July 27, 2012

New Soap Opera: The Comedy of Euros

Posted in Banking, Bankruptcy, Economy, Europe, Finance, greece, Spain tagged , , , , , , , , , , , at 8:49 PM by Robert Barone

The term “European Theater” was first coined during World War II. Today in the financial markets, the term has come to symbolize an ongoing soap opera, where the audience is continually held in suspense as the bad actors (the politicians) promise actions and solutions to current crises, which have been created by their prior actions. Each time solutions are proposed, the audience breathes a sigh of relief (i.e., relief rally in the equity markets) only to be disappointed when they find out that the solutions won’t work or can’t be implemented.
 
As a result, the crisis and suspense continues, keeping the audience’s total attention (even while dinner on the stove at home is burning). Meanwhile, a new issue or crisis appears, it seems, on a daily basis.
 

Likely New Episodes

Daily we watch yields on Spanish and Italian debt move ever higher, now in zones where other countries have cried “uncle” and asked for bailout help. At the same time, the credit default swaps on Spanish and Italian debt have risen to record levels.
 
New Episode: Will the capital markets force a Spanish bailout by locking Spain out of the debt markets?
 
  • Spanish bank recapitalization: We have recently learned that the European Central Bank is willing to impose losses on the shareholders and junior bondholders of some of the Spanish savings banks. (When they bailed out Ireland, all bondholders were saved.) The draft of the document meant to give Spain’s banks 100 billion euros has this provision, but the periphery’s finance ministers are opposing it.
 
  • New Episode: Is 100 billion euros enough for Spain’s banks? The general rule of thumb appears to be that the ultimate amount needed is usually higher by a factor of at least two.
 
  • Spain’s regional provinces are now coming hat in hand for bailouts of their own. And those regional governments must refinance more than 35 billion euros in the near future.
 
  • New Episode: Are there enough resources in the European Financial Stability Facility (EFSF), the temporary bailout fund, and the European Stability Mechanism (ESM), the proposed permanent bailout fund, to bail out Spain and its regions? What about Italy?
 
  • The problematic link between Spain’s sovereign and its bank’s balance sheets has not been severed, as the audience was led to believe during the “Summit” episode.
 
  • New Episode: Will the ESM require the Spanish government to guarantee the bank capital? If so, will market reaction drive borrowing rates for Spain even higher, or lock them out of the capital markets altogether?
 
  • Greece now appears unable to produce an austerity plan acceptable to the Troika (EU Commission, ECB and International Monetary Fund). Greece has a 3.8 billion euro bond payment due in August. And the ECB just announced that it will no longer accept Greek government bonds as collateral for loans, thus locking Greece out of ECB borrowing.
 
  • New Episode: Will the Troika impose its own plan, or will it withhold bailout funding? Without access to the ECB, will Greece default again? And, will this lead to Greece’s immediate and disorderly exit from the monetary union?
  • Each monetary union country is required to put capital into the ESM. Italy will be required to pony up 20% of the ESM capital.
 
  • New Episode: What sense does it make for Italy to borrow at 7% when the ESM would offer a rate of return that is closer to 3%?
 
  • The ECB holds tons of Greek debt on their balance sheet at par (i.e., 100% of face value) (Portuguese, Spanish and Italian debt, too). If (when) Greece leaves the monetary union, they will renounce this debt, causing the ECB to need more capital to cover this loss.
 
  • New Episode: Will the remaining members be able to contribute even more capital? That will put additional pressure on the weaklings — again, Portugal, Spain and Italy will have to go to the capital markets to borrow at extremely high rates to meet their capital contribution requirements.
 
  • Will the ESM be allowed to purchase sovereign debt in the secondary market as promised in the “Summit” episode? This is meant to support Spain and lower the interest rate it has to pay to borrow. The Dutch, Finns and probably the Germans may say ‘Nein.’

Politicians in a Box

The bad actors in this soap opera, the politicians, know that if they attempt to do the right thing, they will be voted out of office by populations who value their entitlements more than anything else. Look at Greece and the near victory by the Syriza party (anti-austerity) in the last set of elections. And now, we see riots in Spain.
 
These bad actors have proposed so-called “fixes” that merely kick the can down the road, from bailouts (Greece, Portugal, Spain, Ireland) to a banking union in order to avoid addressing the core issues. The fixes enacted calm the audience for shorter and shorter periods. For example, the deposit flight from Spain’s banks now continues unabated, despite the capital plan for Spanish banks announced during the recent “Summit”.
 
This soap opera will continue to play out because liquidity does not produce solvency. The ECB and politicians can throw all of the money they can create at the problem, but, until debt restructuring occurs (i.e., dealing with the debt), the soap opera will continue. Debt restructuring means that some lenders won’t get repaid at all and others will have to take a haircut. Inevitably, some financial institutions (i.e., lenders) will fail. The game to keep them alive cannot go on forever.
 
Eventually, the markets will tire of the soap opera, lose confidence (as they appear to be doing), and close the capital market to these players. It would be much better to have an orderly restructuring than a disorderly one imposed by a panicky market. But, so far, no European leader has stepped up with such a plan (i.e., a plan to exit the weaklings from the monetary union).
 
Without such a plan, the stronger European nations (like Germany, Finland and The Netherlands) will soon have had enough and will leave the monetary union on their own, most likely, to go back to their old currencies.
 

The Final Episode?

It appears that many of the New Episodes described above will soon play out as the situation appears to be in endgame mode. Some sort of resolution acceptable to the capital markets is being demanded by those very markets. The roller coaster is at full speed and it appears the tracks are about to end.
 
What new games can the European politicians play to buy more time? Is there anything they can do, short of having a plan to exit the southern weaklings that can now save the euro? What can they do now to even buy more time?
 
Unfortunately, it appears that a market-imposed resolution, which means market panic and financial chaos for Europe with grave worldwide implications, is rapidly approaching.
 
 
Robert Barone (Ph.D., Economics, Georgetown University) is a Principal of Universal Value
Advisors (UVA), Reno, NV, a Registered Investment Advisor. Dr. 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 Company where he chairs the Investment Committee.
 
Information cited has been compiled from various sources which UVA believes to be accurate and credible but makes no guarantee as to its accuracy. A more detailed description of the company, its management and practices is contained in its “Firm Brochure” (Form ADV, Part 2A) which may be obtained by contacting UVA at: 9222 Prototype Dr., Reno, NV 89521. Ph: (775) 284-7778.

July 23, 2012

Time for us to make enlightened policies

Posted in Armageddon, Bankruptcy, debt, Economic Growth, Economy, Europe, Finance, Foreign, recession, Spain, Uncategorized, Unemployment tagged , , , , , , , , , , , , , , at 8:10 PM by Robert Barone

On July 6, the country received another disappointing jobs report. For the month, the establishment survey indicated jobs grew by 80,000; for the quarter, such growth averaged 75,000, about one-third of the 26,000 monthly average for the first quarter. Clearly, the worldwide slowdown in Europe, China, India, Brazil, etc. is having an impact here.
 
Deleveraging and slow growth
 
Let’s be clear. We are in the midst of a worldwide debt deleveraging (i.e., consumers are paying down debt instead of consuming). So, absent another round of sweeping innovation anytime soon (e.g. the Internet), in the natural course of things, economic growth is going to be painfully hard to come by. As a result, it is doubly important that economic policies promote the growth that is available.
 
Policies are key
 
Clearly, monetary policy has led with pedal-to-the-metal and unconventional therapies. On the fiscal side, the Keynesian remedies (huge deficits) have been applied. Together, however, such policies haven’t worked well enough to establish a solid economic foundation, as the recent data prove. For those who study economic history, it is clear that deficit spending alone doesn’t work if government is simply stepping into the role of debtor in place of households, as total debt owed has continued to rise.The scary part is the interest cost of the rapidly accumulating debt when interest rates rise. For those who don’t believe me, just look at Greece, Portugal, Ireland, Spain, Cyprus and Italy in today’s world. Rising interest rates (near 7 percent for the 10-year government issue) make it impossible for states to survive without bankruptcy, a bailout or financial ruin.

 
Policy failures
 
In times like today, when deleveraging is slowing economic activity, government should adopt policies that promote the private sector, because it is the private sector, not government, that is the engine of economic growth. Unfortunately, the following federal policies currently are negatively impacting the private sector:

• Taxes:
Uncertainty surrounding tax policy causes the private sector to take less risk, which lowers investment and job creation. For the last several years, Congress has signaled that significant tax increases are just ahead (currently referred to as the “fiscal cliff” due to occur on Jan. 1, 2013), only to push them back at the last minute for another short period. Nevertheless, the uncertainty persists, and economic hesitancy pervades.
 
• Corporate cash: America’s multinational corporations are flush with cash, and while the politicians chide them for not putting it to work at home, it is their very policies that are to blame. Sixty percent of that corporate stash is held offshore, and it won’t come home because, if it does, 35 percent of it will disappear in taxation. Policies that encourage the return of that cash and its investment at home would spur job creation and economic growth.

• Corporate tax rate:
Having one of the highest corporate tax rates in the world discourages investment at home and makes investment elsewhere more fruitful. Corporate taxes are paid by consumers via higher prices.

• Energy policy: 
Cheap energy is the No. 1 requirement for robust economic growth. Current policies appear to be designed to raise energy prices to spur the development of government selected industries. The result is great waste (e.g. Solyndra) and significantly reduced economic growth.

• Taxmageddon:
The U.S. has a joke for a tax code. Talk about a Rube Goldberg! High, and threatened increased taxes on capital and investment just discourage economic growth. The tax code needs to be thrown out in favor of a broad-based, simple, and fair system.

• The financial system:
Scandal after scandal show how pervasive lawlessness is among the world’s “too big to fail” institutions. So far, no U.S. banker has gone to jail, nor trial, nor has anyone been indicted. Regulatory policy encourages moral hazard (excessive risk taking backed by implicit taxpayer bailouts) and discourages lending to the private sector. All of this reduces economic growth.
 
 

Investing in a deleveraging world 

 
For investors, the markets will continue to show volatility, with market up-drafts occurring when there is a perception of a policy change. For example, the recent hope generated by the late June “European Summit” caused a large rally in the equity markets, as will the hoped for move by the Fed toward more stimulus when and if it occurs. Down-drafts occur when poor economic data cross the tape.
 
Implications for Nevada
 
The policy prescription doesn’t end at the federal level. It is also relevant at the state and even local levels. Nevada has been challenged to attract new businesses now that gaming is widespread.The tax system in Nevada could be such a strength, especially when compared to what is going on in California. CNBC ranks Nevada 18 in “Business Friendliness,” but 30 in “Cost of Business.” Two things are critical: 1) The Legislature must stop threatening new business taxation every two years when it meets. The uncertainty this breeds prevents businesses from relocating here.

2) Policymakers must identify those businesses that would benefit from such a philosophy. There might be several categories that would so benefit, but one immediately comes to mind (maybe because I have worked in it all my life) — financial and intangible asset firms. This category includes managers of investments, hedge funds, trusts, patents and trademarks, insurance companies and services, banking and subsidiary finance companies. While these firms are usually small, their salary levels generally are high. A University of Nevada, Reno study indicates that salaries in these firms average $88,000, twice the state’s average.

Jon Ralston, a political columnist and host of a daily political commentary show seen locally, recently criticized the Apple move, saying that they will grow “astronomical profits” but that the state won’t benefit much because the number of jobs is small. But its move, along with those of Microsoft (which now employs several hundred), Intuit (also a large employer), Oracle and others, appears to recognize that Nevada, indeed, has something to offer now. If the state attracts enough of these companies, there will be plenty of tax revenue generated. The state should play to its current strengths and make sure its policies protect and nurture those strengths.

 
 
Robert Barone (Ph.D., Economics, Georgetown University) is a Principal of Universal Value
Advisors (UVA), Reno, NV, a Registered Investment Advisor. Dr. 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 Company where he chairs the Investment Committee.
 
Information cited has been compiled from various sources which UVA believes to be accurate and credible but makes no guarantee as to its accuracy. A more detailed description of the company, its management and practices is contained in its “Firm Brochure” (Form ADV, Part 2A) which may be obtained by contacting UVA at: 9222 Prototype Dr., Reno, NV 89521.
Ph: (775) 284-7778.
 

July 9, 2012

The New Bank Paradigm: Squeezing Out the Private Sector

Posted in Banking, Big Banks, debt, Economic Growth, Economy, Europe, greece, Italy, Spain, Uncategorized tagged , , , , , , , , , , , , , , , , , at 3:08 PM by Robert Barone

Since the world adopted Basel I in 1988, it has allowed the Europeans to dictate the bank capital regime for major industrial economies. We are now in the process of adopting Basel III capital rules. Unfortunately, these rules have so biased the financial system that the private sector, the engine of job creation, has all but been squeezed out.Under all of the Basel regimes, “sovereign” debt is considered riskless. Everything else has a varying degree of risk to it which requires a capital reserve. Loans to the private sector have the highest capital requirements. Americans have always viewed our US Treasury debt as “riskless.” So, on the surface, it appears reasonable that no capital should be required, and Americans think no further. But, further thought would reveal two significant issues: 1) The “sovereign” debt of other countries may not be riskless (ask the private sector holders of Greek debt, or Jon Corzine and MF Global (MFGLQ) folks about the risks associated with Italian debt); 2) The bias imparted with this sort of capital regime makes loans to the private sector unattractive, especially in times of economic stress where bank capital is under pressure. But, it is in times of such stress that loans to the private sector are needed to create investment, capital spending, and jobs.

One of the reasons for all of the stress in Europe is the fact that their banking system holds huge amounts of periphery country debt (Greece, Spain, Portugal, Italy) with no capital backing. On a mark to market basis, most, if not all, of the capital of the periphery banks disappears. In fact, the European Central bank (ECB) itself is still carrying the Greek debt it holds on its books at par, as if there is no chance that they won’t be repaid in full.

Since the financial crisis of ’08-’09, Western banking systems have come to rely on government, at first as the capital provider of last resort, but now, at least in Greece and Spain, as the capital provider of first resort (most likely because there is no other). In a symbiotic relationship, those same governments have come to rely on the banks to purchase their excessive supply of debt. The capital rules favor this unhealthy relationship. In effect, we now have a banking DNA bias against private sector lending.

We have heard the politicians in Washington rail against the banks for not making loans to the private sector. Yet, all of the rules, regulations, and enforcement processes make it difficult, if not impossible, to do just that. The overbearing regulatory process strangles private sector lending at small community banks. And, as indicated above, the capital regime itself, which impacts all banks, discourages private sector loans. For example, a $1 million loan to the private sector requires $200,000 in capital backing plus an additional $20,000 to $30,000 in loss reserve contribution from the capital base. That same $1 million loan to the US Treasury, via purchases of Treasury securities, requires no capital or reserve contribution. The ultimate result is that, since the financial crisis when western governments found out that it was politically okay to “save” (i.e. recapitalize) large banks with public monies, they also found out that the capital and regulatory regime now made those same banks major buyers of excessive government debt.

Unfortunately, while governments like this and will continue to promote it because it keeps the cost of borrowing low and provides them with a ready market for deficit spending, government is not the economic engine. That is what the private sector is. Simply put, the banking model in the west now promotes moral hazard (banks making bets that are implicitly backed by taxpayers) and Too Big To Fail (TBTF) policies while it stifles private sector lending. The Dodd-Frank legislation has institutionalized this model with government intervention now seen as the first response to a banking issue. If it hasn’t, then why did President Obama say on The View the business day after JPMorgan Chase (JPM) announced its trading loss that it was a good thing that JPMorgan had a lot of capital else the government would have had to “step in.” Or why has Jamie Dimon, JPMorgan’s CEO, been required to testify before both House and Senate Committees about a loss of less than 3% of the bank’s $190 billion capital base? As further proof of government control of the banking system, the FDIC recently announced that, under its Dodd-Frank mandate, it is ready to take over any TBTF institution, “when the next crisis occurs.” Isn’t it clear that the relationship between the US federal government and the banking system is unhealthy, perhaps even incestuous, to the detriment of the private sector? That very same banking model is emerging in Europe with the emergency funding by the European Financial Stability Fund (EFSF) to recapitalize the Spanish banks and talk of a pan-European regulatory authority and deposit insurance.

The emerging banking model is one in which central governments and the money center banks co-exist in a mutual admiration society where government capitalizes the banks and the banks are the primary buyers of excessive government debt. Because government doesn’t create any real economic value (it regulates it and transfers it from one group to another), the domination of government assets on bank balance sheets in place of private sector assets spells real trouble for the future economic growth in the Western economies.

 
 
 
Robert Barone (Ph.D., Economics, Georgetown University) is a Principal of Universal Value
Advisors (UVA), Reno, NV, a Registered Investment Advisor. Dr. 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 Company where he chairs the Investment Committee.
 
Information cited has been compiled from various sources which UVA believes to be accurate and credible but makes no guarantee as to its accuracy. A more detailed description of the company, its management and practices is contained in its “Firm Brochure” (Form ADV, Part 2A) which may be obtained by contacting UVA at: 9222 Prototype Dr., Reno, NV 89521. Ph: (775) 284-7778.

June 6, 2012

Analysis: Little to like about last week’s employment data

Posted in Banking, Big Banks, Economic Growth, Economy, Europe, Housing Market, recession, Unemployment tagged , , , , , , , , , , , , , , , , at 5:31 PM by Robert Barone

Worse yet, the March and April Establishment Survey reports were revised downward by 49,000, not an insignificant revision. So, employment has been much weaker than originally indicated for the past three months. Further, we’ve recently seen an upward pop in the weekly first-time applications for unemployment insurance.
 
The more comprehensive unemployment rate (U-6, which is the broadest measure of labor-market slack) rose to 14.8%, from 14.5%. We are seeing employers substituting part-time workers for full-time workers — again, a negative indicator.
 
Average weekly earnings fell 0.2% in May because of fewer hours worked, on average. This indicator has fallen in two of the past three months and is a harbinger of what we are likely to see in second-quarter consumption spending.
 
Construction employment, while up slightly in the actual number count, was negative when seasonal adjustment is applied. May normally shows positive hiring in the industry, but this May, hiring was significantly below expectations, thus the negative seasonally adjusted number. I suspect this is because of housing markets still struggling with falling prices and excess inventory (Nevada, Arizona, Florida and parts of California). Additionally, we have recently seen a fall in the number of building permits.
 
Downward revision to first-quarter gross domestic product, to 1.9%, from 2.2%, was mainly because of a weaker consumer. Given this poor employment report, second-quarter real GDP might barely be positive in the official reporting.
 
I have written about downward bias flaws in the reporting of official inflation indexes. That means real inflation is higher than what is reported. Those who buy gasoline and food already know this. The implication is that official real GDP numbers are biased upward. Think about that! If inflation is only 2% higher than that officially reported, then the recession that “officially” ended three years ago might be ongoing.
 
None of the above speaks to the potential future shock that might hit the U.S. economy from the fallout of the European banking and debt crisis and the deep recession unfolding there. Any contagion from Europe will only compound the issues identified above.
 
The only silver lining is that weakening demand so evident in the reports has pushed oil prices down precipitously. Thus, we can expect some relief at the pumps this summer. Otherwise, the report was abysmal.
 
 
Robert Barone and Joshua Barone are Principals and Investment Advisor Representatives
of Universal Value Advisors, LLC, Reno, NV, an SEC Registered Investment Advisor.
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.
 
Universal Value 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 “Firm Brochure”, (Form ADV, Part 2A). A copy of this Brochure may be received by contacting the company at: 9222 Prototype Drive, Reno, NV 89521, Phone (775) 284-7778.
 
Robert Barone (Ph.D., Economics, Georgetown University) is a Principal of Universal Value
Advisors (UVA), Reno, NV, an SEC Registered Investment Advisor. Dr. 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 Company where he chairs the
Investment Committee.
 
Information cited has been compiled from various sources which UVA believes to be accurate and credible but makes no guarantee as to its accuracy. A more detailed description of the company, its management and practices is contained in its “Firm Brochure” (Form ADV, Part 2A) which may be obtained by contacting UVA at: 9222 Prototype Dr., Reno, NV 89521. Ph: (775) 284-7778.

May 24, 2012

Too Big to Fail: Four Years Later, Things Are Riskier Than Ever

Posted in Banking, Ben Bernanke, Big Banks, Europe, Federal Reserve, Finance, greece, investment banking, investments tagged , , , , , , , , , , , , , , , , , , , , , , at 7:58 PM by Robert Barone

The turmoil in Europe, trading losses at JPMorgan (JPM), and recent revelations about naked short-selling by Goldman Sachs (GS) and Bank of America-Merrill Lynch (BAC) should be giving every American and every policy maker heartburn because each and every one of these issues has potential to cause systemic financial shocks. It all ultimately comes down to the continuing saga of “Too Big to Fail,” or TBTF. TBTF nearly brought the financial system down in ’08 and ’09. It was supposed to be fixed by the Dodd-Frank legislation. But today, the TBTF institutions are even bigger than they were in ’08.

European Worries

On a daily basis, reports indicate that instability is growing in the European Monetary Union’s (or EMU) banking system. There have been outright runs on Greek institutions and rumored runs on Spanish banks. In Greece, it’s been reported that some businesses will not accept euro notes (i.e., the paper currency) issued by the Greek central bank for fear that if Greece leaves the EMU, those notes will be turned into new drachmas, which will be worth only a fraction of what real euros are worth.

In the US, the paper currency is issued by a Federal Reserve Bank. There is a number on each bill (1 to 12) that shows which Federal Reserve Bank was the issuer. Like the US, each participating central bank in the EMU can issue currency; the first letter of the serial number is coded to indicate which bank issued it. Currency issued by the Greek central bank is coded with a “Y.” Some Greeks are demanding currency coded with an “X” ( i.e., Germany).

There are growing worries about European bank solvency, and Moody’s recently downgraded a significant number of the larger Spanish and Italian banks. If Greece leaves the EMU, contagion could result. If funding markets for European banks freeze (causing one or several institutions to be unable to meet their daily liquidity requirements), there is a high probability that any contagion would spread to US financial institutions.

At the very least, the interrelationships between large US and European institutions will cause significant issues if a fat tail event occurs on the continent.

In fact, on March 21, Fed Chairman Bernanke warned Congress that the risks of impacts from such events on US banks and money market funds appeared to be significant.

Lack of Internal Controls at TBTF Institutions

On May 11, Jamie Dimon announced that JPMorgan had lost $2 billion or more in a failed “hedge” trade. Since then, the estimates of the loss have escalated; some think it could be as much as $5 billion – $7 billion. This shows that even the best-of-breed bankers, like Mr. Dimon, are unable to place sufficient internal controls over the riskiest of operations.

Over the past several years, we’ve seen such trading blow-ups at several of the TBTF institutions. The so-called “Volcker Rule,” a portion of the Dodd-Frank legislation that is supposedly effective this fall, should prevent “proprietary trading” at the TBTF institutions. But many think that such rules will be easy to get around; Mr. Dimon has indicated that this huge loss was due to a failed “hedge,” and not proprietary trading. JPMorgan had $182 billion in capital according to their March 31 filings, so the loss of a few billion isn’t going to put this institution in any danger or require any taxpayer assistance.

However, on the Monday after the JPMorgan announcement (May 14), President Obama appeared on ABC’s The View and commented that it was a good thing that JPMorgan had plenty of capital, noting that had this happened at a weaker bank, “[W]e could have had to step in.”

Think about this statement. The first reaction to stress in the financial system is for the government to step in! Compare that to the first Chrysler bailout in 1979. At that time, Lee Iacocca, Chrysler’s Chairman and CEO, had to beg Congress for nearly four months for a loan guarantee (not a direct loan) of $1.5 billion.

In fact, the day before Mr. Dimon announced JPMorgan’s large loss problem, the FDIC’s acting Chairman, Martin Gruenberg, announced plans and procedures for the FDIC to seize large financial institutions “when the next crisis brings a major financial firm to its knees.” Instead of getting rid of TBTF, it is now institutionalized. The FDIC’s announced plans are simply in accordance with Dodd-Frank.

During the week of May 14, the lawyers representing Goldman Sachs and Bank of America-Merrill Lynch in a lawsuit filed by Overstock.com filed an unredacted set of documents with the court (i.e., the whole document was submitted instead of only certain parts), thus putting them into the public domain.

Those documents revealed that these TBTF institutions knowingly ignored the laws and regulations against “naked” short-selling. When one sells “short,” one must first borrow the stock, or else there is nothing to prevent someone shorting (i.e., selling) so many shares as to significantly and negatively impact the market price for the stock (which is what a short-seller hopes for). “Naked” short-selling occurs when the stock is sold without borrowing it from another owner, and three business days later, the seller “fails” to deliver the stock.

Because of their size and power, the TBTF banks could depress the stock price of any company they choose. If one of their units puts a “sell” recommendation out and the trading department “naked” short-sells, then the “sell” recommendation becomes a self-fulfilling prophecy. This, in fact, is what Overstock.com’s lawsuit has been about.

So let’s review:

1. Bernanke worries that European bank insolvencies or liquidity issues may have significant systemic impacts on US financial institutions – if anyone knows, he should know.2. JPMorgan’s losses elicited a response from the US president about the immediate active role of government with regard to issues at the TBTF banks.3. The FDIC announced its policies, plans, and procedures to seize TBTF institutions when the next financial crisis occurs.

4. It has come to light that some TBTF institutions have skirted laws and regulations.

If there were no TBTF institutions in the US, then little of the above would be of concern. Instead:

1. While the European contagion would still be a worry, it wouldn’t be as much of a worry regarding its risk to our entire financial system because no one institution alone would be a systemic risk.2. The government shouldn’t ever have to “step in” if a bank failed. Sure, there would be market reaction and shareholders and bondholders would have consequences, but as long as the failed institution couldn’t cause systemic issues, there would be no need for government (taxpayer) involvement.3. The expensive and extensive policies and processes now being set up at FDIC would be unnecessary.

4. Without the power that comes with being TBTF, the “naked” short-selling and other abuses would be much less effective or profitable.

5. The TBTF institutions are so complex that even the likes of a Jamie Dimon can’t provide effective internal controls and risk management. Smaller institutions that have such issues won’t cause systemic risk.

The lessons of the ’08-’09 near systemic meltdown were clear: TBTF is a huge policy issue. Unfortunately, after Dodd-Frank, not only are TBTF institutions bigger and systemically more risky, but we now have a government all too willing, and maybe even eager, to “step in.”

 

Robert Barone and Joshua Barone are Principals and Investment Advisor Representatives of Universal Value Advisors, LLC, Reno, NV, an SEC Registered Investment Advisor.  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.
 
Universal Value 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 “Firm Brochure”, (Form ADV, Part 2A). A copy of this Brochure may be received by contacting the company at: 9222 Prototype Drive, Reno, NV 89521, Phone (775) 284-7778.

Robert Barone (Ph.D., Economics, Georgetown University) is a Principal of Universal Value Advisors (UVA), Reno, NV, an SEC Registered Investment Advisor. Dr. 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 Company where he chairs the
Investment Committee.

Information cited has been compiled from various sources which UVA believes to be accurate and credible but makes no guarantee as to its accuracy. A more detailed description of the company, its management and practices is contained in its “Firm Brochure” (Form ADV, Part 2A) which may be obtained by contacting UVA at: 9222 Prototype Dr., Reno, NV 89521. Ph: (775) 284-7778.

May 21, 2012

Rebellion Against Austerity From Greece To Washington

Posted in Economy, Europe, government, greece, investment banking, investments, QE3, recession, Uncategorized tagged , , , , , , , , , , , , , at 10:38 PM by Robert Barone

Since the initial euro crisis erupted in Greece two years ago, I have speculated that the necessary move toward austerity would be sidetracked by a political response from the impacted populations, which would elect leaders who promised a move away from such austerity. I didn’t realize how rapid and rabid the response would be.
 
The table below shows a list of headline anti-austerity movements, and, yes, I’ve included such movements in the U.S.
 
Country
Anti-Austerity Development
France The May 6th election of Hollande, a leader who promised more government spending, higher taxes and a reduction in the retirement age, at a time when budget deficits and austerity are key issues.
Greece Greek voters flocked to anti-austerity parties during the May 6th elections, stoking concern in Europe that austerity may be derailed.
Ireland Sentiment has turned sour on austerity with elections scheduled this spring.
Argentina Nationalization of Spanish owner Repsol’s (REP) 51% stake in YPF (YPF), a major oil producer.
Bolivia Seizure of Spanish power grid operator Red Electrica’s (REE.MC) 57% ownership of a Bolivian power line company which controlled 85% of the power lines in the country.
Spain Inability (or lack of determination) to meet promised austerity targets.
U.S. Political attack on the so-called wealthy and on cash rich corporations for not paying their “fair share” of taxes, in order to keep from having to cut spending.
 
Much of the backlash is occurring because governments can no longer fulfill the promises made, whether they be in transfer payments, services, or salaries and benefits, etc., due to shortfall of revenue and a remarkable growth in public debt burdens. As is clear now, it is one thing for politicians to talk about austerity, and another to live with the immediate consequences, often resulting in higher unemployment and recession.
 
Europe
 
Naturally, the hotbed of anti-austerity is Europe where they have long lived the entitlement life. Europe is clearly in recession, and it appears that it will be a long and deep one. The latest data from Europe shows that the Purchasing Managers’ Index (PMI) for March was 43.8 (where 50 is the line of demarcation between contraction and expansion). In Spain, now officially in recession, the PMI was 43.5, and in depression wracked Greece, it is 40.7. The manufacturing indexes in Europe are also contracting. The manufacturing PMI in France in March was 46.9, and even in mighty Germany, the manufacturing index was 46.2.
 
Spain’s unemployment rate is over 24%; Greece’s more than 21%. In Europe, the number of unemployed stands at 17.4 million, an increase of more than 1.7 million in the past year. The official unemployment rate in the European Union will soon surpass 11%. So, it isn’t any wonder that those politicians that have adopted the Robin Hood approach have gained populist support. After all, politics are politics – and populations used to entitlements naturally vote for candidates that promise to give them something, usually by taking it away from someone else.
 
When the European Central Bank (ECB) embarked upon its Long Term Refunding Operations (LTRO1 and LTRO2), which gave all European banks access to 1% money for 3 years in order to stave off a rapidly approaching financial crisis in those banks, there was an unwritten quid pro quo. The bargain was the liquidity to stave off the financial crisis, and, in return, the member countries would have to embark upon a path of fiscal reform–austerity–that is now being unwound.
 
The question is, will the ECB continue along this money printing path to stave off the next phase of the financial crisis if the member countries have shunned their part of the bargain? Or, will the new and emerging concept of a European “growth pact” give the ECB the political cover it needs to continue printing. I suspect the latter.
 
The concept of a “growth pact” is nothing new to Europe. Austerity in the ’90s morphed into the “Stability and Growth Pact” (SGP), and it appears to be doing so again. The idea is to have the economy “grow” so that tax collections rise and deficits are reduced. Who can oppose that idea? Unfortunately, there is little that the European governments can do pro-actively to spur such growth.
 
The best thing would be to get out of the way of the private sector, but such ideas are anathema. Nevertheless, the Keynesian hope is that more deficit stimulus and more money printing with less austerity will prove to be the cure. I doubt this approach will be anything more than further can kicking. Furthermore, it is a dangerous game, especially in the hands of politicians, because even the “growth pact” still demands discipline in the budget and spending process.
 
In Greece, no government has been formed from the May 6th election results which pits polar opposite political views among the highest vote getters. The leader of the party with the second most votes ran on a platform to renege on the austerity agreements already in place with the external financing partners, to raise public pension payments and salaries, etc. And that leader seems to have gained even more popularity for the upcoming June elections. At current spending rates, Greece will run out of funds to pay its obligations by the end of June. And, it will be up to the Troika (European Commission, European Central Bank, and International Monetary Fund) to determine if Greece will get its next tranche of external financing (i.e., loans).
 
It appears that Europe is moving perilously closer to financial chaos. A Greek default on its external debt could easily result in a disorderly withdrawal from the EMU (European Monetary Union), which could trigger worldwide financial instability. Imagine if you were a Greek citizen and you woke up one morning to find that the euros in your local bank had been converted to new drachmas on a 1:1 basis. Later that day you discover that your new drachmas are worth substantially less than the euros you had yesterday. People aren’t dumb. Over the past few months, we have observed, through the borrowings at the ECB, a growing silent run on European banks in the at-risk countries (Spain, Italy). Italy even limited the amount of cash a bank can give its clients. And now, there is an outright run on Greek Banks.A Greek dismissal or withdrawal from the EMU along with its default on external debt is likely to trigger massive outright runs on Spanish, Italian and other weak European banks. The domino effects of this are unknown – all the way from other weak EMU partners electing the Greek path to a complete implosion of the EMU. The impacts will be worldwide. Expect volatility in markets and significant U.S. dollar strength.

 
The Americas
 
The U.S. isn’t too far behind Europe in the entitlement game as it has caught up rapidly over the past decade. But, in the U.S., the anti-austerity movement has taken a slightly different track. The ploy here is to avoid the basic issue of federal government overspending, over indebtedness and over promises. So, the greedy and evil corporations, which “evade” just and fair taxes, are blamed for the deficit because they refuse to pay their “fair share.” And those same corporations that “hoard” cash are responsible for lack of job growth because they won’t spend and invest those cash hoards.
 
The simple truth is that Apple (AAPL), Microsoft (MSFT), Wal-Mart (WMT), and all of the others are simply playing the tax game that was written and is orchestrated by none other than the politicians themselves. In what remains of our capitalist system, corporate managers are supposed to maximize profits, and one doesn’t do that without uncovering every dollar-saving loophole written into the tax code.
 
As for the cash, much of it remains offshore because it would be taxed if brought back. But it remains unused because of the ongoing uncertainties today’s politicians have imposed. No tax law is now permanent or at least has a long enough life for corporate managers to make prudent investment decisions. Most have a one or two year life (Bush tax cut extensions, payroll tax reduction, depreciation laws, etc.). Without some certainty about the tax code, about deficits, or about the cost of energy, those cash hoards simply won’t be invested – at least not in the U.S or other slow growth industrial countries.
 
This rhetoric is really a diversion from the real issue of too much debt, unsustainable deficits, and living beyond our means. The size of government is being addressed at most state and local levels (even by Jerry Brown in California, but definitely not at the federal level.
 
Unfortunately, the movement away from austerity either prolongs the crisis, or makes it ultimately worse. In Bolivia, the series of nationalizations that began in ’06 (natural gas fields) are now causing capital formation issues. The gas wells are producing less, as is the normal course for such wells, but there is no internal capital for new exploration (all the capital that could, fled long ago), and foreign capital simply won’t go there based upon the last six years of political behavior and private sector confiscation (besides Bolivia, the other Latin American countries with extreme left wing governments are Venezuela, Argentina, Ecuador, and Nicaragua).
 
As is evident in places like Bolivia and Venezuela, the move away from austerity via class warfare, confiscation, and nationalizations only prolongs the economic problems, usually making them far worse than the original austerity would have imposed.
 
Conclusion
 
The point is, “taxing the rich,” attacking successful corporations, nationalizing industries, or simply allowing government to pick the winners and the losers does nothing to create economic growth or jobs. It does just the opposite. Austerity, in some form, is necessary to pay back the over borrowing and over consuming of the past. There is no way around it.
 
Printing more money, running high deficits and taxing the productive members of society will not fix the growth and jobs issues. Rejecting the necessary austerity will just exacerbate the problem(s) or shift the burdens to other unsuspecting citizens, like seniors, retirees, or onto future generations through high or hyper inflation.
 
Erskine Bowles, a Democrat, co-chair of President Obama’s Commission on Fiscal Responsibility and Reform, and co-author of the Simpson-Bowles fiscal plan said this to the Council on Foreign Relations on April 24th:
 
Without serious debt reduction, it won’t take much of an increase in interest rates to create a fiscal crisis for the country the likes of which only those who lived through the Great Depression can recall. Once interest rates reach a level that reflects the genuine risk inherent in our ongoing fiscal mismanagement, and debt service eats up more and more of a shrinking pie, the financial crisis we just lived through (and are still living through) will seem like a sideshow… Deficits are truly like a cancer and over time they are going to destroy our country from within.
 
Most industrial countries with large fiscal deficits have a choice between something bad (austerity now) and something awful (high inflation, hyperinflation, social upheaval, or worse). While no one likes austerity, the consequences of choosing to kick the can further down the road are much worse. Yet, that is clearly what is happening with likely dire financial consequences, perhaps as soon as Greece formally defaults. Nonetheless, at this particular moment, “austerity” has become just another dirty word.
 
Robert Barone and Joshua Barone are Principals and Investment Advisor Representatives of Universal Value Advisors, LLC, Reno, NV, an SEC Registered Investment Advisor.  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.
 
Universal Value 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 “Firm Brochure”, (Form ADV, Part 2A). A copy of this Brochure may be received by contacting the company at: 9222 Prototype Drive, Reno, NV 89521, Phone (775) 284-7778.Robert Barone (Ph.D., Economics, Georgetown University) is a Principal of Universal Value Advisors (UVA), Reno, NV, an SEC Registered Investment Advisor. Dr. 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 Company where he chairs the Investment Committee.

Information cited has been compiled from various sources which UVA believes to be accurate and credible but makes no guarantee as to its accuracy. A more detailed description of the company, its management and practices is contained in its “Firm Brochure” (Form ADV, Part 2A) which may be obtained by contacting UVA at: 9222 Prototype Dr., Reno, NV 89521. Ph: (775) 284-7778.

May 8, 2012

Chained-CPI is not an accurate deflation gauge

Posted in Ben Bernanke, Economy, Federal Reserve, Finance, government, Housing Market, IRS, medicare/medicaid, social security tagged , , , , , , , , , at 5:09 PM by Robert Barone

Circulating around the Beltway is a concept called Chained-Consumer Price Index (Chained-CPI). It is being billed as a new and “more accurate” way to measure the rate of inflation.In an April 25th article, the editors of Bloomberg View stated that the Chained-CPI “is a more accurate gauge of U.S. inflation that would yield immediate savings … The fix to this has already been endorsed by lawmakers in both parties, the Obama administration, many economists, and a series of bipartisan deficit-reduction panels.”According to Bloomberg View, the Chained-CPI is “a more exact measure that accounts for the substitutions consumers make when a product’s price goes up.” Remember this substitution concept, for, as you will see, it is the problem not the solution.
 
Currently, the most popular measure of inflation is the Consumer Price Index. The Bureau of Labor Statistics (BLS) produces several CPI measures monthly, but the one that makes the headlines is called CPI-U. In theory, CPI-U represents the buying patterns of all urban consumers.

This CPI measure is the “benchmark” that determines cost-of-living adjustments (COLAs) for a wide range of government programs, including Social Security, Medicare and government pensions. It is also widely used by the IRS in the tax code, in union contracts and in most long-term rental agreements.

The reality is that, like much of what comes out of Washington, the “Chained-CPI” concept is neither new nor more accurate. This chain-weighted concept is just another step in a series of steps that began in 1980 aimed at changing the CPI concept from one that measures the cost of maintaining “a constant standard of living” to measuring, really, not much at all, as I will explain later. The real purpose of altering the methodology is twofold: 1. To reduce the reported increase in inflation for political reasons; and 2. To lower future federal budget costs of Social Security, Medicare and government pensions by lowering the COLA adjustments without having to haveCongress vote for those or the administration sign it into law. Just note, however, what class bears the biggest burden of this – seniors and retirees.

The CPI rate of inflation reported for the year 2011 was approximately 3 percent. That was higher than what appears to be “tolerable” for America’s political class. But, we have a fairly recent concept called “core” CPI, which is the CPI-U excluding food and energy.

Both Fed chief Bernanke and Treasury Secretary Geithner believe that this is a better measure of “underlying” inflation. Apparently, they don’t believe that Americans are much impacted by the cost of petroleum products or food. I promise, however, that when the “core” CPI is higher than the CPI itself, “core” will be ignored!

If the methodology for computing the CPI-U were the same formula that was used in 1980, then the 3 percent rate of inflation reported for 2011 would have been closer to 11 percent, according to John Williams of Shadowstats.com, who follows this indicator in detail.  In 1980, the CPI measured a “standard of living,” with the price index telling us how many dollars more it would take to buy the exact same basket of items we bought in a prior period, say, last year. Below is a simple example using two goods: T-bone steaks and hamburger.

 

Weight (W)

Price (P)

W x P

T-Bone

50%

$10.00

$5.00

Hamburger

50%

$3.00

$1.50

   Index

 

 

$6.50

The table shows that the consumer has chosen, at current prices, to spend 50 percent of his/her budget on each item. The weighted index is $6.50. Now, assume that the price of T-bone steak rises to $12 while hamburger rises to $3.25. The table below shows that the weighted index would be $7.625.

 

Weight (W)

Price (P)

W x P

T-Bone

50%

$12.00

$6.000

Hamburger

50%

$3.25

$1.625

   Index

 

 

$7.625

That is, it now takes $7.625 to purchase what $6.50 used to purchase. What that says is that to maintain the “standard of living” that $6.50 used to buy now takes $7.625. So, prices have risen (i.e. inflation) by 17.3 percent [(7.625-6.5)/6.5].

We all know that when prices change, and especially if incomes are not rising as fast as prices, consumers substitute lower cost goods that usually are of lower quality. When that happens, the “standard of living” is clearly falling. The following is an example of how the Chained-CPI would significantly lower the reported inflation rate.

The table shows the same two goods, but because incomes have not risen, consumers have cut back T-bone steak to 40 percent of their budget and increased hamburger to 60 percent. As shown in the following table, the weighted index is $6.75 and the resulting reported rate of inflation is 3.8 percent [(6.75-6.50)/6.50)] rather than the 17.3 percent rate associated with maintaining a defined “standard of living” (i.e. 50 percent T-bone and 50 percent hamburger).

 

Weight (W)

Price (P)

W x P

T-Bone

40%

$12.00

$4.80

Hamburger

60%

$3.25

$1.95

   Index

 

 

$6.75

U.S. consumers already know that their living standard is being eroded, and that the reported rate of inflation understates reality. This has been the explanation of why. And, clearly, the “Chained-CPI” is not a “more accurate” gauge of inflation.

If you think about it, the two weighted average costs using different weights are not really comparable at all. What would you say if consumers had to substitute canned dog food for hamburger? Would you think the measure of inflation meant anything? The 3.8 percent is a math result, the product of numbers in a formula. But the numbers being used in the calculation measure different things and are not comparable. The result is that the Chained-CPI doesn’t really measure anything.

Nevertheless, the coming use of the Chained-CPI will allow reporting of much lower rates of inflation than is the reality, reducing Social Security, Medicare and government pension COLAs, all without any action on the part of Congress or the administration.

It also will distort to the upside the reporting of other economic activity where nominal” (i.e. current dollar) indicators, such as GDP, are translated into “real” terms by deflating them with an artificially low measure of inflation.

As I’ve said in many past blogs, much of the recession is being carried on the backs of those living on fixed incomes, savers, those living off of accumulated assets and retirees. Not only do they now get near 0 percent on their savings, but now they will be further cheated out of part of the COLA adjustments that would keep them at their current living standard via their Social Security, Medicare and, if a government retiree, pension. Isn’t it wonderful how government works?

April 24, 2012

After further review, employment remains unhealthy

Posted in Economic Growth, Economy, Federal Reserve, Finance, investment advisor, investment banking, investments, recession, Uncategorized, Unemployment tagged , , , , , , , , , , , , , , , , , , , , at 3:40 PM by Robert Barone

 Most of the business media is content to rehash headline data, simply passing on what the large wire services report with no further analysis. The headline, then, becomes the “conventional wisdom.”

Such was the case on the first Friday of April with the reporting of the unemployment rate. The conventional wisdoom was that there was some disappointment in that, using the Establishment Survey of the Bureau of Labor Statistics (BLS), the nation only created 120,000 new jobs. But the unemployment rate itself sank to 8.2 percent. For that we should be grateful, at least according to the conventional wisdom.
 
The accompanying chart tells quite a different story. It is a long-term chart. The period measured (horizontal axis) begins in 1988, so it covers about a quarter of a century. The right hand vertical axis measures the “headline” unemployment rate. That’s the headline rate most often reported. In government jargon, it is known as the U-3.
 
The scale is inverted, so a rising line means the unemployment rate is falling. This unemployment rate is supposed to measure the number of people looking for work who can’t find it as a percentage of all people with and without jobs. The left hand scale is a measure of the employment rate in its most basic form. Most readers won’t recognize this, as it is seldom reported, but it measures the number of people employed as a percentage of the population. As such, it is a better measure of the job market in that, unlike the unemployment rate, its definition can’t be changed (more on that later).
 
Looking at the chart, note that in the late 1980s, 63 percent of the population was employed. This rose to nearly 65 percent at the turn of the century. After falling to 62 percent in the 2001-02 recession, it rose back to 63 percent in 2007. Since the Great Recession, this measure of employment has been bottom bouncing just above 58 percent.
 
But what is really noticeable is the huge divergence between the two since 2010. The question to be asked is, “How can the ’employment rate’ show little to no improvement, while the ‘unemployment rate’ would lead one to conclude something altogether different?” The answer lies in how things are defined.
 
In 1994, BLS redefined the term ‘discouraged worker.’ This person was counted as unemployed only if he or she had been ‘discouraged’ for less than a year. After that, he or she was longer counted as ‘looking for work.’ Today, with jobs so hard to find, we clearly have many people who have been out of work for more than a year but are still actively seeking employment. Our social safety net even recognizes jobs are hard to find – unemployment insurance payments are available for 99 weeks. But our measurement of “unemployment” stops counting people as unemployed or even looking for work after 52 weeks. They are simply defined away! This goes a long way toward explaining the increasing discrepancy between the two series.
 
This past weekend, I made an off-the-cuff observation to my wife as we visited a fast food establishment with the grandchildren in tow. I noted employees seemed to be a lot older than what I remembered from a few years back. In recent blogs, both David Rosenberg (Gluskin Sheff) and John Hussman (Hussman Funds) wrote about the changes in the distribution of job creation since the end of the recession in June 2009. According to the Federal Reserve Bank of St. Louis, total employment in non-agricultural industries (seasonally adjusted) has grown 2.15 million since that time. For workers 55 and older, employment has grown by 2.98 million.
 
That means that employment has continued to contract for those under 55 years of age since the recession’s so-called end! How can that be healthy?
 
There is a term business media uses called “financial repression.” Essentially, it refers to the zero interest rate environment in which savers and retirees are no longer able to live off the interest on assets they accumulated prior to retirement. So they re-enter the labor force, working for minimum wages to supplement now inadequate retirement incomes.
 
The employment picture, then, when viewed from this lens, is much worse than the headline data and conventional wisdom would have you believe. I don’t think this is a surprise to most Americans, but it would certainly help if the business media stopped pretending.
 
Robert Barone and Joshua Barone are Principals and Investment Advisor Representatives of Universal Value Advisors, LLC, Reno, NV, an SEC Registered Investment Advisor.   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.
 
Universal Value 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 “Firm Brochure”, (Form ADV, Part 2A). A copy of this Brochure may be received by contacting the company at: 9222 Prototype Drive, Reno, NV 89521, Phone (775) 284-7778.
 
Robert Barone (Ph.D., Economics, Georgetown University) is a Principal of Universal Value Advisors (UVA), Reno, NV, an SEC Registered Investment Advisor. Dr. 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 Company where he chairs the Investment Committee.
 
Information cited has been compiled from various sources which UVA believes to be accurate and credible but makes no guarantee as to its accuracy. A more detailed description of the company, its management and practices is contained in its “Firm Brochure” (Form ADV, Part 2A) which may be obtained by contacting UVA at: 9222 Prototype Dr., Reno, NV 89521. Ph: (775) 284-7778.

March 26, 2012

Robert Barone: Is U.S. housing healing?

Posted in Banking, Big Banks, debt, Economic Growth, Economy, Finance, Foreclosure, government, Housing Market, investment advisor, investment banking, investments, Nevada, recession, Uncategorized tagged , , , , , , , , , , , , , , , , , , , at 5:15 PM by Robert Barone

Last Tuesday, a headline in the business media read: “U.S. housing heals as starts near three-year high.”
I scratched my head. The last three years have been the worst in recorded U.S. housing history. The accompanying chart tells the story. It is a real stretch to believe that this data indicates “healing.” Worse, everybody knows that the extremely mild winter has pulled demand forward; this is especially true for housing starts, as contractors don’t pour foundations in freezing weather, but use mild periods in the winter to get a head start for spring sales.
The data shown in this chart is “seasonally adjusted,” a statistical process that attempts to normalize fluctuations in data caused by such things as weather or holiday shopping. The seasonal adjustment process assumes January and February have typical winter weather. So, if the mild winter caused contractors to pour more foundations than they would have in a normal winter, then the seasonal adjustment process overstates what would be a normalized level of housing starts.
There is a similar story for sales of existing homes — the data was released last Wednesday. Because of the weather and other significant issues, I suspect that new starts and sales (where the “seasonal factors” normalize to the downside) will disappoint in the months ahead. Here’s why:
There are 3 important price categories: less than $300,000; $300,000 to $800,000; $800,000 and above.
There are three important buying groups: first-timers; move-ups; retirees. Generally, the first-timers purchase the under $300,000 homes, while the move-ups purchase in the other two categories. Retirees, usually sell from the upper two categories and “downsize.”
Government stimulus programs and record low interest rates have made homes the most affordable in decades (current index = 206; 100 means that a median income family can afford a median income home). First-time buyers can get a low down payment low interest rate loan (what happens if interest rates rise?), but those in the move-up category must rely on traditional bank-type financing, which requires a big down payment.
The home price downdraft since 2007 has taken many of the move-up buyers out of the market. CoreLogic data shows that 50 percent of current U.S. homeowners (the move-ups and the retirees) have less than 20 percent equity in their homes. That means that a significant percentage of move-ups cannot sell their existing home, pay a realtor’s commission (usually 6 percent), and have a 20 percent down payment for the move-up property.
History shows a healthy housing sector is critical to U.S. economic growth, and that when the move-ups are not healthy the sector does poorly.
Retirees are finding their homes are not worth what they thought. Their tendency is to stay put and wait for a better market. In fact, the media hype around “healing” is probably keeping them in their homes, as they now believe that a better market is just ahead! This is called “shadow” inventory, which means that the number of homes officially for sale understates the real supply.
With this view, we would expect the low-priced homes to be doing well but the upper two price brackets to be doing poorly. February data from Dataquick for the Southern California housing market confirms this view. First-time buyer price point sales (under $300,000) are up 9.5 percent from a year earlier, while the other two price point sales are both down (the $300,000 to $800,000 down by .8 percent, and the $800,000 and above down by 12.6 percent).
Nothing in this data, from the seasonal adjustment bias to the health of two of the three buying groups, tells me U.S. housing is healing.

March 15, 2012

Markets Hooked On Liquidity Drug From Central Bank Pushers

Posted in Banking, Ben Bernanke, CDS, Economy, Europe, Federal Reserve, Finance, Foreign, government, investment banking, investments, ISDA, QE3, recession, sovereign debt, Uncategorized tagged , , , , , , , , , , , , , , , , , , , , , , , at 10:04 PM by Robert Barone

From early last October to the end of last month, the S&P 500 rose 25%; amazing for an economy that is struggling to stay out of recession.  Then again, the equity markets are hooked on the liquidity drug.

When Federal Reserve Chairman Ben Bernanke, in his recent semi-annual testimony before Congress, did not hint that QE3 was just around the corner, the market sold off.  When the European Central Bank broke its traditional role as lender of last resort and morphed into a gift giver to its member banks (to the tune of more than a trillion dollars), much like our Fed, the equity markets soared.

Money printing can’t go on forever, can it?

In every historical context, whenever the equity markets have a run up not based on economic fundamentals, eventually, they return to what those fundamentals dictate.  And here are some of the underlying economics:

  • There is no doubt that American manufacturing is undergoing a renaissance.  Labor costs in Asia are on a steep rise while wages here have been stagnant for several years.  Shipping costs, quality control and culture are other factors.  But, manufacturing represents less than 12% of GDP.  It, alone, cannot drive significant economic growth.
  • Gasoline prices are up more than $.60/gallon year to date with talk of $4.50 gas by summer. That cost/gallon is already here in some markets. Every penny increase drains $1.5 billion annually from other consumer discretionary spending.  That’s about $90 billion so far for 2012.  And what happens to gas prices if the Middle East flares up again?
  • While the first quarter is far from over, early data suggest a much softer than expected GDP.  Retail sales have been soft except for automobiles (pent-up demand or just a rush to buy fuel efficient vehicles ?).  Consumers (70% of GDP) have shown no real income growth for many quarters, and incomes are tumbling in Europe.  Inventories appear to be on the high side given the level of demand.  So additional production won’t be forthcoming.
  • Despite a reinstitution of 100% depreciation for capital equipment, much of that demand was pulled into 2011, as the business community was uncertain as to whether or not the tax break was going to be reinstated in 2012.    The state and local government sector is still in contraction, and, given the slowdown evident in the rest of the world, exports aren’t likely to add to GDP.  Of course, the market may like the softer side of GDP, as it likely ensures another dose of the liquidity drug from the money czar, Bernanke, the king of money printing.
  • Europe is sicker than the markets have priced in.  The hoopla around the Greek bailout is just another can kicking.  Because the Greek populace hasn’t accepted the idea that they have lived beyond their means for the past decade, austerity won’t be successful.  Politicians who promise to end the austerity are likely to be elected.  Eventually, Greece will need to have their own currency which can fluctuate in value vis a vis other currencies with commensurate interest rate levels.
  • It is rare that all of Europe is in recession at the same time.  The current market expectation is that Europe’s recession will be mild.  But, don’t forget, Germany’s biggest export clients are other European countries.  In fact, as a general rule, all of Europe’s economies export heavily to each other.  Being in recession together is going to have a large impact on those exports.  In addition, if the Euro remains at its current lofty level (above $1.30), it will be more difficult to export to non-EU countries.
  • The determination by the ISDA (International Swaps and Derivatives Association) that Greece officially defaulted on its debt when it invoked its recent legislatively passed “Collective Action Clause” to force investors to take losses is actually good news for the other so-called troubled European sovereigns (Portugal, Spain, Italy, Ireland) because it assures private sector investors that if they buy the so-called troubled foreign sovereign bonds, hedge them with Credit Default Swaps (CDS) and a Greek style default occurs, they will be paid at or near par value.  If the CDS payout had not been triggered, the private sector investors would view the purchase of such sovereign debt as having significantly more risk, and that would result in a much higher interest cost of that sovereign debt to the issuing countries.  In addition, it would throw the whole CDS concept into confusion, potentially impacting even the higher quality sovereigns like, Germany, the U.K., Canada, Australia, and even the U.S.
  • This is not to say that the world is now safe from financial contagion, as, in the context of world markets, Greece’s default is an expected and well prepared for event. The real worry should be if Spain (debt > $1 trillion) and/or Italy (debt> $2 trillion) default.  In addition, the CDS market is not transparent, and no one knows where the CDS obligations lie.  While a Portuguese and/or Irish default would have about the same individual impact as that of Greece (economies slightly smaller and not as indebted), we should worry that a rolling set of smaller defaults would eventually cause a major CDS insurer to fail due to the cumulative impact of the several defaults.  After all, it is likely that the CDS insurers who dabbled in Greek CDS, are also involved in CDS insurance of the other high debt European countries.  And, if a significant CDS insurer defaults (e.g., an institution similar in size and stature to AIG in 2009), we could, indeed, have contagion.
  • But even ignoring Greece for the short term, the ECB’s LTRO 1 and 2 appear to make Europe’s banks even more vulnerable.  Unlike the Fed, which purchased questionable assets from bank balance sheets and put them on its own, the ECB has not followed suit.  In fact, it stepped in and, by force majeure, inserted itself as senior to other bondholders holding the exact same Greek bonds, thus avoiding any losses in its own portfolio.  That makes losses for the private sector even greater.  Worse, it sours potential investors in European sovereign debt, seeing that they cannot easily quantify their risks as they can’t know how much of the same sovereign debt they own may be owned by the ECB.  This partially reverses the positive impact that the triggering of the CDS default will have on the European sovereign debt market.
  • Finally, the LTROs may make European banks even more insolvent than they are now, as they have been encouraged to take the cheap ECB funding and purchase European sovereigns for the interest spread (by Basle II and III rules, the debt of the European sovereigns is “riskless” and requires no capital backing on a bank’s balance sheet)!  Further sovereign debt crises, e.g., Portugal, Spain, or Italy, will eat away at already scarce European bank capital.  Contagion could very well result.

Looking at the GDP of Europe relative to China, if one includes all of the European Union countries and those closely related, Europe’s economy is about twice the size of China.  If China’s GDP growth went from 9% to 3%, the equity markets would certainly have a huge sell off.  But, it is likely that Europe’s GDP will fall from about 1.5% in 2011 to -1.5% in 2012, maybe even more than that.  Do the math!  This is equivalent to a Chinese hard landing.  As the European recession unfolds, the equity markets are likely to wake up.

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Speaking of China, a slowdown is clearly developing.  They actually ran a trade deficit for the first two months of 2012 signaling a real slowdown in exports.  Retail sales have been softer than expected and the real estate bubble there appears to be in the process of popping as property sales and prices are plunging.  No wonder the government recently lowered its official growth forecast from 8% to 7.5%.  This is not to say that China, itself, is entering a recession, but a slower growth rate there (2nd largest economy) in combination with growth issues in the US (largest economy), Japan (3rd largest), and a significant recession in Europe bodes ill for worldwide growth and will eventually play out in the equity markets.

The profit implications for multinational corporations of the severe recession in Europe, and a slowdown in China and elsewhere are significant.  Analysts have continued to forecast rapid earnings growth and high profit margins even in the face of rising energy and food costs and stagnant U.S. and falling European incomes.  Using such rosy profit forecasts makes the market look undervalued.  However, a 15% – 20% profit decline is normal for a recessionary world.  If you plug that in, the equity markets look overvalued today.

Wasn’t it somewhere around this time last year that the equity markets were also priced for perfection?  Didn’t we hear that the economy had achieved “escape” velocity and that the recovery was about to accelerate?  And, didn’t the market sink when the economy fizzled and needed the QE2 liquidity drug injection?  In fact, the S&P 500 ended 2011 at exactly the point where it began, with a lot of volatility in between.  So far, 2012 appears to be following 2011′s path.

Robert Barone and Joshua Barone are Principals and Investment Advisor Representatives of Universal Value Advisors, LLC, Reno, NV, an SEC Registered Investment Advisor.

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.

Universal Value 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 “Firm Brochure”, (Form ADV, Part 2A). A copy of this Brochure may be received by contacting the company at: 9222 Prototype Drive, Reno, NV 89521, Phone (775) 284-7778.

Robert Barone (Ph.D., Economics, GeorgetownUniversity) is a Principal of Universal Value Advisors (UVA),Reno,NV, an SEC Registered Investment Advisor.  Dr. 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 Company where he chairs the Investment Committee. 

Information cited has been compiled from various sources which UVA believes to be accurate and credible but makes no guarantee as to its accuracy.  A more detailed description of the company, its management and practices is contained in its “Firm Brochure” (Form ADV, Part 2A) which may be obtained by contacting UVA at:9222 Prototype Dr.,Reno,NV 89521.  Ph: (775) 284-7778.

 

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