that we sit idly by whilst
our virtue is being stolen. We do nothing.

A view of the world through rose-colored glasses does no one, any
good. We are not as resilient as we think we are. Instead, we exist in
a world of synthetic productivity where multi-tasking renders us
incapable of doing anything effectively or with any level of
competence. Multi-tasking, that art of simultaneous ineffectiveness is
a counter productive weapon that to a large degree has contributed to
the potential failure of this nation. If you were to listen to Alan
Greenspan however, you would believe that multi-tasking through
technological gains by way of the “new paradigm” was the gold at the
end of the Information Superhighway and that exotic mortgages and the
burgeoning spending class paved the road to riches. We now know these
premises to be empirically wrong.

It can now be argued that what would seemingly be advancements in
productivity are proving to be setbacks. The Information Superhighway
has led us to an era of technological arrogance. In reality all we have
accomplished is to dilute our ability to carry out simple tasks as we
click from a quarterly sales report due in an hour, to Facebook, to
on-line solitaire, to writing an email explaining to our boss why the
quarterly report will be delayed this day. We are a nation of excuse
makers. We look for someone else to keep us one step ahead of our
accumulating debt that smothers the potential of what could have been
an equitable future. Ironically, it is our technological arrogance that
impedes our ability to produce and manufacture our way to prosperity.

Craftsmen who used to flock to this country to fulfill the needs of
a manufacturing base flock here no more. “Made in the USA” used to mean
something. It meant quality. It was the definition of industrial
capitalism. But now through the wonders of globalization we have
exported our craftsmanship through an outflow of jobs to China and
India as we turned everyone in the USA into real estate agents,
mortgage brokers, and web designers – a perfect playground for bankers
to ply their craft, lending money in every creative manner both
thinkable, and unthinkable. “Made in the USA” has been reduced to the
status of punch-line – synonymous only with “Mortgage Backed
Securities” and other “Toxic Derivatives.”

Is it any wonder we have evolved into the ‘entitled society’? If we
weren’t on the government payroll, or subsidized by the US taxpayer
through social welfare then we were borrowing our way to prosperity.
Enter the God-fearing middle class. Just dumb enough to buy into the
scam a couple hundred million people began signing over their
paychecks, selling their future for the enjoyment of having things now.
We were transformed into non-productive Sheeple, selling our souls for
an easier life in lieu of a better future for our children. At our
current rate of productive attrition we will soon be a nation of
declawed housecats, possessing no skill-set whatsoever to survive in a
world where the ability to produce real goods still reins supreme. Yet
we remain the ‘entitled society’, when we are entitled to nothing.

We forget (through economic amnesia) that throughout history all
societies fail. Nicolaus Copernicus maintained that civilizations
failed when bad money, controlled and understood by an elite few, drove
out good money. The same can be said for morality. Bad, drives out
good. This is a reality of which we should all be acutely aware but
rather are immune to its possibility. We dangerously believe we cannot
fail. That, in fact, is the greatest gamble of all. A roll of the dice
against history, a bet against all natural laws of the universe, all
things are in a state of entropy. All things eventually wither away to
nothing. To possess longevity is to be ahead of the universe. Sadly, we
have constructed a fragile world that produces material things that do
not last. The fiat money we use as the currency of our production is by
design, destructive itself. The Federal Reserve prints greed, nothing
more. But still we covet it. We pursue it as if it had value. And in
this pursuit we destroy earth’s resources as if the laws of nature have
no relevance. We believe there is only now.

We, the entitled society, morally and fiscally bankrupt have borrowed,
spent, and bailed our way into a historical corner. Nero should be so
proud. Our public trusts are nothing more than government sanctioned
check-kiting operations shifting liabilities from one credit card to
another faster than our creditors can say “Federal Reserve.” The
Ponzi-scheme that is our fiat currency system is about to go the way of
what was for a time the symbol of American superiority, General Motors.
It used to be said that what was good for General Motors was good for
our nation. As I claimed in 2005 that GM would go bankrupt I will now
guarantee that the US government is soon to follow. How our ultimate
entropy will take form I cannot say, but form it will. We will default.
We will restructure. It will be at this point our arrogance will end.

It was just a matter of time before the administration’s covert plan of rewarding bank execs for massive failure by allowing them to load up their balance sheets with record risk once again, while paying out historic bonuses, blew up in Larry Summers’ face. Today’s attempt by the government to not only allow the failed Citi management team to pay itself an infinite amount of money more than it deserves for destroying one of America’s landmark companies (why the hell is Vikram Pandit still in charge of the Titanic?) but to pretend that it “generated” another taxpayer win by selling off its shares at a profit, was aborted after hours, when Citi could barely find enough interest to sell $17 billion at the embarrassingly low price of $3.15, below that government’s cost basis. This will preclude Obama from making a TV appearance tomorrow of how the US taxpayer made even more money by backstopping Moral Hazard. What the US taxpayer however did do, is funnel money straight out of its pocket, into that of Vikram’s worthless lackeys. We somehow doubt this will make the teleprompter of whatever it is Obama will be praising in his TeeVeethon tomorrow.

More from the WSJ:

The U.S. government reversed plans to begin reducing its trimming its 34% stake in Citigroup Inc. (C) after investors balked at buying the bank’s shares, according to people familiar with the situation.

Citigroup was nearing completion late Wednesday on the sale of about $17 billion of newly issued shares. But the offering encountered such a lukewarm response that Treasury Department officials decided to hold off on selling any of its shares until next year, these people said.

At the expected sale price of $3.15 a share, the U.S. government would have suffered a loss of 10 cents per share on its 7.7 billion-share stake in Citigroup, or about $770 million.

Treasury officials also agreed not to sell the government’s shares for at least 90 days. The 90-day lockup is a significant concession because the government previously could sell its Citigroup shares whenever it wanted.

Citigroup said Wednesday evening that it plans to go forward with repaying the financial lifelines it got under the Troubled Asset Relief Program. That includes unwinding a deal in which the government shields Citigroup from most losses on $301 billion of assets held by the company.

As Citigroup gauged interest in its huge offering, announced Monday, some investors said they were willing to buy shares only if the company extracted an agreement from the Treasury Department to hold off on any future stock sales for at least 90 days, according to people familiar with the matter.

The government now plans to unload its Citigroup stock gradually over the next 12 months, people familiar with the situation said. That is a major shift from the Treasury Department’s announcement Monday that it planned to dispose of the shares over six to 12 months.

Is this merely one of the ever increasing cracks in the economic team’s bailout plan, which as all investors are fully aware are completely unsustainable in the long run, yet sufficiently plausible over the next 90 or so days (until QE presumably ends) that one more day of buying by various algos may be warranted. Perhaps the 90 days will end up being a far too optimistic expectation.

Courtesy of David Rosenberg of Gluskin-Sheff

It’s that time of the year when ‘sell-side’ research departments publish their Year-Ahead Reports (as I once did in the not-too-distant past); as do all the financial magazines.

I realized after countless emails and phone conversations (in that order) that there is a very high expectation that I publish one too. I honestly have no intention of publishing a specific set of forecasts in my current role as the Chief Economist and Strategist for Gluskin Sheff for public consumption — the granularity of my recommendations is reserved for our Investment team and our client base. Be that as it may, I am more than happy to comment on what I see as an emerging consensus and my general view on the direction of the economy and the markets in the coming year without getting into too much detail or numerical forecasts, which are the domain of the ‘sell-side’ macro teams globally.

At the outset, let it be known that when I read everyone else’s year-ahead prognostications, all I can think of is, “where do I store this stuff for a year so I can look back and say ‘That was so wrong!’.” It’s not that the reports are always bullish every year; it is that they seem so contrived. And, as I mentioned in the December 10th edition of Breakfast with Dave, this year, probably like most years, there seems to be a remarkable level of agreement. Based on my reading, here is what I conclude the consensus views are as we head into 2010:

• Muted recovery, but positive growth, for sure! No risk of a ‘double dip’.
• Equity markets up!
• A barbell strategy of domestic multinational blue chips and emerging market equities.
  The U.S. dollar is…neutral, but we did locate more bulls than bears (so much for the ‘carry trade’ thesis).
• Positive on commodities for the most part.
• Concerned about government balance sheets, and therefore…
• …Bearish on long term government bonds because they are the ‘competition’ and, after all, who would tie their money up for 10 years at 3.5% when you can lose 22% in stocks? And, therefore…
• …Bullish on spread product (as long as it’s not long-term). And, therefore…
• …Really comfortable with high yield (just for the coupon and the view that default rates will come down).
• Certain that volatility will not be an impediment.
• The Fed will begin to raise rates in the second half of the year, but that this will have no impact since they will still be low.

So here we are with a glorious opportunity to reintroduce Bob Farrell’s Rule 8: “When all forecasts and experts agree, something else is going to happen.”

That being said, these economists and strategists, many of whom I know, are smart guys (and gals) and they are human. To ‘talk your book’ is human; to have the courage to ‘buck the consensus’ is divine. I too am human; I also like to feel that I have courage of my convictions; and I too have a “book” (of sorts — it’s called reputation). But I have decided to take the opportunity of the “Year-Ahead Moment” to transition from sell-side to buy-side and more importantly, to reflect on the past year and really try to prognosticate from the gut. You would be surprised how a blend of intuition and experience can make a difference in a cycle like the one we are in that has absolutely nothing in common with the other recessions of the post-WWII era.

Forecasting is a humbling profession even in the best of times and I have learned a lot in the past year, especially from my partners here at Gluskin Sheff who realizes all too well that:

1. It is what is embedded in asset prices benchmarked against the forecast that is of utmost importance for investors;
2. The focus of any forecast must take into account the reality that minimizing portfolio risks is at least as critical as maximizing the returns, and;
3. Every forecast has an error term and the range around any projection in a post-bubble credit collapse can be extremely wide.

I do not view the economic events of the last two years as a classic recession/recovery phase. They only exist in the context of a secular credit expansions and contractions. We are in a post-credit bubble credit collapse that is ongoing, à la Bob Farrell’s Rule 4: “Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways.”

Mainstream economists called this downturn “The Great Recession”. This is truly a gentle way of saying “Depression”. When we can have the courage to come to grips with the fact that we did in fact experience a depression of sorts, which is by definition a credit event, then and only then can we draw a conclusion that a sustainable recovery will not get underway until the ratio of household credit to personal disposable income reverts to the mean (and goes to an excess in the opposite direction). I know it sounds harsh, but we shall endure — believe it. Transition is rarely without pain.

The ratio of household debt to disposable income is up from a 30% ratio back in the 1950s to 125% today (though down from 139% at the peak in 2007). Mean reverting to a ratio closer to 60% means that the deleveraging process will be a multi-year event and by the time it is over, more than $7 trillion in additional household credit will have to be extinguished. For more on this see the unbelievably grotesque article on the front page of last Thursday’s (December 10) Wall Street Journal — The New American Dream.

Perhaps inflation is a consensus forecast but deflation is the present day reality and often lingers for years following a busted asset and credit bubble of the magnitude we have endured over the past two years. The fact that China’s voracious appetite for basic materials will continue to exert upward pressure on commodity prices does not detract from this view, especially given the widespread excess capacity in the manufacturing sector and the new frugality that has gripped, and in many cases, been embraced by the retail sector. Higher raw material prices, owing to developments in Asia as opposed to demand pressures here at home, will prove to be a sustained source of profit margin compression for many sectors and companies linked to finished consumer goods and services.

So, much of what I have read in various Year-Ahead Reports predict corporate earnings, GDP growth here and abroad, interest rates and relative values of currencies. As I mentioned earlier, the error term is bound to be very wide in this new paradigm (since WWII) of a secular credit collapse. GDP growth in 1934 was 10%, but the Depression wasn’t over until 1940.

Since 1989, the Japanese stock market has had no fewer than four 50%-plus rallies and there still has been no period of growth that can be called a sustained expansion. Today, we have our own special set of conditions and it is bound to be tricky as is typical during a post-bubble credit collapse, no matter how intense the government reaction. Prematurely committing to the ‘risk’ trade is probably going to be the most lamentable action over the next few years.

Suffice it to say, we believe that the dominant focus will be on capital preservation and income orientation, whether that be in bonds, hybrids, hedge fund strategies, and a consistent focus on reliable dividend growth and dividend yield would seem to be in order. To reiterate, I see the range of outcomes in the financial markets and the economy to be extremely wide at the current time. But one conclusion I think we can agree on is the need to maintain defensive strategies and minimize volatility and downside risks as well as to focus on where the secular fundamentals are positive such, as in fixed-income and in equity sectors that lever off the commodity sector.

This, in turn, underscores my primary focus of favouring Canadian dollar based investments over the U.S. because at no time in my professional life have the downside risks — economic, fiscal, financial and political — been so low on a relative basis and the upside potential so high as is the case today. The near-2,000 basis point gap this year between the TSX and the S&P 500 — the former leading — should be taken in the context of being just past the halfway point of a secular (ie, 16-18 year) period of outperformance. Northern exposure never felt this hot.