July 30, 2013

Universal Value Advisors – The Sad Truth Behind the SAC Indictment

Posted in Economy, Uncategorized tagged , at 4:23 PM by Robert Barone

Anyone with money in Steven Cohen’s SAC Capital Advisors would be foolish to keep it there, even if they are sure the company will beat the Justice Department’s indictment.

That’s because those funds could become subject to a forfeiture action.

The issue here is the very use of the indictment, not the veracity of the allegations. The Justicee Department knows that the use of indictment process itself is likely to shut down the hedge fund company.

The allegations themselves are packed with emotion, with U.S. Attorney Preet Bharara accusing SAC of being “a veritable magnet of market cheaters.”

The Justice Department is charging SAC of hiring employees who had access to people who might possess inside information, or of paying incentives for trading ideas that turned out to be profitable, as if these activities, in and of themselves, were crimes.

One allegation, that the firm failed to use effective compliance procedures to prevent the use of inside information, may be valid, as there have been several confirmed insider trading incidents, and the firm has agreed to a substantial $616 million fine as a result.

But, doesn’t the fine settle the issue? Isn’t that what a settlement agreement is all about? Is there sufficient provocation to wield power which, when used, is almost certain to shut the company down without real due process”.

Let’s go back to the Enron accounting scandal. In 2002, the Justic Department indicted accounting firm Arthur Andersen for obstruction of justice and obtained a conviction because Arthur Andersen had destroyed Enron documents at the conclusion of its audit.

The indictment itself effectively put Andersen out of business, and 28,000 jobs were lost.

In 2005, however, in an unusual unanimous decision, the Supreme Court overturned the “obstruction” conviction, indicating that Andersen was operating within its document-retention policy and that it could not be concluded that obstruction had occurred just because documents had been destroyed.

Because the Justice Department recognized that its indictment process alone had unintended consequences, it has since used something called a “deferred prosecution agreement” which suspends an indictment as long as the company works diligently to comply with laws or regulations.

Why isn’t the deferred prosecution agreement being used in the SAC case, especially since there is no indictment of Mr. Cohen himself and settlements have been reached in the insider trading allegations?

Just as an exercise, let’s compare the regulatory record of SAC Capital to that of JPMorgan Chase (JPM) (JPM). In March, SAC agreed to pay a record $616 million to settle insider trading cases.

But, that amount pales in comparison to the $16 billion that JPMorgan Chase has paid in litigation expense over the three years ended Dec. 31 as documented by Matt Taibbi in Rolling Stone. He catalogs no fewer than 13 prosecutions and settlements with regulators plus a multitude of settlements in civil actions.

“There have been so many settlements with so many agencies around the world … that they’re almost impossible to count,” he wrote.

Yet, despite these ongoing regulatory issues at JPMorgan Chase, CEO Jamie Dimon is President Obama’s “favorite banker” and was seriously considered to succeed Tim Geithner as Treasury Secretary.

I am not a fan of SAC Capital or any of Wall Street’s too-big-to-fail institutions and have frequently expressed my displeasure with their greed and abuses.

Here’s the question I’m asking: Is the Justice Department using brute-force indictment power on SAC in order to quell criticism that it has handled Wall Street with kid gloves and that no CEO on Wall Street has been prosecuted, much less convicted, since the financial meltdown five years ago? (Lehman Brothers, Bear Stearns, Washington Mutual, Wachovia, Merrill Lynch, MF Global.) The answer to the question appears to be: yes.

After all, SAC is a big name Wall Street firm, but it only has 1,000 employees. Shuttering it is not likely to have major consequences (although it does account for 3% of Wall Street’s trading volume). Not so for JPMorgan Chase. With more than 260,000 employees, the direct use of the indictment power would have systemic implications.

Robert Barone (Ph.D., economics, Georgetown University) is a principal of Universal Value Advisors, Reno, a registered investment adviser. Barone is a former director of the Federal Home Loan Bank of San Francisco and is currently a director of Allied Mineral Products, Columbus, Ohio, AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Co., where he chairs the investment committee. Barone or the professionals at UVA (Joshua Barone, Andrea Knapp, Matt Marcewicz and Marvin Grulli) are available to discuss client investment needs.

Call them at 775-284-7778.

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

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July 22, 2013

Muni Investors Beware: Detroit Is Tip of Iceberg

Posted in Bankruptcy, Economy, Uncategorized tagged , at 9:43 PM by Robert Barone

When Detroit filed for bankruptcy protection last week, no one was shocked. It felt like it was inevitable. Now one has to ask whether analyst Meredith Whitney was correct but just early in her call in late 2010 on municipal defaults?
For Detroit, the real culprits in the bankruptcy were skyrocketing pension and health care costs, even though mismanagement and reduced state and federal aid also played a role.

Those same issues are at the root of most of the fiscal challenges faced by state and local governments. As I write, there is controversy over the legality of Detroit’s bankruptcy filing because state law prohibits such a filing if it contemplates a reduction in pension benefits.

That said, there is no doubt that Detroit, with more than $18 billion of debt, cannot pay its creditors. Of that debt, the city owes $3.5 billion to its pension plans. The answers that Detroit will deliver to the marketplace regarding the distribution of its assets will be based on forthcoming judicial decisions that will determine which group of creditors skates and which ones get savaged. Detroit may well become the model for how the courts treat the creditors of future municipal bankruptcies. The credit markets are certain to take note, and there are certain to be reactions and price adjustments as a result.

Detroit may be just the beginning of the spate of municipal bankruptcies that Meredith Whitney forecast more than two and a half years ago. In the last month, studies have shown that municipal fiscal problems are much worse than previously believed. Actuarial estimates of unfunded liabilities have risen, not only because governments have failed to properly fund the plans under the old guidelines, but because the guidelines have changed.

A couple of years ago, Morningstar estimated the funding status of each state’s pension program. The 2011 results ranged from 43.4% (Illinois) to 99.8% (Wisconsin). That study showed that only 30% of state programs were at least 80% funded. But now, those estimates have all changed as, in late June, Moody’s introduced new measurement methodologies. Not surprisingly, Illinois was still at the bottom. What is significant is that Moody’s found that the median state must now devote 45% of its annual revenue just to fund and catch up with its existing pension obligations.

At the same time that Moody’s concluded that retirement costs have been vastly underreported, the Government Accounting Standards Board (GASB) was introducing new accounting rules for municipalities to increase transparency and reduce that underreporting. Significantly, last September, a report by the U.S. Senate’s Joint Economic Committee (JEC) estimated that underfunding to be as high as $3.5 trillion.

Artificially low interest rates have a lot to do with pension underfunding. If actual pension plan investment returns are lower than the actuarial return assumptions, there won’t be sufficient assets to pay the retirees. In July, Moody’s reduced the return assumptions for CALPERS from 7.5% to 5.5%, causing the funding status of CALPERS to fall from 82% to 64%.
As you can imagine, the new studies and reporting rules are playing havoc with the interest rates that municipalities must pay. Much of the recent rise in rates in the muni markets have been blamed on Federal Reserve Chairman Ben Bernanke’s “tapering” pronouncements, which had a huge impact on the Treasury yield curve. But there can be little doubt that much of the recent increase in Muni-Treasury spreads was the result of the Moody’s study and the new GASB rules.

Although a financial meltdown was avoided in 2009, the crisis clearly isn’t over. State and local budget issues are going to have a significant impact on economic policy going forward. Their recognition may even delay the start of the Fed’s “tapering” program.

Muni investors, be forewarned: There is volatility ahead in the marketplace. As it turns out, the much maligned pronouncements on the health of state and local government finances by Meredith Whitney in late 2010 were actually prescient. Even the JEC agrees with her conclusions, as they reported that “some state pension funds will run out of assets in as little as five years.”

Robert Barone (Ph.D., economics, Georgetown University) is a principal of Universal Value Advisors, Reno, a registered investment adviser. Barone is a former director of the Federal Home Loan Bank of San Francisco and is currently a director of Allied Mineral Products, Columbus, Ohio, AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Co., where he chairs the investment committee. Barone or the professionals at UVA (Joshua Barone, Andrea Knapp, Matt Marcewicz and Marvin Grulli) are available to discuss client investment needs.

Call them at 775-284-7778.

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

July 17, 2013

Pride Is Costing Wal-Mart and Washington

Posted in consumer spending, Economy tagged , , at 7:13 PM by Robert Barone

Dictionary.com defines pride as “an inordinate opinion of one’s own dignity, importance, merit, or superiority.” And nowhere was pride more evident than last week in the confrontation between the Washington, D.C., City Council and Wal-Mart (WMT). Pride got in the way of both sides, turning what was at least three years of hard work and promise for Washington redevelopment into a political fiasco.

Wal-Mart has a reputation of using its size and economic power to get its way. Today we call that “bullying.” Ask any vendor about margin squeeze. Ask any community banker with a Wal-Mart account about negative float.

Until recently, Wal-Mart’s business model kept its stores in rural and suburban areas. But over the past few years, sales growth in the U.S. has stalled. So Wal-Mart has sought to put stores in urban areas. The governing councils in large cities, however, tend to have more liberal-minded majorities with ties to unions and sympathy toward small business.

Wal-Mart is non-union and has a track record of driving out small business when it arrives in a market. It has been rejected by the New York City Council and apparently gave up on stores in the Boston area last year.

When it came to Washington, however, Wal-Mart appeared to have turned over a new leaf. Working closely with Mayor Vincent Gray, Wal-Mart established the “Community Partnership Initiative” to help the city. Last year, through its foundations, Wal-Mart contributed $3.8 million to charitable organizations in Washington, including those helping the poor and homeless.

“This agreement represents an unprecedented citywide commitment from a retailer… Wal-Mart is showing what it means to be a good corporate neighbor,” Gray said.

With the blessing of the city, Wal-Mart decided to build six stores in Washington — three stores under construction and three in planning. The stores would mean 1,800 direct new jobs, and 3,000 jobs when multiplier effects are added, plus 1,000 temporary construction jobs. At least three of the stores are crucial to economic redevelopment and renewal in the Washington neighborhoods of Sykland, Capitol Gateway, and New York Avenue.

Last week, the council, caving to political pressure, passed an ordinance aimed at Wal-Mart. It requires companies operating in spaces of more than 75,000 square feet and whose sales are more than $1 billion annually to pay a minimum wage of $12.50 an hour. The current minimum wage in Washington is $8.25 an hour. And for unionized businesses, the ordinance doesn’t apply.

The accompanying rhetoric was laughable. For example, $12.50 an hour is called a “living wage” by its proponents, which ignores the obvious — if it is a “living wage” for Wal-Mart, then why doesn’t it apply to fast-food chains or other retailers?

When Wal-Mart got wind that the council was likely to pass the ordinance, it returned to its proud and bullying ways, and threatened publicly to abandon the three stores in planning and reconsider whether to open the three stores under construction.

The council became defensive and stubborn. Councilman Vincent Orange said the council should not condone “poverty wages” and kowtow to such threats.

Councilman Marion Barry, perhaps not the best spokesman for honesty and integrity — he’s an ex-felon who faces sanctions from the council for not disclosing payments from constituents, said, “They have held us hostage, we’re not going to take it.”

In the end, pride on both sides has turned the win/win into a lose/lose. For Wal-Mart, six profitable stores are now in limbo. But for the residents of certain neighborhoods in Washington, it is much worse.

One blogger wrote, “1,800 jobs at $8.25/hour is still superior to 0 jobs at $12.50/hour,” and Wal-Mart has said that its average U.S. hourly wage is $12.57.

So for now, no jobs, no economic redevelopment, no charitable contributions, and Washington consumers must drive to Maryland or Virginia to benefit from Wal-Mart’s low prices.

It isn’t too late. The mayor has yet to sign the bill or veto it. Both sides could swallow their pride and compromise, turning the current lose/lose back into a win/win.

Robert Barone (Ph.D., economics, Georgetown University) is a principal of Universal Value Advisors, Reno, a registered investment adviser. Barone is a former director of the Federal Home Loan Bank of San Francisco and is currently a director of Allied Mineral Products, Columbus, Ohio, AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Co., where he chairs the investment committee. Barone or the professionals at UVA (Joshua Barone, Andrea Knapp, Matt Marcewicz and Marvin Grulli) are available to discuss client investment needs.
Call them at 775-284-7778.
Statistics and other information have been compiled from various sources. Universal Value Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information.

July 16, 2013

It’s a struggling world amid economic recovery

Posted in Economy, Inflation, Uncategorized tagged , at 5:33 PM by Robert Barone

Despite tax increases and sequestration, the U.S. economy managed to officially grow 1.8 percent in the first quarter and likely at a similar rate in the second.

Strangely, despite the lack of growth, the equity markets were up almost 16 percent in the U.S. in 2013’s first half. With the release of the June employment data, there is now no doubt that the job market is actually growing jobs, although questions remain as to the quality of those jobs (with part-time jobs growing and full-time jobs contracting).

While June’s official U3 unemployment rate held at 7.6 percent, the more comprehensive U6 measure (includes some discouraged workers and those holding part-time jobs but desiring full-time) rose from 13.8 percent to 14.3 percent, quite a large single-month jump.

Thus, four full years after the recession ended, the “recovery” in the U.S. remains fragile and uncertain. Nevertheless, it does not appear that a new recession is approaching.

Reality inflation

One reason for the fragility is the fact that household income has continued to lag real inflation.
According to Ed Butowsky, founder of Chapwood Investments, while household incomes have risen at a rate at or slightly above the “official” U.S. rate of inflation, the real cost of living rose at double-digit rates in nearly every one of America’s 50 largest cities.

Yet, despite the income challenges, somehow the American consumer has managed to find enough resources to step up purchases with both credit card debt and auto sales showing near-record increases in June.

Some say that consumer deleveraging has ended. In reality, it is the cost of servicing debt as a percentage of disposable income that is key, and this cost is at a modern-day low.

So, while the level of debt remains high, as long as rates are low the consumer can still comfortably service that debt. This is no different than the home purchase equation. A lower interest rate means that, for a given income level, the consumer can afford a more expensive home.

The world

When we look outside the U.S., we see two different camps with differing equity market results: those with activist central banks and those without.

It appears that, in 2013’s first half, the equity markets in the higher-growth areas of the world (China, Russia, Brazil) did poorly (China, -11 percent; Russia, -11 percent; Brazil, -18 percent) while the low-growth areas (Japan, Europe, U.S.) had positive performance (Japan, +32 percent; Switzerland, +15 percent; U.S., +14 percent).

This strange phenomenon can be explained by the money printing binge of the central banks in the U.S., Europe (including Switzerland) and Japan. The central banks in the rest of the developed world have not printed. Thus, the equity markets in areas with activist central banks are clearly responding to money printing while those in the rest of the world appear to be responding to fundamental economic growth.

Headwinds

Going forward, the headwinds for growth in the U.S. and the world are significant:

• Economic growth is consumer dependent (70 percent of GDP in the U.S.). Money printing cannot last forever and the Fed has already announced plans to “taper” its printing. As a result, we have seen interest rates spike up, and a growing economy means that interest rates will rise further.

This can’t be good for a consumer still struggling with job quality and income rising more slowly than the reality of inflation.

• Europe remains mired in recession with the debt and budget issues of the EU periphery (Portugal, Spain, Italy, Greece, Cyprus …) not yet resolved and in some cases, not yet addressed.

Central Banks in Europe and England recently reaffirmed easy money policies well into the future. But politically, no progress has been made on a banking union, a move that is quite critical to establishing financial stability for the euro.

• GDP growth rates in every part of the world have fallen since their initial bounce after the financial meltdown in 2010. This includes developed economies, developing economies and the BRICS (Brazil, Russia, India, China, South Africa) economies.

China’s officially projected 7.5 percent growth rate is now completely discredited. Marc Faber (The Gloom, Boom and Doom Report) recently opined on Bloomberg TV that China’s growth rate had fallen to 4 percent at a maximum. The prices of raw materials and shipping manifests back up the theory that a huge growth slowdown has occurred there.

• Besides the growth issue in China, a political crisis has erupted in Brazil, one of the BRICS’s stalwarts. The coup in Egypt, unrest in Turkey and the ongoing civil war in Syria all threaten tenuous Middle East stability, to say nothing of Iran’s ongoing nuclear program.

Conclusion

The headwinds worldwide are strong and significant. A growing U.S. domestic economy with the Fed stepping back from Quantitative Easing implies rising interest rates which, given the state of consumer finances, could prevent the economy from attaining “escape velocity” and keep it growing at subpar levels.

Furthermore, attaining that “escape velocity” has become more difficult with inflation reality much higher than official inflation figures and slower worldwide growth.

One obvious conclusion: The world’s political and economic systems appear as unstable as at anytime in the past 25 years. I don’t know what will cause the next crisis or when it might occur, but I do know that now is not the time to take a lot of risk.

Robert Barone (Ph.D., economics, Georgetown University) is a principal of Universal Value Advisors, Reno, a registered investment adviser. Barone is a former director of the Federal Home Loan Bank of San Francisco and is currently a director of Allied Mineral Products, Columbus, Ohio, AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Co., where he chairs the investment committee. Barone or the professionals at UVA (Joshua Barone, Andrea Knapp, Matt Marcewicz and Marvin Grulli) are available to discuss client investment needs.

Call them at 775-284-7778.

Statistics and other information have been compiled from various sources. Universal Value Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information. Read the rest of this entry »

July 1, 2013

Market proof: Hooked on the liquidity drug

Posted in Economy, Uncategorized tagged , , at 10:44 PM by Robert Barone

The reactions of the stock and bond markets to the mere mention of a slower rate of money printing shows how those markets have become hooked on such injections.
The consequences of the first baby-step change of policy toward something more normal evoked violent market reactions not only in the U.S. but worldwide.
Those reactions may quash the nascent private sector recovery, will certainly risk short-term negative effects of a stronger dollar on imports and exports, will likely have negative consequences on housing values and sales, and will exacerbate the long-term issues of the size and cost of the debt.
While the Fed didn’t actually take any steps at all with regard to a reduction in money printing, the markets reacted just to the fact that they were thinking about such action.
The wealth effect
The “wealth effect” has been studied for decades with the universal conclusion that its overall economic impact is marginal, i.e., the wealthy simply have a low marginal propensity to consume.
The benefit of higher stock prices (the rich get richer) appears to be the only benefit of the massive quantitative easing programs. As documented by two revered market pundits, Rosenberg and Gundlach, QE has a near-90 percent correlation with the equity markets.
In recent weeks, we saw the violent reactions in both equity and fixed-income markets to the mere concept of “tapering,” which is not tightening, but simply less easing (a change in the second derivative). Clearly, just the thought of lesser ease has begun to reverse the small success that massive QE has had. Since May 22, when Federal Reserve Chairman Ben Bernanke announced that the Fed was thinking about “tapering,” the S&P 500 fell nearly 6 percent as of June 24 and daily volatility spiked, a sign of high uncertainty.

Housing

One bright spot in the U.S. has been a recovery in home prices. While suspect because of a lack of first-time buyers, the run-up of 71 basis points, or .71 percentage points, in the 30-year fixed mortgage rate is sure to have an impact on home values.
Those who could afford the $1,144 monthly payment for a $250,000 home in May can now only offer $229,000 for the same property to maintain the same payment. That’s an 8.4 percent reduction in affordability and is sure to negatively impact the sector.

Deflation

Deflation is a worldwide issue even among emerging industrial powers like the BRICS. China’s economy, which has been the world’s economic growth engine for the past half-decade, appears to be slowing significantly despite its official purported 7.5 percent growth rate.
The government’s attempt to control real estate speculation has resulted in a credit crunch in the banking system which is likely to have a negative impact on China’s lending growth.
Marc Faber, author of the “Gloom, Boom and Doom Report” newsletter, opined on Bloomberg TV on June 21 that China’s growth rate was, at a maximum, 4 percent. That is just a little more than half of official estimates and, if true, is a shock to the world’s economy.
The underlying data tell the story, including depressed raw commodity prices, excess high seas shipping capacity, the value of the currencies of commodity producing countries like Australia and a falloff in exports from lower-cost producers like South Korea. The Asian equity exchanges have been pounded hard this year, a sign that economies in that part of the world are struggling.

Debt costs

The rising cost of U.S. debt, much of which is financed by foreigners, makes even a small move toward normal monetary policy highly risky for U.S. fiscal policy.

The U.S. public is unaware that the true deficit, using Generally Accepted Accounting Principles, which all of corporate America is required to use, has exceeded $5 trillion for the past five years.
Instead, the $1 trillion cash flow budget deficit is viewed as the issue. Nevertheless, as time passes the already built-in additional $4 trillion per year of promises will become current obligations.
I have seen several estimates of the cost of that future debt in rising interest rate scenarios. None is pretty. The most recent from Jeffrey Gundlach of Doubleline estimated the cost of the debt and deficit at $2.5 trillion by 2017 if the 10-year rate were to rise gradually from a 2.1 percent level (the level when he calculated the estimate) to 6.0 percent. As of this writing, the 10-year rate is near 2.6 percent.
By then, Gundlach says, the debt itself will be $26 trillion. Such deficits and debt levels risk not only inflation, but the dollar’s role as the world’s reserve currency.

Conclusion

The consequences of rising U.S. interest rates could be dire.
Within the U.S., home values are likely to stop rising and could easily begin falling again. Stock prices have become more volatile and bond prices have been hard hit. The rise in consumer confidence, largely due to home and stock values, could reverse, impacting consumer spending and employment. Rising interest rates in the U.S. will exacerbate worldwide deflation and could have dire consequences for U.S. fiscal policy.
The size and rapidity of the rate rise was probably a surprise to the Fed. I suspect that if the summer’s economic data shows softness in the economy, the Fed will jawbone rates to lower levels.
Nonetheless, this episode has revealed the truly difficult road ahead for the Fed, as one of the unintended consequences of the Fed’s massive experiment in money printing is the equity market’s addiction to it.
Robert Barone (Ph.D., economics, Georgetown University) is a principal of Universal Value Advisors, Reno, a registered investment adviser. Barone is a former director of the Federal Home Loan Bank of San Francisco and is currently a director of Allied Mineral Products, Columbus, Ohio, AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Co., where he chairs the investment committee. Barone or the professionals at UVA (Joshua Barone, Andrea Knapp, Matt Marcewicz and Marvin Grulli) are available to discuss client investment needs.
Call them at 775-284-7778.
Statistics and other information have been compiled from various sources. Universal Value Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information.