October 28, 2010

QE2: More Harm Than Good

Posted in Banking, Big Banks, Bonds, Capital, community banks, crises, derivatives, Finance, Forward thinking, government, investment advisor, investment banking, investments, local banks, municipal bonds, San Francisco, Stocks, taxes, Uncategorized tagged , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , at 9:24 PM by Robert Barone

With voters up in arms about unconscionable federal and state deficits and likely to change the ability of the federal government to add even more “stimulus” in the next Congress, all eyes are now on the Federal Reserve (Fed).  QE2 (Quantitative Easing 2 – government speak for money printing) has been promised by various Fed documents and Federal Open Market Committee (FOMC) member public speakers, including Chairman Bernanke himself.  The equity markets have responded.  Priced in is a large stimulus with the expectation that it will lead to an increase in the anemic rate of economic growth, and, hopefully, a lowering in the rate of unemployment.  Any disappointment is likely to have a significant impact on the equity markets.

But, beyond the transitory impact on the equity market, is QE2 good public policy?  A good, question, especially since QE1 did not produce any measurable economic growth.  Some folks argue that QE1was a success in the sense that it saved the credit markets from complete collapse and likely saved several large financial institutions.  However, the issue today isn’t the functioning of those markets.  In fact, new debt issues have no trouble finding buyers today.  The issue today revolves around an economy that cannot find traction.


So, what does the Fed hope to accomplish by bloating up its already pregnant balance sheet?  It is pretty clear that the economy is in a liquidity trap.  That is, like the 1930s, the banking system already has an extremely high level of excess reserves and there appears to be no demand for borrowing.  On the contrary, because consumers have too much debt, they are now foregoing consumption and borrowing despite historically low interest rates (Mohammed El-Erian’s “New Normal”).  Thus, on a monthly basis, we continue to see significant loan contraction.  The actual implementation of QE2 (the buying of bonds and notes in the open market) adds reserves to the banking system, and lowers interest rates on the part of the yield curve in which the purchase operations take place, with, perhaps, some trickle down to the rest of the yield curve.  Given the level of excess reserves already in the system, the Fed certainly can’t be hoping that these actions will spur loan growth.  And, given the already historic lows in interest rates, they can’t be foolish enough to think that the lowering of rates by a few basis points will have a significant impact.  Then, what can the Fed possibly be hoping for in this round of money printing?

Another Asset Bubble?

Asset inflation is one possibility.  And the announcement of QE2 has been, to date, successful in inflating equity prices.  The hope here appears to be that rising equity prices will cause a “wealth effect” – an increase in consumer confidence and more spending because of the perception of rising equity values.  All past studies of the “wealth effect” that I am aware of suggest that its impact on consumption is quite small compared to other policy tools.  Unfortunately, all of the other tools have already been completely deployed.

Inflation Expectations?

QE2 also increases the potential money supply, resulting in rising inflation expectations, and, ultimately resulting in a weakening dollar relative to other currencies.  In other blogs, I have discussed the “race to the bottom” in the world’s currencies (see “How the U.S. Should, But Won’t, Handle Job Creation”, Minyanville, 10/6/10).  Given the very strong deflationary pressures in housing and from record levels of unemployment, it appears that the Fed hopes to combat such pressures by influencing inflation expectations.  Again, the impact here doesn’t appear to be very robust.

Trade Deficit Reduction?

Finally, it seems that the Fed, by its QE2 announcement, must believe that a weaker dollar will improve the trade deficit and ultimately bring jobs back to the U.S.  This appears contrary to what Treasury Secretary Geithner says about a strong dollar, but there just isn’t any other possible interpretation.  Because other countries react by lowering the value of their currencies to protect their export industries, there doesn’t appear to be any benefit here, either.

Negative for Jobs

There are potential intermediate and long-term negative consequences of QE2.  One possible negative impact is on jobs, and is contrary to the objective of the QE2 program.  First, many companies have invested in plant and equipment overseas, so their commitment isn’t reversible in the short-term.  Second, most companies look for a business environment where they are comfortable, i.e., where there is visibility into the future tax and regulatory environment, something that the U.S. currently lacks.  Third, and what isn’t widely recognized, is that a weak dollar policy (QE2) drives dollars (capital) to other countries in the attempt to protect its value.  As dollars flow to places with more stable tax and regulatory environments, it is invested there, thus enhancing economic growth there, not here.  The dollars that do return to the U.S. are invested in very short-term investments (U.S. Treasury Bills and Notes) which, by their nature, are not invested in long-term projects (i.e., they finance current U.S. government deficits), and, therefore, do not create jobs.

Negative for Consumers

The intermediate and long-term impacts of QE2 is also likely to be negative for consumers.  Ever lower interest rates on consumer deposits and along the yield curve continues to remove income from savers and investors and transfers it to the large financial institutions and to the large publicly traded companies.  The lower cash throw offs from savings and investments causes lower levels of consumption.

In addition, the weaker dollar, as a result of QE2, has two more negative impacts on consumption:

  • A weaker dollar means higher commodity prices in dollar terms (note the rise in the prices of gold, industrial metals, oil, and agricultural commodities since the announcement of QE2) which are inputs in the manufacturing process.  If they can, manufacturers will pass along these higher costs to consumers in the form of higher prices.  In this case, consumption will be negatively impacted unless consumer incomes rise faster than the prices (not likely with high unemployment levels).  In the more likely case that most of the increase in input costs cannot be passed on because of consumer resistance, corporate margins get squeezed.  Again, a negative result for economic growth.  Furthermore, some of these commodities are more important than others, e.g., oil and food.  After 40 years of dependence on foreign oil, we should be well aware of the negative impact on consumption of rising gasoline prices.
  • Then, of course, there is the direct impact of a weaker dollar on the prices of imported goods.  Despite Walmart’s commitment to lower prices, because they are a huge importer of foreign manufactured goods, as the dollar weakens, even their prices will have to rise.

More Harm than Good!

Most of the large multinational firms can deal with a weaker dollar and new regulations.  For them, because they have significant sales in other currencies, a weaker dollar is beneficial to their overall dollar denominated income statements.  But small, domestic businesses are another story.  In this economy, they cannot pass on increases in their input costs due to a weakening dollar.  Furthermore, rising taxes and fees from federal, state, and local governments (e.g., the costs of Obamacare) and added regulations (e.g., new IRS 1099 reporting requirements) are overwhelming small businesses.  Small businesses create the vast majority of jobs in the U.S.  The weaker dollar implied by QE2 will further impact the already reeling small business sector.  There is only one conclusion to be drawn:  QE2 is likely to do much more harm than good.

Robert Barone, Ph.D.

October 25, 2010

Statistics and other information have been compiled from various sources.  Ancora West Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information.

Ancora West Advisors LLC is a registered investment adviser with the Securities and Exchange Commission of the United States.  A more detailed description of the company, its management and practices are contained in its registration document, Form ADV, Part II.  A copy of this form may be received by contacting the company at: 8630 Technology Way, Suite A, Reno, NV 89521, Phone (775) 284-7778.


October 20, 2010

Fool’s Gold 3: The Empire Strikes Deals

Posted in Banking, Big Banks, Bonds, Capital, community banks, crises, derivatives, Finance, Forward thinking, government, investment advisor, investment banking, investments, local banks, municipal bonds, San Francisco, Stocks, taxes, Uncategorized tagged , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , at 5:59 PM by Robert Barone

On October 8, 2010 California Governor Arnold Schwarzenegger signed a compromise budget that closed the $19 billion dollar state budget shortfall, 100 days overdue.  Three days later, Ron Diedrich, acting director of the California Department of General Services, proclaimed he had completed a deal to sell 24 government buildings to a consortium called California First, LLC.  The deal, in which California will lease-back the space, was completed for the sum of $2.3 billion, one billion of which will be used to pay off the current debt on the buildings, and rest going to the state’s general fund.  Is this good public policy?  Is California selling off the family jewels to meet structural budget shortfalls?   Should other states follow California’s lead?

Assets sales are not a new idea.  In fact, recently there have been many such announcements.  The UK government plans on selling $25 billion worth of assets including the Channel Tunnel rail link and a bridge over the Thames River. The Irish government, on July 23rd, announced plans to sell $115 billion of assets which include airports, railroads, ports, and the national television service.  And, the Russians outlined plans to sell $29 billion of minority stakes in state owned companies.  Closer to home, in December 2008, Chicago leased out parking meter rights for 75 years for $1.2 billion to a group called Chicago Parking Meters LLC (Morgan Stanley, Abu Dhabi Investment Authority, and Allianz Capital Partners).

Let’s take a closer look at the Chicago meters deal.  In December of 2008, Mayor Daley said, “This proposed agreement, which will provide the city with a one-time payment of just under $1.2 billion comes at just the right time.  This use of metered parking proceeds will give us the flexibility to address our worsening economy, protect our city’s finances and taxpayers, and keep investing in our city’s human needs over the next few years.”  Here is where the money went: $ 400 million went into a long-term reserve fund which they claim will earn them $40 million (that’s 8% a year!).  $325 million of the sale went to balance Chicago’s budgets through 2012, (in 2009 Mayor Daley claimed the city had annual structural deficit of $200 million),  $100 million went to support human infrastructure projects, and the last $324 million to another reserve fund called Budget Stabilization, which can be tapped at the Council’s will.  Sounds good right?

Not so fast said Alderman Scott Waguespack in a recent Bloomberg news release. “Chicago gave up billions of dollars in revenue when it announced in 2008 that it leased Morgan Stanley its 36,000 parking meters, the third-largest system, for $1.15 billion to balance its budget.”  Waguespack was one of five to vote against the deal, (there are 50 on the Council).  He could be right.  Chicago Parking Meters’ revenue rose 48% to $18.3 million for the quarter ended June 30, 2010.  Based on new projections, the lease deal could yield more than $11.6 billion over the 75 years to Morgan Stanley and Partners.  And it could rise even higher depending on rate increases the partnership has the right to make over the next five years, (increases after that must be approved by the Council), and CPI adjustments the partnership can make over the lifetime of the lease.  The office of the Inspector General concurs with the Alderman, and believes that, “the city’s chief financial officer, who negotiated the agreement, failed to calculate how much the system would be worth over 75 years.  The present value of the contract was $2.13 billion, more than the $1.15 billion the city received.”  With the Mayor’s recent retirement announcement, this deal could leave a bad taste in Chicagoans’ mouths for years to come.

In January 2010, Los Angeles City Council released $500,000 in funds to finance a feasibility study on leasing 41,000 parking meters.  Mayor Bloomberg of New York also likes this idea and assigned Deputy Mayor Stephen Goldsmith to look into it.   Milwaukee is proposing selling its water supply, and in Louisiana and Georgia, airports are being put on the block.  Warren Buffett said in Congressional testimony that he is worried about how municipalities will pay for public workers retirement and health benefits, suggesting that the federal government will eventually have to step in.

Returning to California, it looks like Governor Schwarzenegger agrees with Warren Buffett.  He stated, “There are similarities in what’s happening in Great Britain and what’s happening in California.  We’ve got to go and spend less money. I think governments have promised people too much.”

So did California sell off the family jewels?  To answer that question let’s take a closer look at the transaction.  California First, LLC., a group made up of Hines (a privately owned real estate firm with $23 billion in assets and offices worldwide) and an international private equity firm, Antarctica Capital Real Estate, offered $2.33 billion for the 24 buildings on 11 parcels of land.  California First will lease back the space to the state for 20 years at market rates.  The state will also have the right to buy back the buildings at anytime.

Governor Schwarzenegger has said, “This sale will allow us to bring in desperately needed revenues and free the state from ongoing costs and risks of owning real estate.”   But, while the state does exit the risks associated with real estate ownership, it subjects itself to long term lease liabilities.  A report from the Associated Press stated that the deal would end up costing the state $5.2 billion in rent over the next 20 years.  This was confirmed by a study from Beacon Economics which looked at the rent over 30 years.  A recent report from the California State Analyst’s office entitled, “Should the State Sell its Office Buildings?”, stated that California originally bought office buildings to save money.

The problem here is that such short term revenues do not change the long term structural deficits. Schwarzenegger appears to understand the long term structural problems of California recently saying, “We’ve got to roll back the pensions. And that’s not just in California but all over the world.”  But it doesn’t appear that the California Legislature has accepted that there has been a paradigm shift, a “New Normal” as Mohamed El-erian of PIMCO puts it.  Instead, the Legislature appears to have decided to band-aid the current budget shortfall, using assets sales as a bridge loan. The Legislature hopes that the economy will recover, and return to the so called Old Normal.  Robert Kurtter, a managing director at Moody’s said, “We view these asset sales as 1-shots…that create structural budget imbalances in future years, but that may be necessary actions to bridge the time gap until revenue stabilization or growth returns.”  These types of one time budget maneuvers were cited in a recent downgrade of Arizona’s debt by Moody’s.

In reality, using such asset sales as bridge financing will only work if the structural deficits are addressed.  That is, the budget needs to be in balance before the state’s assets are depleted.  This can be done by a) reducing spending and fixing such things as the state pension plan, b) by raising taxes, or c) combinations of the two. It’s a roll of the dice with low odds to assume a return to the Old Normal.  One thing is for sure.  Whether or not spending is reduced, look for the next Califorina legislature to raise taxes on it citizens and corporations.


Robert Barone, Ph.D.

Joshua Barone, Managing Partner

October 15, 2010

Statistics and other information have been compiled from various sources.  Ancora West Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information.

Ancora West Advisors LLC is a registered investment adviser with the Securities and Exchange Commission of the United States.  A more detailed description of the company, its management and practices are contained in its registration document, Form ADV, Part II.  A copy of this form may be received by contacting the company at: 8630 Technology Way, Suite A, Reno, NV 89511, Phone (775) 284-7778.


October 7, 2010

Job Creation: It takes the Right Environment

Posted in Banking, Big Banks, Bonds, Capital, crises, Finance, investment advisor, investments, San Francisco, Uncategorized tagged , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , at 4:29 PM by Robert Barone

Job creation is probably the most important issue in the November elections.  What policies should be implemented to insure the creation of jobs?

Most folks don’t understand how or why we got to the high rates of unemployment.  But, only with that understanding, an understanding of what happened in the competitive economic environment that has made the U.S. uncompetitive and rocketed its unemployment rate into the stratosphere, will Congress and our economic policy makers be able to choose the correct path.

The answer is simple: it is a matter of cost.  It just costs too much to produce most goods in the U.S.  And, while the Congress and the Administration regularly demonize those private sector companies that produce their goods in lower cost countries, it is clear that the government itself is a huge part of the problem.

Over the past 20 years, the federal budget has grown at a compounded annual rate of 5.6%; that number is 6.8% over the past 10 years.  But, disposable personal income grew at a much slower 4.8% annual rate over the 20 year period and an even slower 4.5% annual rate over the last 10 years.  The implications of this data are that 1) taxes and fees have increased the costs of private sector businesses; 2) the ever growing government, by its nature, expands its span of control over the lives of its citizens through a rapidly expanding set of rules and regulations, all of which raise the cost of production.

Over the last two decades, the growing uncompetitiveness of  U.S. private sector business was obvious, as production facilities moved south of the border or overseas, and the lower cost countries like China, So. Korea, Mexico, Thailand, etc., began to emerge as economic centers.  While this was obvious, the ultimate impact on the U.S economy was masked by two bubbles, first the dot.com bubble, followed immediately by the housing bubble.  Both of these bubbles were enabled by excessively easy monetary policies.  And during this period, fiscal policy steadily marched toward structural deficits.  With the false sense of prosperity caused by these bubbles, there was no sense of urgency to reverse the trends.

Nevertheless, the bursting of the bubbles has unmasked two significant economic issues:  1) Overtaxation – the U.S. has one of the highest corporate tax rates in the world, and is one of a handful of countries that taxes its citizens on their worldwide incomes instead of the income made within the country.  In addition, the U.S. has relatively high income taxation coupled with state and local income, property, and sales taxes, various business fees, and a 15% payroll tax burden (not to mention the cost of other benefits paid for by many businesses). Business owners, looking for high returns on investments, move production to lower cost areas to avoid many of these onerous costs; 2) Over regulation – every Congress produces ever increasing regulations; state and local governments are no better.  And no regulations, no matter how worthless, ever go away.  For example, it costs the private financial sector significantly more to administer “backup withholding” (i.e., W-9s) than the cash generated for the government.

In addition, today we appear to have rogue government agencies that make their own laws (for example, the EPA does not appear to consider the cost/benefit in its rulemaking), compete in the private sector (the FDIC is now encouraging foreclosures on viable projects in order to maximize the return to itself – see Moral Hazard at the FDIC, TheStreet.com, August 4, 2010 and Reform is Needed at the FDIC, TheStreet.com, September 22, 2010), and transfer/redistribute private sector resources with strings attached, less the inefficient costs associate with bureaucracy (for example, The Department of Education has overseen the deterioration of American education with the imposition of non-productive and often nonsensical requirements on monies granted).

Besides the agencies, each Administration makes its own “law” through “Executive Orders”, sometimes just to satisfy a lobby.  For example, the ban on the reprocessing of nuclear waste by President Carter helped throttle the U.S.’s nuclear power program, and has contributed to its foreign energy dependence.  The most recent example of this is President Obama’s order closing deep water drilling in the Gulf of Mexico, an order that could cause much more economic damage than the BP oil spill itself.

The combination of the false prosperity caused by the bubbles, and the deterioration of the education system, has left the job market in disequilibrium.  By that I mean, there appears to be many available high paying jobs that go unfilled because there are not enough skilled or educated people in the ranks of the unemployed.  In fact, the unemployment rate among college graduates is 4.5%, less than half the 9.6% national rate.

What I have been discussing are long term issues, ones that will take years to resolve if, and only if, the high cost and the education issues are resolved.  Unfortunately, the U.S. is a country that demands immediate satisfaction.  So, the desire to fix the issue as rapidly as possible has led policy makers to opt for a weak dollar policy, i.e., a fall in the value of the dollar relative to the currencies of the major trading partners.  If this were possible, it would result in a reduction in the cost of production in the U.S. relative to the rest of the world because a unit of a foreign currency could now buy a greater quantity of American made goods. (What is ironic is that Congress raises the minimum wage, then, via a weak currency policy, effectively offsets the increase!)  But, despite the nice theoretical framework that a weaker dollar will increase exports and thus domestic employment, this won’t work in a dynamic system.  That is, the result of a weakening dollar is dependent on the reaction of the trading partners.  If the U.S. were some insignificant economy in the world, like, say, Grenada, no one would react if it weakened its currency.  But, the U.S. isn’t, and its trading partners are not going to let jobs in their economies migrate to the U.S.  So, their reaction to a weakening dollar is to weaken their own currencies to keep their relative cost advantage – and, thus, we have what appears to be “a race to the bottom” in the currency arena (and thus a spike in the price of Gold).  The reluctance of the Chinese to revalue the RMB (currently pegged to the dollar) is a good example.  A revalued RMB means less exports and more imports for China’s economy, thus stimulating jobs for those exporting to China and hurting China’s industries that produce for exports.  Because the trading partners will react, any attempt to weaken the dollar to gain exports is a zero sum game.  It leads to protectionism (e.g., recent U.S. tariffs on Chinese tires have recently been countered by increased duties on U.S. chicken exports to China), not to increased economic activity and more jobs.

The only way to increase manufacturing jobs is to increase production efficiency, either through lower costs, natural advantages (i.e., cheap natural resources), or a technological break through (which only lasts for a short period until the technology is disseminated to the rest of the world).  If costs are lowered sufficiently, manufacturing companies will choose to locate their production facilities in the U.S., thus creating jobs here.  No other policy trick will ultimately work.

In the end, the road to economic health and job creation is a long one that requires patience and political will.  For policy makers, this means lowering the costs of production in the U.S. via lower taxes, less regulation, a policy aimed at low cost energy, and a reformation in the delivery of education.  By their actions, I don’t think the policy makers in D.C. get this, so we are likely to have another round of the same old policies that simply don’t work.

Robert Barone, Pd.D.

October 5, 2010

Statistics and other information have been compiled from various sources.  Ancora West Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information.

Ancora West Advisors LLC is a registered investment adviser with the Securities and Exchange Commission of the United States.  A more detailed description of the company, its management and practices are contained in its registration document, Form ADV, Part II.  A copy of this form may be received by contacting the company at: 8630 Technology Way, Suite A, Reno, NV 89511, Phone (775) 284-7778.